Tax relief on your pensions can amount to huge savings
If I was to offer you €100 every month in return for €60, would you take me up on that offer?
Let me double it, and give you €200, in exchange for €120. How about €400, for €240 every month?
If you had the money, I think you would find it hard to turn down such an offer, I mean who in their right mind would offer you such a deal. The Government, that’s who, by way of tax relief on your pension contributions’.
Remember back in 2002, when the SSIA savings scheme was first introduced? The government back then was offering a 25% return on amounts up to a maximum saved of €254 each month. So, for every €10 you saved, it was really only costing you €7.50.
Contributing to a pension scheme is even better, because if you paying tax at the higher rate i.e. 40%, for every €10 you save, it is only costing you €6 because the government is topping it up by €4.
If you are single and earn more than €33,800 or you are married with one income and earn more than €42,800 or married with two incomes that exceed €67,600 per annum, you will pay a portion of your income at 40%, and therefore entitled to tax relief at 40% on your pension contributions.
People understood the SSIA concept because it was simple, but unfortunately they don’t understand the benefits of contributing to a pension plan, which is a factor as to why more than half of the working population are making no pension contributions whatsoever.
A survey carried out by Standard Life which found 75% of 1,000 people did not know the state topped up pension contributions by 40% for those on the higher rate tax bracket.
According to Revenue, there are c. 500,000 higher rate taxpayers and I’m wondering, how many are missing out on this incredible tax break? Are you one of them?
Let me put this tax break another way for you - if you saved €60 every month, and you wanted to turn it into €100, you would need a return of 67%. Can you tell me who else is going to give you a guaranteed, no risk, no questions asked return of 67% every month?
There are those who still won’t put additional money into a pension scheme even if they have it, because they think pensions funds are too risky.
“Markets are very volatile and if they drop you are going to lose all your money” is a comment I hear all the time.
Let’s assume markets perform really badly, let me show you what impact this would have on the amount you personally contribute:
Even if markets dropped by 20%, you would still see a gain of 34% on the amount you contributed that month.
To put this into perspective, the biggest ever stock market drop in a single month was recorded back in September 1931, when markets fell by 29.63%. If that happened today, your €60 would be valued at €70.37, so even though the market fell by that amount, your return that month would have still been 18%.
So, if anybody tells you, you are putting your money at risk by putting it into a pension fund, they have no idea what they are talking about, and please stop listening to them.
If markets fall your investment falls, yes, but that leaves out the amount you actually put in each month, after tax relief. You are actually putting your money and your quality of life when you are older at risk by not contributing to a pension fund.
And don’t think that saving money into a regular savings account is as good as putting it into a pension either.
Currently the best interest rate for saving money on a regular monthly basis is with KBC at 3.5% gross. When you factor in DIRT at 41%, and inflation at c. 0.3%, your real return is 1.77%.
When you save money into a regular savings account, you are saving it with after tax income i.e. you have had to pay income tax, USC and PRSI on the income you earn first, before you can save what’s left over.
If you are single and earning €40,000, your effective tax rate is about 25% after you take into account tax credits/income tax bands etc. So, for every €100 saved into a regular savings account, it is costing €125 because €25 of the amount you earn is going in taxes.
If you save that same €100 into a pension, it is costing you €60, because you are saving it before income tax takes hold of it.
So, you have a choice between:
Save €100, and get a return of 1.7%, where the cost to you is €125, or;
Save €100, get a return of 67%, where the cost to you is €60
I know which one I would choose.
Liam Croke is MD of Harmonics Financial Ltd,
based in Plassey. He can be contacted at firstname.lastname@example.org or www.harmonics.ie