Assumptions

I’m basing this study on a couple starting to invest at age 40, earning a combined gross income of 94,000€. This is higher than the average income but was chosen as an average over 20 years for simplicity sake.

They save 1,960€/month (or 23,500€/year) towards option A, a self directed investment and option B, a pension.

While there is no limit to what you can contribute to investments outside a pension, the 1,960€month is the full 25% allowable in a pension from age 40. You can contribute more as you age but I kept the base amount the same over the 20 years, again for simplicity and ease of comparison.

The total they invest in both cases is 470,000€ over 20 years.

They retire at age 60 and live on 40,000€ combined.

This results in a portfolio of just over 1 million in both portfolios.

Investment outside a pension

I’m assuming the self directed investments are in Irish domiciled ETFs. These incur a 41% deemed disposal exit tax every 8 years. This tax amount is taken out of the portfolio growth amount.

I’m assuming a growth of 7.91% in the accumulation phase. This is the historical stock market average of 10% minus 0.19% management fees and Ireland’s 30 year average inflation of 1.9%.

In the withdrawal phase the growth goes up to 9.81% as the inflation of 2% is taken into account in the withdrawal amount. For example: In year 1 the couple withdraws 40,000€ and in year 2 they withdraw 40,800€ (2% more).

Pension

I’m assuming the same growth as outside a pension using ETFs in a self administered fund and pension management fees of 1.25%. This results in growth of 6.85% in the accumulation phase (compared to 7.91% outside a pension) and 8.75% in the withdrawal phase (adding inflation back in as it is taken into account in the withdrawal amount).

The annual withdrawal starts at 40,000€ and increases by inflation of 2% each year. However, at age 60 the withdrawal has to be a minimum of 4%. At age 70 the withdrawal increases to 5%. And once the portfolio exceeds 2 million the withdrawal rate goes up to 6% as per revenue rules.

Income taxes at the marginal rate are taken out of the portfolio growth amount.

Any amounts that exceed the inflation adjusted 40,000€ are reinvested into a self directed ETF portfolio.

Whether you take the money out of the pension or not, you will pay income tax as though you have withdrawn the full 4-6%. You could leave the excess in the pension to continue growing but then your withdrawal percentage and taxes will be higher and higher as the years go on. You may be better off withdrawing the full amount which you are paying taxes on and reinvest it outside of the pension to reduce this impact. This also keeps your pension below the 2 million mark for longer, reducing your mandatory withdrawal (and tax) rate for as long as possible.

The full 200,000€ tax free lump sum is taken at retirement and reinvested into an ETF portfolio. I use the same assumptions as the non-pension investment.

How do they stack up?

After 20 years, by age 80, the investment portfolio outside of a pension stands at 2.1 million. While the pension including separate investment for lump sum and excess withdrawals stands at almost 2.7 million. A difference of 675,000€.

After 40 years, by age 100, the investment portfolio outside of a pension stands at just over 5 million. While the pension stands at 8.9 million. A difference of 3.8 million.

Management fees and performance

What if your pension management fees are higher? Or what if the performance is lower than what you can get outside of pension? Or some combination of the two ie: your real rate of return?

If your pension management fees are just 0.75% higher (at 2%) or your performance is 0.75% lower than you could get by investing yourself (at 9.25% instead of 10% before fees and inflation) then you will have 23,000€ less in your portfolio than investing yourself after 20 years but 476,000€ more after 40 years.

Do you know how your pension is performing and how much you are paying in fees? These two elements are very important as you can see that even very small differences in percentage will totally wipe out any tax advantages you are getting.

Any more than a 1.9% variance in combined fees and performance and you will be better off investing yourself in a self directed fund and keeping your money accessible at any time.

Average pension fees and growth

For a bit of context, the average charges for pensions in Ireland according to this 2012 report were 2.18%.

The average pension growth in the same report was -4.82% after fees and inflation based on historical average, though the report only has data from 2007 (-7.3%), 2008 (-35.7%), 2015 (4.5%), 2016 (8.1%) and 2017 (6.3%). Even if you take out the crash in ’08 it’s still only 2.9% (or 6.98% if you add back in the 2.18% in fees and 1.9% in inflation instead of 10% in the stock market).

If I apply these rates to my example, your pension would only be worth 643,000€ by age 60 and you would run out of money by age 87.

Lower exit tax

Fund managers are petitioning to bring exit tax back in line with DIRT and while that seems unlikely it’s not impossible. Exit tax and DIRT were aligned from 2001-2016. Going down as far as 23% back in 2008.

If brought back down to 33% then the 2 cases in this post would be more comparable. After 20 years the pension would have 197,000€ more than the ETF portfolio. After 40 years the pension would have 716,000€ more.

Are pensions the best investment in Ireland?

So are pensions the best investment in Ireland?

Like most things, it depends. It depends on:

• Your real rate of return which takes into account your performance, management fees and inflation
• Years to retirement

Real rate of return

In order for a pension to fare better than self directed ETF investments you need to have a real rate of return of 5.95% or higher.

You can calculate your real rate of return by taking your performance – annual management fees – inflation.

So in the first case I looked at it was 10% performance – 1.25% fees – 1.9% inflation = 6.85%

Years to retirement

Different pensions have different retirement ages. Make sure yours aligns with your goals. If not you will need to take that into consideration when planning out your investment goals.

You may need to invest outside of the pension as well as in the pension in order to bridge the gap between the age you can access your pension.

Summary Table

Why am I still avoiding a pension?

So why, if the pension is clearly the most tax efficient option, as long as the real rate of return is 5.95% or higher, am I still holding off?

Personally, I am aiming to be financially independent by age 45 at the latest. This would leave at least 5 years until I could access my pension if I had an executive pension. It would require me to draw down on my self directed investments during that time until I could access the pension.

I currently have investments scattered across Ireland and Canada and already have complicated tax matters and withdrawal strategies to account for.

After all my analysis, I still have questions unanswered and am getting to the point that I’d just like to streamline and simplify my portfolio.

I recently met up with a couple who have already retired early and are offering consultations to others on their path to FIRE. They said that one woman who was highly educated felt like she needed to have an overly complex portfolio as she felt that the more complex would mean the better returns. She felt that since she was so well educated she should be using her intelligence to outsmart the system when in fact it was making matters worse.

I’m actually starting to feel like maybe I’m a bit like that woman. I am over analysing all the variables and just need to take a step back, possibly consolidate and simplify my investments and continue plugging away at our goal.

And this may seem crazy to some but, who cares if after 40 years I have 5 million instead of 8.9 million. As long as my portfolio is sustaining my retirement lifestyle then the rest is just excess.

As for leaving money to my son, yes that would be nice, but I hope that we will be able to teach him to provide and invest for himself so that he won’t need to rely on an inheritance from us.