The most attractive investment product on the market

A pension is the single most important and tax-efficient investment most people are ever likely to make.

With generous tax reliefs on contributions and investment growth, retirement saving should be a no-brainer, yet it took government intervention in the form of the MyFutureFund auto-enrolment scheme to bring more than 800,000 people into the pensions system.

On the face of it, pensions should be nigh on irresistible as an investment proposition, particularly for higher-rate taxpayers. Tax relief on contributions means that every €100 saved only costs those individuals €60 with the State effectively making up the difference.

And the benefits don’t end there. All investment growth in pension funds is completely tax free. In addition, there is no exit tax on retirement unless the individual opts to exceed the tax-free threshold when taking their lump sum.

For members of occupational schemes, employer contributions need to be brought into the equation. Even the most basic schemes tend to see employers matching employee contributions up to a limit of 5 per cent of salary. For those fortunate individuals, every €200 saved may only cost them €60.

It sounds almost too good to be true, but it’s not. Yet hundreds of thousands of people spurned the opportunity for many years.

Kristen Foran, national sales director with Zurich Life Assurance plc, believes there are several underlying reasons for the lack of take-up in the past. “First and foremost, it’s not exactly an exciting subject,” she says. “By its nature, it’s a bit complex. It’s tough for people to understand and the way the tax relief works can be a bit difficult for people to get their heads around. Also, putting money away for retirement can seem a very long way off, particularly when you are not able to access it before then. That causes issues for some people.”

The absence of an investment culture hasn’t helped either. “With a pension, you are investing your money, you’re not putting it in a bank account,” she adds. “Lots of people aren’t comfortable with that. The Government’s proposed new Personal Investment Account (PIA) is aimed at getting more people investing and hopefully that will help. We are great savers in this country but not good investors.”

Pensions are widely misunderstood, despite their importance, says Rav Vithaldas, partner and pensions assurance leader at EY Ireland. “A common misconception is that retirement is too far away to start planning for now,” he says. “However, time is one of the biggest advantages pension savers have, as starting early allows more time for compound investment growth.”

People often think there is no need to contribute more to their pension as they will spend less once retired, he adds. “In reality, many people spend more on healthcare, leisure and longer life expectancy can increase retirement expenses.”

He agrees with Foran that lack of access can be off-putting but contends that this is actually a benefit. “This is precisely what makes pensions such effective long-term savings vehicles. The restrictions encourage disciplined saving.”

Those misconceptions can lead to people making costly errors. “A lot of people tend to contribute the minimum amount, and this means they are not fully availing of matching employer contributions,” says WTW head of financial planning Stephen McCormack. “That’s one of the shortcomings of the MyFuture Fund auto-enrolment scheme. People in it think they’ll have a good pension regardless of how many years they have until retirement.”

Foran agrees. “MyFuture Fund is great. It has expanded coverage, but what about adequacy?” she asks. “Maybe it will deal with that issue as contributions go up over time. But it’s the same for everyone and doesn’t cater for different circumstances.”

The issue she refers to is that there is no facility for MyFuture Fund members to make additional contributions to make up for lost time. A 50-year-old enrolled in the scheme this year only has 15 years to build up their pension pot and just five of those at the highest effective rate of 14 per cent including employer contributions and the Government top-up.

Given that pension savings time horizons are generally between 30 and 40 years, that’s not a very long time at all.

But MyFuture Fund has certainly raised awareness of pensions. “It’s getting people to think about it,” says Foran.

“The introduction of auto-enrolment is probably one of the most significant pensions reforms, but additional improvements could further strengthen retirement outcomes,” says Vithaldas. “Greater financial education would help people better understand pensions from an earlier age. Simplifying pension products and terminology would make the system more accessible. Encouraging higher contribution rates through automatic escalation features could help people save more without requiring active decisions.”

McCormack agrees on all counts. “There needs to be more education. I would bring that right back to schools to teach young people about the benefits of long-term investments, tax relief and compounding. Providers and employers also need to give a lot more online support. And they need to make it simple; our industry is great for jargon. There is also scope for incentives for increasing contributions over time.”

Getting started is the most important thing, says Foran. “Even if you start at a very modest level your pension will benefit hugely from compounding. And even if you stop contributions for a period, the pension will continue growing and compounding. But if you put the money in the bank, its value will be eroded by inflation over time.”