Should I increase my investment in my pension in my 50’s

mcauleyej

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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:
  • 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 investedReturn up to which you should pay off mortgageReturn below which you should invest in a fundReturn above which you should invest in a pension
50 to 4.5%4.5% to 38%Above 38%
100 to 4.3%4.3% to 17%Above 17%
150 to 4.1%4.3% to 11%Above 11%
200 to 4.0%4.1% to 8.7%Above 8.7%
Table 1: Net Rates of Return at which different mechanisms are better value assuming that full pension income is taxable

Years investedReturn up to which you should pay off mortgageReturn below which you should invest in a fundReturn above which you should invest in a pension
50 to 4.5%4.5% to 25%Above 25%
100 to 4.3%4.3% to 11.5%Above 11.5%
150 to 4.1%4.3% to 7.4%Above 7.4%
200 to 4.0%4.1% to 5.5%Above 5.5%
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:
  • 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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