All,
Should I increase my investment in my pension in my 50’s?
I’m trying to determine if I should take out an AVC, put money directly into an investment fund such as Irish Life MAPS or pay off my mortgage earlier.
I’ve done a simple model and the outcome is not what I expected so I’d like to share it with you in case either:
A. I’ve made a stupid mistake in my calculations or
B. It’s of interest to you.
In Table 1 you put in a lump sum now and take it out as a fully taxable lump sum at a point in the future. I know this is only valid in the case where you have Defined Benefit Pension and are already getting a lump sum of 1.5 times final salary. Therefore, In Table 2 I assume that 25% of your pension is tax free. In both cases I assume no employer contribution.
I've updated my model a few times and so the percentages may not be exactly correct but are close and I assume AMRF rules do not apply.
Assumptions:
Table 1: Net Rates of Return at which different mechanisms are better value assuming that full pension income is taxable
Table 2: Net Rates of Return at which different mechanisms are better value assuming that 75% of pension income is taxable
What I conclude from this is:
Should I increase my investment in my pension in my 50’s?
I’m trying to determine if I should take out an AVC, put money directly into an investment fund such as Irish Life MAPS or pay off my mortgage earlier.
I’ve done a simple model and the outcome is not what I expected so I’d like to share it with you in case either:
A. I’ve made a stupid mistake in my calculations or
B. It’s of interest to you.
In Table 1 you put in a lump sum now and take it out as a fully taxable lump sum at a point in the future. I know this is only valid in the case where you have Defined Benefit Pension and are already getting a lump sum of 1.5 times final salary. Therefore, In Table 2 I assume that 25% of your pension is tax free. In both cases I assume no employer contribution.
I've updated my model a few times and so the percentages may not be exactly correct but are close and I assume AMRF rules do not apply.
Assumptions:
- Current income is taxed at 40% PAYE with USC at 8% and PRSI at 4%. If I put money into my AVC I don’t pay PAYE.
- Future income is taxed at 40% PAYE with USC at 4.5% and PRSI at 4% as I won’t have hit the PRSI or USC age limits.
- If I invest in a fund my returns are taxed at 41% and I pay the 1% Government Levy on entry
- I can alternatively put a lump sum against my mortgage at a rate of 2.75%
- I’m assuming that the costs of a fund or an AVC are the same and I’m looking at net returns (I need to check this assumption)
- I’m also ignoring the 8 year tax rule on funds that will benefit pensions over the longer term.
- All tax laws stay the same ad infinitum
| Years invested | Return up to which you should pay off mortgage | Return below which you should invest in a fund | Return above which you should invest in a pension |
| 5 | 0 to 4.5% | 4.5% to 38% | Above 38% |
| 10 | 0 to 4.3% | 4.3% to 17% | Above 17% |
| 15 | 0 to 4.1% | 4.3% to 11% | Above 11% |
| 20 | 0 to 4.0% | 4.1% to 8.7% | Above 8.7% |
| Years invested | Return up to which you should pay off mortgage | Return below which you should invest in a fund | Return above which you should invest in a pension |
| 5 | 0 to 4.5% | 4.5% to 25% | Above 25% |
| 10 | 0 to 4.3% | 4.3% to 11.5% | Above 11.5% |
| 15 | 0 to 4.1% | 4.3% to 7.4% | Above 7.4% |
| 20 | 0 to 4.0% | 4.1% to 5.5% | Above 5.5% |
What I conclude from this is:
- Paying off your mortgage earlier (@2.75%) is the equivalent of getting between a 4% and 4.5% in a fund/pension and is guaranteed.
- The closer you are to needing the money you want to save the better you are in taking the tax burden now and investing the money in a fund. This also gives you the benefit of being able to access the money when you want it.
- The longer you leave you money in a pension the lower the return is required to make that the best option but at some stage ~4% it will always be better to pay your mortgage off than put money in a pension.
- The pension option will improve further from 66 when PRSI falls away and further from 70 when USC reduces.
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