The Pension Bridge to a low risk retirement.

The OECD published their review of the Irish pension system last week. It highlights a number of risks facing Ireland’s population, not least an increase in old age poverty in Ireland. The principal risks are flagged by the recommendations for Ireland of at least an auto-enrollment pension scheme arrangement (with an opt out) or a mandatory pension scheme. Why? Because too few Irish workers have pension plans (National Household Survey 2009 recorded 54% pension coverage), and of those who do, many will not have an adequate pension because they are insufficiently funded.

Furthermore, the population in ireland is now forecast to grow to pre-famine levels by 2046 (6.7 million with life expectancies of 85 and 88 for men and women) when the population of over 65’s (532,000 today) is forecast to rise to 1.4million in 2046 according to Aideen Sheehan in the Irish independent (1st May 2013), placing a huge future burden on the exchequer and possible lowering of current state pension (€11,976).

Do Irish workers prioritize their retirement plan or do they use the excuse that pension planning is risky business? Lets consider the risks when you do/don’t take out a pension plan.

Risk Principles

First, some risk principles. In business today, innovation is the key to creating value for the future. Innovation involves taking risks however and the question is how much risk to take? The answer is different for every organization and this concept is just as applicable to individuals as they too seek greater returns on pension and non-pension investment.

Attitude to risk  (sometimes referred to as tolerance or appetite for risk) and risk capacity are different elements of risk. The risk tolerances for an individual is first, his/her understanding of risk in terms of volatility/fluctuations in investment value, and second his/her acceptance of greater risk for higher possible returns to either short or long term investments. Attitude to risk is therefore subjective as what is risky for one may be perceived as less risky to another.

Risk capacity on the other hand is more objective and can be assessed for an individual based on his/her age and life stage, current and future earnings, current income and expenditure, assets and liabilities and time to retirement.

In simple terms, two individuals aged 29 and 59 could have the same attitude to risk, but due to their personal circumstances will have very different capacities for risk. To illustrate using the pension example with a retirement age for both of 65, given the big difference in time to retirement, the 29 year old has a much greater capacity for risk/volatility than the 59 year old who cannot afford much volatility at that life stage. The time to accumulate a pension fund is from an early age, and the time to preserve it is in the latter years. Your risk management strategy needs to reflect that. Strangely, many people do the exact opposite trying to play catch up and take unnecessary risks in later years.

Steve Jobs a pioneer and founder of Apple who had a tolerance for high risk once said ‘in the annals of innovation, creating new ideas is only part of the equation, execution is equally important’ and he was so right! It’s all very well having a great idea (income in retirement), but many great ideas fail unless the execution is spot on. In this way, if the idea is seen as somewhat risky, the key to desirable returns will be in the planning and execution of a successful risk strategy.

An important thing to understand about risk is that if you do not take some risk, you cannot expect a real positive return i.e. the real value may actually fall through inflation risk. Now this strategy may be in order if preservation (latter years) is the key requirement rather than in an earlier accumulation phase. In any portfolio, risk is inevitable and therefore understanding the risks at play is important while, knowing how to manage these risks is critical.

Consider individuals who wish to save regularly in low risk accounts rather than save for their retirement through their pension. They are skeptical and sometimes confused by investment risk and even more skeptical about pensions risk. Aside from the long term nature of pension planning, individuals either ignore or don’t understand the basic tax efficiency of what I like to call the pension bridge of:
(a) tax free invested money on way in
(b) tax free growth up to retirement age
(c) compounding growth effect on (a) & (b)
(d) tax free lump sum on way out
…people are still very anti pension. If you are feeling this way too, educate yourself today by speaking with an experienced financial advisor and then make your mind up about the merits of saving for your retirement and the choices over risk.

The greatest risk I see young and older workers taking today is not starting their retirement plan early enough or at all, missing out on pension investment tax relief and not funding sufficiently for their retirement which is what the OECD are talking about in their report.

Remember, our life expectancy is far greater than our parent’s generation, meaning we have a greater need for an income in retirement. The state pension (35% average wage) has been deferred up to 68 years, and it is likely that the government will at least bring in auto-enrollment for pension plans for all workers in the near future.  So what are you waiting for? Build that bridge!


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