# Is a pension worth it if you're on the lower tax rate?



## Maybrick (29 Jun 2019)

I was recently talking to a relative and asked him, "Have you thought about starting a pension?" He surprised me by answering, "I've looked into it and I don't see the point." His position, roughly, is this:

He is just over 40, self-employed and earns around 30,000, so pays a lower income tax rate.
The tax relief he would get on a pension would be relatively small and eaten into by charges etc.
When he retires at 68, a typical annuity would pay around 4pc- so he needs to live to 93 just to get his original investment back.
He owns his home outright and has a healthy lump sum (something like 200,000) thanks to an inheritance, so no immediate cash worries.

In his own words, "I think I'll just keep saving - it's a guaranteed return, gives me more flexibility and is a hell of a lot less complicated."

I felt like I should have a counter-argument, but couldn't immediately think of one. Can anyone help?


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## noproblem (29 Jun 2019)

In his own words, "I think I'll just keep saving - it's a guaranteed return".
Love to know what he means by this but in any case and answering your question and reminding you that time does fly. I'm 66 from earlier this year, had thought a little like the man you mentioned, but kept paying into the state system and now get almost €250.00 paid to me every single week. I've plenty of other investments too but in my mind the contributary pension that's given to me is money for old rope and is now proving a great investment. Oh, this is just my opinion.


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## The Horseman (29 Jun 2019)

The benefit of a pension contribution is it attracts tax relief on the way in and Also on the way out up to certain amounts. As far as I know this lumpsum can be accessed once you turn 50. Comparisons between returns on existing investments v pension returns should be considered. Due to your relatives age I would not place too much reliance on the state pension. Unless your relative will have over 2000 prsi contributions by the time they retire they will get a prorata of the pension. This will probably change before your relative is due to retire. Remember we have a pensions time bomb.


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## Brendan Burgess (29 Jun 2019)

At 40, he definitely should *not *be contributing to a pension which attracts tax relief at only 20%. 

It will be taxed on the way out.  So it could well be taxed at 20% or more when he receives it.

The thing to do is to continue saving. If he earns income at the higher rate in the future, then he can contribute to a pension.

If he has a mortgage, he should pay it off.

If he is renting, he should look at buying a house. 

Brendan


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## The Horseman (29 Jun 2019)

I disagree pension returns earn between 3 to 4% before tax per annum (this ignores the tax break on your contributions). Unless your investment is returning a greater yeild than that then you are earning less on your investment than on your pension pot returns.


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## Gordon Gekko (29 Jun 2019)

I think he should be contributing to a pension.

He’s in a low USC band so it’s less relevant.

He can invest his net €80 and have his returns taxed. Or he can stick €100 into a pension for 25 years of tax-free growth. Then take 25% of it out tax-free. Then take 4% of his ARF out each year. Worst case scenario he’s paying 20% tax, no PRSI, and low rate USC. It’s the 25 years of tax free growth that’s the clincher.


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## adox (29 Jun 2019)

Brendan Burgess said:


> At 40, he definitely should *not *be contributing to a pension which attracts tax relief at only 20%.
> 
> It will be taxed on the way out.  So it could well be taxed at 20% or more when he receives it.
> 
> ...



So are you basically saying that anyone on a lower tax band shouldn’t contribute to a pension??

OP said he has no mortgage and 200k in savings. Surely some of that could be used to contribute to a pension. 

I’m 52 and paying tax at 20% and currently maxing our contributions after ignoring it for many years and just letting my employer contribute.


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## Brendan Burgess (29 Jun 2019)

Your money is tied up in a pension fund which you probably won't access for 13 years.

The only benefit you are getting is the 20% tax relief and the accumulation tax free.

If you are not going to have a taxable income at 65, then it's possibly worth it. 

If you are going to have enough income to pay tax at 40% you would be crazy to contribute to a pension fund.

You put in €100 . It costs you €80.

You get €100 income.  25% tax free.  So you will pay 40% tax on 75% or 30% .
So you get €70 out - or less if you are paying whatever they will be calling PRSI/Income Levy/ USC at that stage. 

So you put in €80 and get €70 out.

If you will have income taxed at 20% when you retire,  you will pay 20% on 75% or €15.
So you put in €80 to get €85 out.  Hardly worth it.

If you will be taxed at 0% , you will put in €80 to get €100 out. That would be worth it.  So very close to retirement when you know for sure that you will be taxed at 0%, then it's worth it. 

It will also be subject to all the high costs and  limitations of pension funds and the uncertainty over what might happen between now and then.

Brendan


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## cremeegg (29 Jun 2019)

Maybrick said:


> I was recently talking to a relative and asked him, "Have you thought about starting a pension?" He surprised me by answering, "I've looked into it and I don't see the point." His position, roughly, is this:
> 
> He is just over 40, self-employed and earns around 30,000, so pays a lower income tax rate.
> The tax relief he would get on a pension would be relatively small and eaten into by charges etc.



This is a good point



Maybrick said:


> When he retires at 68, a typical annuity would pay around 4pc- so he needs to live to 93 just to get his original investment back.



True, but there are many other options besides an annuity.



Brendan Burgess said:


> At 40, he definitely should *not *be contributing to a pension which attracts tax relief at only 20%.
> 
> It will be taxed on the way out.  So it could well be taxed at 20% or more when he receives it.



I dont understand the reasoning here._ [Crossed with your explanation]_

With a pension you can get tax relief now then after 28 years of tax free growth pay tax on the drawdown; OR Tax now and tax every year for 28 years on your investment returns.



The Horseman said:


> I disagree pension returns earn between 3 to 4% before tax per annum (this ignores the tax break on your contributions). Unless your investment is returning a greater yeild than that then you are earning less on your investment than on your pension pot returns.



This has nothing to do with pensions, the investment option you choose has (almost) nothing to do with wether its a pension investment or not.


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## cremeegg (29 Jun 2019)

Brendan Burgess said:


> You get €100 income.  25% tax free.  So you will pay 40% tax on 75% or 30% .
> So you get €70 out - or less if you are paying whatever they will be calling PRSI/Income Levy/ USC at that stage.
> 
> So you put in €80 and get €70 out.



If you put €80 in (€100 invested) in and get 4% after charges, tax free that will be €300 after 28 years.

Outside a pension, if you put  €100 in and pay 20% tax on a 4% return thats €241 after 28 years

So you put 80 in and get 300 out and pay tax on the drawdown. Not quite as bad as you suggest.


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## Marc (29 Jun 2019)

Brendan is mathematically wrong here

I addressed this very point recently in this thread





__





						Key Post - Is it worth contributing to a pension scheme if you don't get 40% tax relief?
					

I’m working through some of this logic myself and at present I have some interesting working conclusions.  You don’t need to save up in a unit linked plan and then add to a pension later you can contribute to the pension now.  I take considerable issue with the assumption that it’s only worth...



					www.askaboutmoney.com
				





I’m willing to go one further and say that for some people it’s worth paying into a pension even if you receive NO tax relief.

This takes up a whole chapter in my Irish Financial Planning book


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## Maybrick (30 Jun 2019)

Thanks for all those replies, plenty of food for thought there.

I have to say, though - if experts such as yourselves can disagree so strongly over what should be a relatively straightforward question, how on earth is the layperson supposed to make intelligent decisions? I appreciate that not everything can be spoon-fed and people have a responsibility to educate themselves - but in my opinion the Irish pension system is far more complicated and confusing than it should be.

On the substantive question, sorry to Marc and others I'm still far from convinced that anyone paying the lower rate of tax has much to gain from starting a pension (which is worrying because lower-paid workers are precisely those who the State should be encouraging to save). Please feel free to have another go at enlightening me!


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## Protocol (30 Jun 2019)

My retired parents have incomes of approx 48-50k and pay 8-10% direct tax plus USC.

Don't assume that all pension income faces 20% tax.


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## Marc (30 Jun 2019)

Protocol has hit the nail on the head here.

You need to stop focusing on your tax status today and focus on the likely tax you will pay in the future.

As I said, this subject is a whole chapter in my book so I agree it is poorly understood generally.


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## NoRegretsCoyote (30 Jun 2019)

Cash saving for the long term seems daft in a world with near-zero interest rates.

Over 25 years equities generally deliver a better return.

Even a full state pension is only about half his income today.

I would put at least something into the pension, even without the tax relief.


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## Brendan Burgess (30 Jun 2019)

Protocol said:


> pay 8-10% direct tax



What?  We have two tax rates in Ireland + USC + PRSI.

You are looking at the average tax rate I assume, which is not relevant. It's the marginal rate.

Brendan


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## Brendan Burgess (30 Jun 2019)

NoRegretsCoyote said:


> Cash saving for the long term seems daft in a world with near-zero interest rates.
> 
> Over 25 years equities generally deliver a better return.



This has nothing at all to do with the question being asked as Creme Egg has already pointed out.



cremeegg said:


> This has nothing to do with pensions, the investment option you choose has (almost) nothing to do with wether its a pension investment or not.


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## Oisin19 (30 Jun 2019)

The tax exempt status of the pension structure is generally worth more to the individual than the tax relief on the way in. The tax relief on contributions is just an added bonus.

You will generally be paying tax at a lower rate on pension payments especially when you factor in the tax free lump sum. For people at the standard rate they get tax relief at 20% but they will generally pay very little tax on future pension income and in a lot of cases will be zero due to the tax thresholds. For high income people they will get relief at the marginal rate but will generally pay tax at the marginal rate on the future income but when you consider the lump sum it reduces the effective rate. 

So in essence you are deferring tax that is due now for a payment of tax in the future at a lower rate. This free use of the money is just an additional bonus to getting the tax exempt status of the structure.

If you are planning on doing *long term savings,* in my opinion the only way to do this is via a pension because of the tax free growth. So it doesn't matter what rate you pay tax at its still the best way to save in the long term.

For example take a proposed property investment of 200k with a potential rental profit of 10k per annum. If you do this personally you will generally lose half of this to the tax man each year. In a pension you keep the full amount. After 20 years you will have saved 100k from this investment if done personally and have saved 200k if done in a pension. Then when you factor in the bonus of the tax relief you have further increased your ROI. This is why the pension is the best structure for long term savings.


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## Oisin19 (30 Jun 2019)

Marc said:


> I’m willing to go one further and say that for some people it’s worth paying into a pension even if you receive NO tax relief.
> 
> This takes up a whole chapter in my Irish Financial Planning book



The pension structure is also a great tool to protect assets for your children. It is probably the cheapest and best trust out there to keep assets out of reach or protect kids from themselves!

For example, make a gift to a child at say age 18 of 100k. Now they contribute the 100k to a pension and invest it in the Stockmarket. The beauty of the pension is that they can't get access to the funds till their retirement. Granted if they are savvy they can get it from age 50 but the point still stands. At age 65 the pot would be worth 3.7m at a rate of 8% per annum.

So no matter what your kids do with their inheritance this pot will be there for them to guarantee their future. Hopefully at this age they will be mature enough to manage wealth. Its a great option to have but rarely used.

Actually you probably don't even need much money to do this. ie you could from the birth of the child do the 3k each year gift and invest it into the stock market. In 18 years time at 8% that pot after tax would be circa 100k. Then at 18 put that lump sum into a pension as above.

So for a tiny commitment of 3k per year for 18 years you create 3.7 million. This is the real power of the tax exempt structure!


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## Daddy Ireland (30 Jun 2019)

All sensible advice Fergal.   Would have an issue with 8%. Perhaps historical returns but I have'nt personally got this return over the past 25 years in managed funds.   More like 5%.  Guess I must have been in the wrong funds.


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## galway_blow_in (30 Jun 2019)

Brendan Burgess said:


> At 40, he definitely should *not *be contributing to a pension which attracts tax relief at only 20%.
> 
> It will be taxed on the way out.  So it could well be taxed at 20% or more when he receives it.
> 
> ...



I'd question if relying on the state pension is a wise plan for anyone under forty five, it's unsustainably high at the moment so whether the tax saving is there or not, perhaps it's very necessary to invest in private retirement provision[/QUOTE]


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## NoRegretsCoyote (30 Jun 2019)

Brendan Burgess said:


> This has nothing at all to do with the question being asked as Creme Egg has already pointed out.



The OP asked about his entire investment strategy:



> "I think I'll just keep saving - it's a guaranteed return, gives me more flexibility and is a hell of a lot less complicated."



Cash saving is a guaranteed *negative *return at the moment after DIRT and expected inflation! So I think the relative benefits of equities are highly relevant to his entire investment strategy.

Of course it all depends on his preferences for income in retirement, liquidity in the meantime, etc. There are plenty of scenarios where a pension makes sense for him and your blanket dismissal of the benefit of the tax relief is daft.


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## Conan (30 Jun 2019)

galway_blow_in said:


> I'd question if relying on the state pension is a wise plan for anyone under forty five, it's unsustainably high at the moment so whether the tax saving is there or not, perhaps it's very necessary to invest in private retirement provision


[/QUOTE]
Agreed 
But also worth bearing in mind that if tax relief is only 20% whilst working, it's probably  unlikely that he will be on higher tax rate in retirement. 
Also it is possible to take  tax free lump sum of up to 150% of Salary out of the accumulated fund, even if that exhausts the Fund (under current legislation).


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## cremeegg (30 Jun 2019)

Maybrick said:


> if experts such as yourselves can disagree so strongly over what should be a relatively straightforward question, how on earth is the layperson supposed to make intelligent decisions?



Speaking for myself I am not an expert on anything.

There are a number of posters on here who certainly expert on certain matters. However I am reminded of the old idea that becoming expert is the process of learning more and more about less and less until you know everything about nothing.

The expertise of people who are expert in pensions is essential when you come to buy a pension, those people are not necessarily the best people to answer the question, "should I invest in a pension"

Finally, its no harm to remember the essential point, if you put money in a pension you get tax relief on the money going in and you get tax relief on the growth of the investment. Thats all good.

There are charges that you don't have with other investments. There are restrictions on what you can do with the pot when you retire. Not so good.

But come retirement age if you invested in a pension at worst you will have suffered an opportunity cost.


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## Maybrick (30 Jun 2019)

cremeegg said:


> Speaking for myself I am not an expert on anything.
> 
> There are a number of posters on here who certainly expert on certain matters. However I am reminded of the old idea that becoming expert is the process of learning more and more about less and less until you know everything about nothing.
> 
> ...



Hi Cremeegg,

Well, maybe 'experts' isn't the right word but you're certainly people who have analysed these issues far more than the average person - which is why I find the diversity of opinions so worrying!

Would everyone at least agree on this - that the advantages of a pension for someone paying the lower tax rate are vastly less than someone on the higher rate?


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## orka (30 Jun 2019)

Conan said:


> But also worth bearing in mind that if tax relief is only 20% whilst working, it's probably  unlikely that he will be on higher tax rate in retirement.


This is true if the person is expected to be on the 20% rate throughout their working life. Someone in their 20s/30s on a career path that will take them to the higher rate would be ill-advised to contribute until they are on that higher rate.  Getting 20% relief and then having to pay 40% + USC on marginal extra income in retirement is a bad idea.
And then there's the issue of the hopefully never-to-be-forgotten government raid on private pensions.  There will be a permanent 2.4% surcharge tax on pensions for those who had saved prior to the raid.  So in the 2030s/40s/50s/60s..., some patsies will still be paying this charge for the 2008 financial crisis.


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## The Horseman (30 Jun 2019)

It is likely someone paying the low rate of income tax on the way in will most likely be paying the low rate on the way out. 

For the same reasons above I would expect the above to be true for higher earners.

I suspect the tax break to the higher earner is only really relevant on the tax free lump sum limits.

For what its worth I understand the Govt are looking at operating a single rate of allowance of circa 25% irrespective if you are a low or high earner.


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## Oisin19 (30 Jun 2019)

I think ye are getting too focused on the tax relief aspect. Why not look at it this way? If you don't put the funds into a pension the alternative is to invest them personally. 

Take two identical twins who have the same money to invest. One goes for the pension option and the other goes for the non pension option. The investments are made at the same time and are accessed at pension age. Which one of these will have the bigger pot at retirement age and thus will be better off in retirement?


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## noproblem (30 Jun 2019)

Fergal19 said:


> I think ye are getting too focused on the tax relief aspect. Why not look at it this way? If you don't put the funds into a pension the alternative is to invest them personally.
> 
> Take two identical twins who have the same money to invest. One goes for the pension option and the other goes for the non pension option. The investments are made at the same time and are accessed at pension age. Which one of these will have the bigger pot at retirement age and thus will be better off in retirement?



Very well put and that's the way it is.  The OP should also remember that he could drop dead tomorrow.


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## Protocol (30 Jun 2019)

Brendan Burgess said:


> What?  We have two tax rates in Ireland + USC + PRSI.
> 
> You are looking at the average tax rate I assume, which is not relevant. It's the marginal rate.
> 
> Brendan



Yes, their average or effective income tax + USC rate is 8-10% approx, on income of 48-50k approx.

PRSI is zero for over 66.

So my father got tax relief at up to 50%, and now pays max 10% direct income taxes.

Yes, his MTR on extra income is 20%, ok yes.


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## Daddy Ireland (30 Jun 2019)

Brendan Burgess said:


> At 40, he definitely should not be contributing to a pension which attracts tax relief at only 20%.



My son is starting his career at 22 on a graduate program starting salary 26k.   If he pays 4% his employer will pay 9%.  So would you advise him as you would advise the 40 year old ?


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## Brendan Burgess (1 Jul 2019)

Absolutely not.  

I will do a Key Post on it to lay it out systematically.

The first point will be that if your employer matches your contribution, you should max your contribution.

Brendan


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## NoRegretsCoyote (1 Jul 2019)

Daddy Ireland said:


> My son is starting his career at 22 on a graduate program starting salary 26k.   If he pays 4% his employer will pay 9%.  So would you advise him as you would advise the 40 year old ?



It would seem daft to discard a very good employer contribution like this, even if he is not paying tax at the higher rate.

Even a 3% real return increases the pension pot by a factor of 3.5 by the time he is 65.

Ignore tax relief, he pays in €4, his employer puts in €9 (€13 in total) and that turns into a fund of €46 at retirement age.

That's an increase of a factor of 11. 

Tax-free compound interest is a very powerful force.


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## Daddy Ireland (1 Jul 2019)

Ok thanks.


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## lledlledlled (2 Jul 2019)

Marc said:


> Brendan is mathematically wrong here
> 
> I addressed this very point recently in this thread
> 
> ...



Hi Marc,
Is your book available online?


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## Marc (17 Jul 2019)

lledlledlled said:


> Hi Marc,
> Is your book available online?



I have broken it down into a series of stand alone guides which I am planning to release in the autumn.

I am literally writing the section right now on why almost "everyone in Ireland" between the ages of 18 and 75 should save in a pension even if they have no earned income at all simply because the alternatives for many people are so much less attractive over time.

For the avoidance of doubt, I'm not suggesting putting all of one's savings into a pension, just the "dry money" * - which I define as your long-term investments that you don't intend to touch.

As in all things it always depends on the exact circumstances of the investor and very specific guidance is necessary.


*'Cash' is 'airgead tirim' in Irish (literally 'dry money)'


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## EmmDee (17 Jul 2019)

NoRegretsCoyote said:


> It would seem daft to discard a very good employer contribution like this, even if he is not paying tax at the higher rate.
> 
> Even a 3% real return increases the pension pot by a factor of 3.5 by the time he is 65.
> 
> ...



I'd put it another way - ignore the tax for a minute... If by putting €4 in an investment, you get 225% return on day 1, it is attractive. The additional benefit is that the initial €1 is "before tax" which would mean an even higher return  if you were looking at after tax income (doesn't really matter if on higher or lower rate). The drawback is that you can't access it for a long while.

Any matching scheme (assuming it is for something you use) is a useful benefit. Our place has a scheme where the employer matches contributions to a account which can be used for leisure activities (buying tickets, sports events, clubs etc) on a 2:1 basis. The benefit is taxable but even allowing for that it is free money as I would be going to these things anyway


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## kevhenry (3 Aug 2019)

Another point is that when you reach age 66 your personal tax thresholds change.

For example, a retiree with a financially dependant spouse can earn up to €36,000 a year before paying income tax i.e. they can earn €3,000 a month.

Anything over that is then taxed at the marginal rate.

Given that the state pension is around €2,000 a month, this leaves the potential to earn an additional €1,000 a month tax free.

A fund of €400,000 - regardless of the rate of tax relief received on the way in - is still a worthwhile objective because it perfectly plugs the gap as follows;

€400,000 fund.

1) Tax Free Lump Sum of €100,000 (25%)

2) The remaining balance of €300,000 can then be annuitised at 4% giving (€300,000 x 4%) = €12,000 a year or €1,000 a month.

Yes, it's more difficult mathematically to reach this figure if only getting 20% tax relief but it's still worth pursuing.

You can get tax relief on contributions and avoid tax on the way out if your fund is below €400,000 and you don't have other income.

The working age tax brackets don't apply in retirement.

In any case, I've never met anyone who complained of having too much money in a pension fund.

Kevin
www.thepensionstore.ie


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## RMGC11 (3 Aug 2019)

kevhenry said:


> Given that the state pension is around €2,000 a month, this leaves the potential to earn an additional €1,000 a month tax free.



I thought the state pension was around half that? Wasn't it around 250/week?


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## Daddy Ireland (3 Aug 2019)

Talking about a married couple.


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## kevhenry (5 Aug 2019)

RMGC11 said:


> I thought the state pension was around half that? Wasn't it around 250/week?


State pension for an individual with a dependant spouse is approx €1,997 p/m


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