€100 into Savings vs Pension
/Some clients prefer to save directly into a savings plan, rather than a pension, mostly due to ease of access. With a pension you could be required to wait until your sixties to access funds, so the limitations are not the same as with a savings plan.
At times it is hard to show people the benefit of long-term savings in a pension, as the tax relief on pension contributions and the tax-free growth on pension plans isn’t always obvious. So, let’s see if we can give it a go today.
As an example, let’s look at a person, who wants to invest/save €100 a month for 30 years in an investment savings plan, while trying to match the kind of growth an aggressive pension fund would target. Savings outside of a pension are usually subject to tax on the growth and can be between 25%-41% depending on your investment. Let’s work off 33% tax (same as DIRT tax) on investment growth for this example.
In a pension, if you qualify for tax-relief and are contributing €100 a month, you will get tax-relief of €20 or €40 depending on your marginal tax rate. This means that you will be paying €20 or €40 less tax or to look at it another way, if you chose instead to take that €100 as income (to invest outside of a pension), you would effectively only have €80/€60 in your hand after income tax has been deducted.
For this exercise, I am going to work off the following assumptions.
1. Saving €100 per month for 30 years, both invested in a fund that has exact same charges and fund return.
2. Tax-relief on the pension at 20% or 40% and tax-free growth allows a contribution of €125 or €166.67 to your pension for €100 cost.
3. Gross roll-up tax of 33% tax on the savings plan (you pay growth on tax at end of policy)
After 30 years
Savings value €67,574
Pension value €103,907 (20%) or €138,546 (40%)
Now, out of the pension you may have to pay some income tax when you are drawing it down. You will currently get a portion of it tax-free and the remainder of the funds are subject to income tax. However, at retirement, most people’s income goes down substantially and in many cases people pay far less or no income tax on their pension deductions. For example, a retired couple over 65 can earn €36,000 income before being subject to income tax.
