From our Life Milestones Blog Series by Accumulus Financial Life Planners
Historically, we get to a certain point in our working careers (normally age related) when we retire from work and receive what is called a pension. The pension was first introduced by the Romans as a payment to the members of its military. It was not until 1883 when Chancellor Otto Von Bismarck said, “those who are disabled from work by age or invalidity, have a well-grounded claim to care from the state”.
In Ireland, the State still provides for its people by way of a State Pension. For the majority that have worked, they will qualify for the contributory pension, often called the old age pension and the payment amount is related to social insurance payments made over one’s working life. The State Pension (Contributory) is not means tested and you can have other income and still receive this payment. The payment is at a basic rate payable once you reach the qualifying age, currently 66 and rising to age of 67 in 2021.
As we mature through the years, there will come a time in our lives when we will be unable to work due to age, invalidity (this may be dictated by the nature of the work e.g. physical etc.) or simply the desire to stop.
Whenever that time arrives, there is a need to replace the income derived from work to fund one’s lifestyle for the remaining years. Therefore, one’s lifestyle in retirement is dependent upon the level of pension income and income from other sources that have been accumulated in the lead up years.
If you read the newspapers, listened to the radio, or watched the news, you would probably agree that the only way to achieve this replacement income is by way of saving through a ‘pension’. We are all too familiar with the visual marketing that surrounds these products with much focus on the lovely picture of a couple sat on a beach, cocktails in hand as the sun sets.
The technical marketing by the various product providers is all around the ‘tax breaks’ that you will receive on taking your money and placing it in the blue, red or yellow version depending upon the company chosen.
It is not our intention to snub pensions and they have a function when used in the correct manner, however they are not all they are cracked up to be and is highly dependent upon each individual’s circumstances and what they are looking to achieve in the future.
Before exploring other options, what does retirement mean to you?
· Does it mean stopping work completely?
· Does it mean stopping your current work and perhaps working for a charity?
· Does it mean, doing less of what you currently do, but still “keeping your hand in”?
· Does it mean doing something of which always dreamed?
· Does it mean carrying on because you love what you do?
· Does it mean you have no choice because you still need to earn income on top of the State Pension to support your Lifestyle Income?
While this list is not endless, planning for the outcome that best meets your needs is imperative. Like everything in life that we desire, the key is ‘getting started’. By way of example, let us look at one example from the list above, ‘Keeping your hand in’ which is a more common theme that we come across in our Life Planning Practice these days.
These individuals tend to own their own business (being the majority shareholder) and can decide on their own exit date. In most cases, they will hold a portfolio of assets ranging from Pensions they have funded during their working life, Cash Deposits, Investment Properties which may include their business premises from which they can derive a rental income, Private Share Portfolio and other Investments.
In this scenario, the exit options look very straight forward, take the pension benefits, add that to the rental income, work a little, Job Done!
Well Yes and No. Yes, this can be done, however a key question to ask is;
How much income does the individual need to meet their Lifestyle Income and on what date?
For most people that find themselves in the happy position of reaching their preferred retirement date, what follows next is the desire to take some time away from it all. This may involve splashing out on a big holiday, new car, holiday home etc. which they have dreamt of for years and this would be facilitated by the tax-free lump sum taken from their pension(s).
Based on recent mortality rates, we will live to approximately 83* (men) and 86* (women) respectively. How to fund this large cash spend is something that requires careful planning and consideration. For example, you may wish to delay taking your pension benefits initially and use some of your cash savings, rental income and part-time income.
There are many solutions, however there is still one fundamental that nearly everyone forgets, which is simply “How much after-tax income do I need to fund my lifestyle”?
The majority of clients who come to us for help and guidance approach their exit in the traditional manner as laid out above. Why would they think any differently, this is the financial model that the industry has promoted for years and continues to promote. You have a pension(s), some cash deposits, perhaps an investment property and everything will be fine.
To get started, write down everything that you spend on your ‘lifestyle income’ today (there are many free apps online or a simple excel spread sheet will suffice).
Then, pick an age in the future when you like to retire or reduce your working week. Deduct any spending from your current ‘lifestyle income’ that you think you will not have at your chosen date e.g. Childcare, Short-term Debt, Mortgage etc. This will give you a good idea of what your “Future Lifestyle Income” may look like, bearing in mind this will change over time and inflation will also have some impact.
So now, you have a start point. Not only do you have start point, but you have a reason, a reason why you are saving each month, a reason why you want to work harder or longer hours, a reason why you may want the promotion etc. A word of caution, just because you earn more, does not mean you need to spend more, often referred to as lifestyle creep, this is a fundamental human trait. Earning more money does not equal automatic financial success. Lifestyle inflation can be damaging to our long-term financial health as it limits the ability to save now and have less for retirement.
As part of your financial analysis, if you find that you have surplus funds left over at the end of each month, set up a dedicated savings or investment account that is separate from all your other accounts. This is made easier today by some of the newer online banks who allow you to create sub-accounts into which you can save for specific events.
Then set up a regular payment to transfer the surplus funds (preferably automated so you are not having to think about it) and watch this pot grow.
Some people may want to DIY this themselves, for others, it’s something they may want to outsource to someone they can trust. To achieve what you want in the future requires discipline, if this is something you feel you may struggle with then, then seek out professional help. A wealth and finance coach can help provide you with the right advice that is personalised to your current financial situation. They can also act as an accountability confidant to make sure you stay on the right track along the way and make the path to success less overwhelming.
Written by Tomas O’Driscoll CFP®
and Life and Money Ireland
This information is for general purposes only. This information is not intended to be a substitute for specific professional financial or tax advice, as individual circumstances vary. Please see a financial professional in regards to your own individual situation.
*CSO Life expectancy table no 17 (2015-2017) at age 65 male add 18 years, female add 21 years