Pension considerations during Covid-19: Part II

Introduction

Hope you enjoyed Part 1 of our 2 piece blog on pension considerations during Covid-19. Here in Part II of our two-part series we will take a closer look at how this Covid-19 recession compares with the most recent 08/09 financial crisis. We will also focus on the variables that should be considered when looking at individual pensions – v – pension schemes and the tax benefits associated with paying into a pension. We will touch on auto-enrolment and the impact that this will have if it goes ahead as planned in 2022.

Why is it important to compare this recession with 2008/09 when considering your pension now?

Pension investors should be careful equating these two events. Many people lost 50%+ in their pensions funds during the O8/09 crisis. Let’s take a moment to consider the pre-global financial crisis (08/09) situation:

Pre-2008/2009

• There was a long period of low interest rates – a commonality with right now. But the parallels end there!
• In 2008 there was a large amount of speculation in terms of what was happening and many were left in the dark in relation to what had really gone wrong with our banking system – until it happened!
• Globally, the housing market had shattered.
• Consumers had taken on more debt than they could afford.
• There was insufficient regulation, risk management and governance sitting over a lot of these financial institutions.
• There were also inadequate financial buffers within the banking system.

Post 2008/2009

Many of these factors either don’t apply now or are certainly improved!

• We see regular stress tests of global banks.
• Recapitalisation of global banks – the restructure of banking debt, including injections of capital into state-run banks in order to adhere to solvency requirements.
• Most of those who were burdened with debt in the financial crisis have learned valuable financial lessons that will not be repeated. With the exception of Joe Duffy who recently claimed he had lost his private pension for the 2^nd time during this latest recessionary crash, highlighting the extreme importance of working with a trustworthy financial advisor throughout your life. One can only wonder where he is getting his financial advice from.
• Our housing market, while overpriced in many areas, is still affected in many ways but this is down to lack of supply as opposed to people over-borrowing to fund their habitual needs.
• Central banks have moved quickly to deploy the fiscal tools necessary to ease our recession in comparison with the last time round. Because of this and other financial stimulus sentiments, the markets have bounced back much quicker this time round. Evidence of this is the strong bounce back on 24^th April mentioned in Part 1 of this article.

This recession is more like a very short sharp shock. We are hopeful that 2^nd half of the year can begin to recover especially in light of the global fiscal actions being taken and based on the Chinese recovery, where all this began. Recent figures have shown solid levels of improvement in their economy in previous weeks. Activity Levels are back up to somewhat in the region of 85% – 90% pre-covid-19 activity levels.*

Should I stop paying into my pension during a recession?

The straight and honest answer to this is, if you can afford to stay paying your regular pension premium – then as ‘Journey’ famously sang, ‘don’t stop believing’.

Whether we go through 1 or 10 recessions in our lifetime, your retirement is still coming and the age at which we will all live until, is growing. Relying on our State Pension is not a place you want to be in when you reach your retirement for many reasons:

• Right now there are 5 to 6 people working for everyone 1 person in receipt of a pension. By 2050 it is predicted that this will be reduced to 1 – 2 people.
• The age at which we receive our state pension has increased to 67 (from 2021) and 68 (from 2028) and while there was speculation that these ages may be paused, it is now looking more and more unlikely. This means that many of us will be working until we are almost 70 years of age before we begin to receive any of the hard earned tax we paid throughout our working lives.
• A National Pensions Reserve Fund was created in 2001, into which the government made annual deposits of 1% of GNP in order to assist with funding future pension deficits between 2025 and 2055. This fund ended up being used in 08/09 to help with the financial crisis and almost depleted. It was replaced in 2013 by the Ireland Strategic Investment Fund (ISIF).
• Our current state pension is €248.30, given to eligible recipients i.e. those who have made sufficient social insurance contributions during their lifetime. One would have to wonder is this sustainable given the predictions above.
• Just over 50% of working people in Ireland are funding for a private pension right now. The burden that will fall on the state if this figure does not rise in future years will be even more substantial than it currently is.

One of the most advantageous factors of paying into a pension is the tax relief benefits that is associated to being in a pension-paying arrangement.  A benefit that should be sang from the roof-tops on a regular basis but for some reason keeps getting lost in the cloud of media negativity that seems to circle around owning / paying into a pension in this country.

Minimising tax

Back in the early noughties, we were awarded a bonus from the government, known to most as the infamous SSIA scheme. For those of us who remember this elusive scheme, we dazzled in the joy of receiving this ‘free money’ – some managing to attain quite a sizeable pot! Tales of ‘bring back the SSIA’ often whimpers through many a conversation among peers but little do people realise, a real-life SSIA lives among us, every day, in the form of a pension.

A pension is one of those remarkable vehicles that can be used throughout our lives to minimise the amount of tax we pay – the bonus at the end is that we have a pot of money to draw on in our wistful retirement years of fun and frolics. At least that’s the way we recommend how people should view their pension planning.

So what are the tax advantages of paying into a pension? 

If you know nothing about pensions, know this:

• For those of you on the lower tax bracket, paying €100 into a monthly pension costs you €80
• For the half million people in Ireland on the higher tax bracket, it only costs you €60
• The government pays the other €20 / €40 for you, every time!
• With that in mind, consider the effect of putting €1,200 into your pension on an annual basis, on the higher tax bracket – it will only cost you €720.
• Multiply that saving by 35 years and the penny will slowly drop. The government handed you almost €17,000 during that 35 year period – for free!**
• Adding an element of risk to enhance the performance of the pension saving means that any growth accumulated, during its investment years, is compounded each year. So the net result could actually be a lot more than €17,000 at the end of a long term pension savings policy.
• The other 2 tax receivable benefits include:
  • Your pension grows tax free i.e. no DIRT or Exit Tax to be paid on what you gain
  • You are entitled to a tax free lump sum when you reach retirement

When asked about the best time to start a pension, our answer is always – yesterday!

Does it matter if you are an individual with a Personal Pension or a member of a Pension Scheme?

Ultimately whether you are paying into your own pension, set up by yourself and controlled by you OR making pension payments into a pension scheme set up by your company, the concept of pension investing is the same in terms of diversification, tax relief etc.

However there are some key differences in terms of decision-making at a time like this so understanding your pension arrangement and

 the key people involved in managing those pensions, is important.

Pension scheme considerations

The pensions authority is responsible for the regulation of occupational pension schemes, trust RACs and Personal Retirement Savings Accounts (PRSAs) but ultimately it is the trustee of an occupational pension scheme who is responsible for the administration of these funded company based pension schemes. So when decisions need to be made about your pension, it is the expertise of the trustee that you will be relying on.

Trustee Duties

That’s not to say that those decisions will be reckless / unfounded. Trustees go through training in order to be able to carry out the duties incorporated into this title. Also, lessons have been learned from the past. Some knee-jerk reactions made in relation to pension investment strategies, due to downward movements in the economy, have not served them well in the past.

Trustees are also bound by the almighty pensions scheme rules under which their remit is dictated. Items like default investment strategies, employer/employee contribution levels etc are set out in these scheme rules so it is understandable if pension scheme members have a question or 2 in relation to their pensions, the contributions and the funds, especially if pay cuts have been taken, lay offs have been given etc.

Pensions Authority Update on Irish Pension Schemes

The pensions authority released an update on April 24^th and its purpose was to quash some pending queries in relation to the implications for pensions schemes in the Covid-19 pandemic. They urged trustees to communicate clearly and accordingly with scheme members if any ‘material changes’ were to be made to the pension scheme arrangements during this time. While acknowledging that employers are faced with a potentially difficult road in the immediate future, decisions made to, for example, temporarily suspend pension contributions are not simple, nor are they straight-forward. Some may even need to seek legal advice before making these decisions as an employer’s commitment to making pension contributions is ‘governed by employment contracts, pension scheme rules, and in some cases, specific sectoral legislation’.***

Surveys quoted by Mason Hayes Curran in a recent podcast entitled ‘Post Covid-19 Pensions – What to expect’ indicate that the business continuity plans demonstrated by trustees have proven that systems are still a-go when it comes to looking after these pensions schemes and that in comparison to 08/09 investment strategies have not been downwardly adjusted to the same extent. In particular, defined benefit schemes in Ireland have generally fared well in comparison to the market collapse of 2008 due to higher allocations to high quality sovereign bonds, and increasingly diversified investment strategies, according to Peter Gray, corporate consulting leader with Mercer.

Personal Penson considerations

Ultimately the same kind of items need to be considered if you have your own pension – the difference is you are the one making the decisions about switching the funds to a lower risk asset class or reducing/stopping contributions due to potentially a decreased inflow of income due to the Covid-19 impact. Before making these decisions, it’s important to speak with a financial advisor in order to get the best investment advice. Decisions made in relation to pensions can have long-term effects on the overall performance of the fund and what you get out of it at retirement. It is very important to keep that in mind.

Lower purchase price of pensions in Unit-Linked funds

It’s also useful to understand, in addition to seeking advice from your financial planner/advisor, that paying into a pension right now can actually be a significant benefit to you. When valuations drop within a pension, it means the unit price at which you buy into a pension has fallen. Therefore paying into your pension now means that you are accumulating a larger sum of units that will ultimately grow in value once markets climb back up – most have rebounded immensely so you may already be seeing those benefits.

Tax Reliefs

Don’t forget about the tax reliefs which you are entitled to as well, as mentioned above. These savings are significant because ultimately they can actually offset a temporary fall in value in many circumstances so that the net effect on your personal money during a downturn may not as substantive as you may have thought.

If you do need to stop or reduce your pension payments, set a diary reminder for 6 months’ time to review and hopefully you will be in a position to be able to reconvene with the pension payments again at that stage.

Auto-enrolment

Make no mistake about it – we have a pension crisis in this country. For many of the reasons mentioned above but also just because, in general terms, we meet very few people outside of our beloved Life and Pensions industry who actually understand how their pension works, the charges and the investment strategies. Education is lacking in this country in what can only be described as the biggest savings fund you will ever accumulate – and a retirement pot that needs to keep you fed and watered for potentially 20 to 30 years once you stop working.

This knowledge gap has led to a severe lack of pension coverage among those employed in Ireland and with increased life expectancy and an aging population, it really heightens the reliance that a lot of people in this country are going to have on our state pension in years to come.

Auto-enrolment has been discussed now for circa 10 years with the roll-out planned for 2022. There is widespread speculation, especially in previous months that, due to the impact of Covid-19, this roll-out may be pushed out further, as other more pressing financial matters take priority within the country.

What is auto-enrolment?

Automatic enrolment allows for employers to introduce a workplace pension scheme and automatically enrol their employees into that scheme. Employers would then be obliged to contribute a percentage of an employee’s salary to help fund their retirement. Auto- enrolment is seen as a real-life solution to what will be an even larger future problem for our already strained state finances, if it is not actioned.

*Source – New Ireland Assurance Fund Centre

**Source – Irish Life Embracing Investments podcast

*** Source – www.pensionsauthority.ie

By Jo Ryan

Senior Financial Advisor, Trust Matters Financial Planning

www.trustmatters.ie