The Irish Times - Fiona Reddan
It’s not a particularly onerous task. You just open the envelope and read through the less than weighty document within, or use your log-in details to do the same online. Yet how many of us can put our hands up and say that we unfailingly peruse this information rather than leaving our annual pension statement gather dust somewhere or remain in our inbox unopened?
As part of our series aimed at helping you get your finances in shape at the start of the year, this week we’re looking at how you can appropriately prepare for your retirement by considering your pension on an annual basis.
In this guide to understanding your annual pension statement, which is primarily aimed at those in defined contribution (DC) schemes, we’ll help you take stock of where you are – and what actions you should be taking to get you to where you want to be. And before you despair that reviewing your pension is just too much like hard work, take some advice from Mairead O’Mahony, DC leader for Ireland with Mercer.
“Those getting statements are the lucky ones – lots of people aren’t getting them because they don’t have a pension,” she says.
And it shouldn’t be too difficult a task.
“If you look at just one or two sections in it you’ll get the bulk of the conclusions you need,” says O’Mahony, noting that most statements can be broken down into three sections: factual information; projection information; and investment information. It’s the last two that will typically be of most interest.
It’s one thing to be pleased when you learn that your pension fund advanced by 10 per cent in a year; it’s quite another however to take this as meaning that your income in retirement will be secure.
Indeed before you even open your annual statement, you should first spend some time figuring out your own goals for retirement. Otherwise it’s difficult to know if you’re on target or not.
“There is little point in looking at anything without knowing what I want to achieve; it’s data rather than information,” says John Tuohy, chief executive of pension advisers Acuvest, adding, “The first thing is to stand back and think ‘what is my savings target’.”
At a minimum, you will probably want to retire on 50 per cent of your income. So, for example, if you’re earning €48,000 you will try to get to a figure that would produce income of €24,000 a year. Bearing in mind you may get roughly €12,000 for the State pension, the remaining €12,000 will have to come from savings.
“So you have to ask yourself, ‘how much capital do I need to produce that type of income?’” says Tuohy.
In the aforementioned example, a person would need a pension pot of at least €300,000 to produce such an income.
With a goal in sight, you’re now in a position to open your statement. And the first place you should look is the “statement of reasonable projection”.
“The most important part is the projection; this is the piece that’s going to be your call to action as it will tell you what income your current pot, plus future contributions, will generate,” says O’Mahony, adding that most savers will see “a significant shortfall” in this projection.
Indeed a survey from Mercer indicates that those aged between 35-45 can on average expect income replacement of 22 per cent in retirement.
“It’s just not enough for most people,” says O’Mahony.
As the graphic (above) shows, a contribution of €200 a month will generate a pension of just €5,620.99 a year, based on an investment return of 5.1 per cent. If your target is €12,000 a year, this means you have a shortfall of 54 per cent.
Indeed to get a retirement income of about half your salary, Tuohy suggests that you need to be saving “at least 15 per cent and ideally 20 per cent of salary”. So, a salary of €48,000 means that between €600-€800 should be going into your pension fund each month.
Of course if you’re in an occupational scheme, the good news is that this 15-20 per cent won’t all come from you.
A typical employer contribution is of the order of 6-7 per cent, while Tuohy notes that “some employers contribute considerably more”. In addition, you get tax relief on your contributions which means that a €400 payment from yourself will only cost you €236.
To help you achieve your goal, check whether or not you’re leaving any employer contributions on the table, as some will match contributions up to a certain proportion of salary – and you may not be hitting this ceiling.
Additional voluntary contributions (AVCs) is another way of boosting your contributions, if, of course, you can afford it. But remember to approach this projection with an element of caution.
“The projection is a number to start with, but it’s by no means the income you’ll end up with, but it’s a place to start,” says O’Mahony
“The big caveat is that this is nothing more than a projection,” says Tuohy, noting that while some pension providers may provide a projection based on just one investment outcome, “a better one would show you a range of outcomes as single point estimates are difficult”.
You’ll typically find the assumptions your projection is based on an investment return of between 4-6 per cent, and this should be detailed either at the back of the document or as a footnote to the projections section.
Once you’ve worked out whether or not your overall fund is on target, the next step is to consider how well your chosen investments are performing.
According to O’Mahony, over the first 20 years of pension saving, contributions are the most important; but in the second half investment returns become more important. So, if you’re in your forties or fifties, it’s critical that you pay close attention to this.
“We would certainly encourage those approaching retirement to dig a bit deeper and find out what they’re invested in – does their fund automatically derisk, for example, as they approach retirement,” she says, adding that it’s also important to ensure you’re in the right fund that will match your retirement plans – ie will you take an annuity or invest in an approved retirement fund (ARF) when you hit retirement age.
“In your fifties you need to start thinking about that,” she says.
Typically, most DC members either opt – or are defaulted into – the so-called default fund. “We’d see about 80-90 per cent of people end up in default,” says O’Mahony, noting that while it may be a “one size fits all” type fund, it doesn’t mean that it may not be right for most people.
“Trustees have really recognised that most people end up in default, so they’re focusing a huge amount of time in getting it right,” she says.
Your statement will show you the breakdown of your investments and where your money is being invested. However, what I think is unusual is that it won’t clearly show how these investments have performed.
Rather it may show you the total value of your pension fund at the end of the previous year, and its current value now, so it’s up to you to work out whether or not your pension is growing or falling. While these figures will clearly show the overall direction of your investments, it will take some additional work to figure out what’s behind the growth/decline.
“To find out more about the performance of those funds you’ll have go to the administrator or go online,” says O’Mahony, noting that this performance is also detailed in the fund’s annual report.
There is also an absence of benchmarking, so not only are you unaware as to the performance of your individual investments, you are also not aware of how your fund has performed in the context of overall market performance.
But when should you take action?
“While this year’s statement should show your pension to be very much heading in the right direction, thanks to strong markets in 2014, a decline may not require action.
“You should consider it as a long-term investment; where members are tempted to make regular changes in response to market movements we would caution against that,” says O’Mahony, noting that in the period following the financial crash of 2008-2009, many members moved out of equity-oriented funds into cash.
“They couldn’t withstand any further deterioration in investment performance. But the markets rebounded strongly after that period so they suffered the full extent of the downfall but didn’t participate in its recovery,” she says.
Something else you might like to think about is while the move from defined benefit to DC schemes means that the onus is increasingly on the individual, an individual’s ultimate pension is still dependent on a certain extent on the trustees guiding the scheme. “You’re relying on the trustees of the scheme – that they have the best funds and providers there,” says Tuohy.
If you’re not happy with the performance of your funds, you can go discuss it with your trustees.
This is another tricky area, as fees may not be overtly disclosed in your statement. However, as a member of a DC scheme or PRSA, you should find how charges impact your pension in your “statement of reasonable projection”. And it’s worth reading carefully as it’s difficult to overstate the impact fees and charges can ultimately have on the income you can expect in retirement.
Let’s consider an example provided by the Pensions Authority. Contributions of €300 a month over a 20-year period, based on returns of 6 per cent a year, could result in a pension fund worth €136,700. However, fees and charges can significantly reduce this. A charge of €10 per member per month for example, will reduce your fund by 3.3 per cent, down to €132,100; a 5 per cent charge on contributions will see your fund fall by 5 per cent to €129,900; while an annual management charge of 1 per cent – which in itself would not appear to be excessive – is the most onerous of all, as it depletes your fund by 10 per cent, or €14,500.
Again though, learning that you’re paying 1.5 per cent a year on your fund may not be very helpful if you can’t compare it with other pension schemes.
“Telling me what the costs are relative to what could be achievable for a scheme of our size would be helpful,” says Tuohy.
If you have changed jobs several times in your career, it’s likely that you may have several occupational pension schemes in place, all requiring attention. As such, it may be time to consolidate as pooling your investments can make it easier to understand – and may also be cheaper.
“There is a significant difference in PRSA-type contracts, where you don’t have the benefit of economies of scale, and occupational pension schemes, where fees tend to be much lower,” says O’Mahony.
Like many things to do with pensions, consolidating is “not straight forward”, says Tuohy. However, it is possible.
“There is a little bit of work to do in it, but we suggest you talk to your administrators and follow their instructions,” says O’Mahony.
It may seem out of place in a pensions article, but for some high-earners, it may be time to stop saving. Due to changes made to the size of a fund that individuals can benefit from tax relief on, O’Mahony suggests that if your pension fund is likely to hit the €2 million standard fund threshold, it may be time to get financial advice.
After this point, the Revenue Commissioners apply “very penal” rates of tax, which means that those edging towards this point should consider stopping AVCs, or asking their employer to restructure their remuneration away from pensions.
So your pension statement may actually be a trigger to stop saving.
If you’ve done all the work outlined above, it would be a shame to let your interest in your pension slide.
But despite advances made in recent years to get employees to engage with their pensions by getting frequent online updates on how their fund is performing, O’Mahony notes that engagement can nonetheless be low. “You may have 50-60 per cent take up for some schemes where employers engage in significant amounts of communication work,” she says, adding that “just a handful of employees” in other schemes may log-on.
But it’s your money so you should stay interested.