AS our personal debt burden worsens – and it will as interest rates rise – the new government will have to finally have to acknowledge this growing burden on individuals, their families and the state.
It should have been dealt with much sooner, but it will, unfortunately mean that two other difficult personal finance issues could be sidelined – the chaos and increasing cost of our three pillar pension system and the huge dilemma for so many people, especially older ones, about how to safeguard and grow their savings as inflation risks rise.
Our three pillar pension system is complex, expensive and increasingly, unsustainable.
Civil and public sector pensions are paid mainly general taxation (especially now that the National Pension Reserve Fund is effectively gone) and from maximum net (after tax relief) worker contributions of about c7% per annum. The cost of benefits is closer to a 20% plus annual contribution. The total public service pay bill will cost €2.23 billion in 2011, compared to €1.35 billion in 2005. The bill has increased by 65% in the past five years and by 2050 will cost €8 billion. The total, mainly unfunded liability for the entire existing public service now amounts to c€108bn, according to the Comptroller and Auditor General.
Meanwhile, the state old age pension costs c€6 billion out of the total state pensions bill of €9.2 billion – and has also soared in the past decade. However, along with the cost, the older population is growing faster than the younger one that pays the state pension bill directly from taxation. The pension time bomb fuse is now much shorter as a result of our state insolvency and revenue that has fallen to just €34 billion.
Finally, private pensions, which have accounted for approximately €3 billion of annual tax subsidie, are the only pension pillar to have been subject to wide-ranging changes: the maximum size of funds that can be saved has been reduced by half to €2.5 million; the maximum annual income on which tax relief contributions can be claimed has been reduced sharply to €115,000; the size of the lump sum that can be taken capped is now €200,000; employer PRSI or USC payments no longer qualify as tax relievable, for private pensions and PRSAs.
And if the new government adopts it, the Fianna Fail proposal to cut tax relief to the 20% standard rate only by 2014 will end the incentive for anyone earning top rate tax to buy a private pension due to the double taxation they will end up paying. An alternative suggestion is a temporary 0.5% levy or tax on the size of all personal pension funds, but for someone soon to retire with, say, a lifetime’s savings of say, €250,000, a four year levy will result in a minimum loss of €1,250 a year.
With so many anomalies applying to one set of pensioners over another – many of these changes don’t apply to occupational or director’s or public service pensions – the pressure will be on by different lobbies to repeal or extend the changes.
Each pillar participant needs to act now in their own interest. I’m not convinced that much reform of public service pensions will be achieved, but if it is, it could mean much higher contribution rates by workers and possibly even the end of the defined benefit scheme in favour of a defined contribution one in which final benefits will depend, as they do increasingly in the private sector, on the value of the investment fund.
Younger civil servants especially need to think seriously about how they will be able to afford to fund such a scheme. They should start investigating the implications by checking out the excellent materiel on the Pensions Board website, www.pensionsboard.ie
Private pension holders still have this year in which to make 41% tax relief pension contributions. Otherwise they could face a pension fund levy this year (or the tax reduction from 2012). There will be no way to avoid the levy unless you retire before it is introduced. Is this possible? Can you afford to retire at 60 or 63? Will your company avail of the new, higher value sovereign annuity for you?
Older workers – with five or more years to retirement certainly need to safeguard their existing gains. Most stock markets have recovered their 2008 losses but many are predicting a correction is overdue: you should shifting your money gradually to safer assets like defensive shares, inflation-linked bonds and some cash and even precious metals.
All the major pension companies now have defensive pension funds that are designed to safeguard existing funds or into which cautious pension investors can begin saving. Speak to your trustee or broker about them. Don’t delay.
Meanwhile, state pensioners need to be prepared in the next year for a possible cut in their pension as all expenditure is reviewed and the state’s finance’s deteriorate further and anomalies are highlighted. There is a huge transfer of wealth going on from young to older generations and immigration is one of the consequences of this.
Are you getting the best and safest savings rates possible from any savings you may have? Do you qualify for the DIRT exemption? Is your savings inflation proofed? How can you maximize savings and investment returns while minimizing risk? Can you still afford to live in Ireland if taxes and costs keep rising and your income keeps falling?
These, and other savings issues will be the subject of next week’s column. Readers are welcome to send me savings topics they’d also like highlighted at firstname.lastname@example.org