Pensions are expensive – don’t leave it too late

Everyone knows that the earlier you start your pension, the better off you will be in the end. Afterall, some of your money will be invested for 40 years. I have come across a number of cases recently where people are nearing retirement and are drastically trying to play catch up. These are people who are contributing to their pension, but just not very much.

How much will €250 a month get me?

Pensions are expensive to fund properly. It is a big boost if you are part of an occupational pension scheme and your employer makes a significant contribution too. But lets have a look at what you get if you contribute €250 a month to a pension and it grows by 6% per annum.

1. 40 years growth – €479,241
2. 30 years growth – €224,814
3. 20 years growth – €113,911
4. 10 years growth – €40,816

What kind of income would those pension pots provide you? Assuming you maintained the same investment strategy and got 6% per annum and you lived 30 years in retirement, you can expect the following levels of income (I am ignoring tax free lump sums in this example).

1. ARF of €479,241 provides an income of €32,845
2. ARF of €224,814 provides an income of €15,408
3. ARF of €113,911 provides an income of €7,807
4. ARF of €40,816 provides an income of €2,979

I want a bigger income than that

If you want an income of €40,000 from your ARF, you will need a pension pot of €583,629 to provide you with that level of income from an ARF assuming 6% return (which means you are invested in equities for your entire retirement). If you had started your pension with €250 a month for the first ten years of your pension saving, how much would you need to pay into your pension to reach that target?

1. 40 years savings – contributions go from €250 after 10 years to €357 per month for 30 years
2. 30 years savings – contributions go from €250 after 10 years to €994 per month for 20 years
3. 20 years savings – contributions go from €250 after 10 years to €3,127 per month for 10 years
4. 10 years savings – you need to contribute €3,575 per month for 10 years

Indexation

Indexing your pension is one way to increase your pension pot at retirement. If you indexed your pension at 5% per annum, how much impact will it have?

1. 40 years growth – €1,005,083 (final premium has increased to €1,676)
2. 30 years growth – €440,201 (final premium has increased to €1,029)
3. 20 years growth – €171,503 (final premium has increased to €632)
4. 10 years growth – €50,151 (final premium has increased to €388)

As you can see, indexation has limited use for those who are drastically behind where their pension needs to be. The longer you wait, the more capital you need to increase your pension pot and the less you can rely on compounding.

A good way to increase your pension pot over time is to redirect pay rises into your pension. Once you are over a certain level of income (it is different for everyone), you have enough money to live your life comfortably. Lifestyle creep is on stuff you may not need and will only give you limited amount of pleasure. Save the money instead, you will get more enjoyment from a great enjoyment than from buying stuff now.

Steven Barrett

09 October 2023