LOUISE FAIRSAVE: Securing retirement
Concerns about likely problems with National Insurance pensions in the future have sparked interest in independently earning a comfortable retirement. Specifically, how can one be in a position, somewhere between the age of 55 to 65 years old, to consider seriously the option of full retirement and so, to retire and maintain a reasonably satisfying lifestyle?
A personal pension fund can establish a source of independent wealth that can reduce a worker’s dependence on a state pension. Saving is the crux of setting up such a fund. The earlier in one’s working career that even the smallest of savings can be set aside, the easier will be the burden of accruing a sizeable fund in the long-term. Then, by investing whatever savings one can set aside, the fund can be significantly enhanced.
The key aspects in growing the fund is to save as much and for as long as possible, to invest at optimal return as safely as possible and not to dip into the fund unless absolutely essential. Exploiting tax incentives for saving towards retirement are also very important. Here, then are three practical examples of approaches to a personal retirement fund:
1. Voluntary contributions may be made to an existing pension scheme. For example, workers may make voluntary contributions to the existing pension scheme provided through their employer. Currently, a prescribed amount of the worker’s income may be voluntarily contributed free of income tax. Many workers are just not aware that this procedure is possible.
The rate of return on the sum saved within the pension scheme is generally much higher than the worker can get elsewhere with similar limited risks. Money saved here is, however, not accessible to the worker until retirement.
2. Retirement savings can be made with an insurance company. A deferred annuity can be purchased. This amounts to purchasing an insurance policy that will guarantee a certain stream of income (in equal monthly amounts) at some future period.
For example, one may buy a five-year deferred annuity that will pay $500 per month say 15 years later. For these monthly pension payments over the five years, the insurance company will quote a monthly premium for the intervening 15-year period.
For a deferred annuity to be even considered for registration for income tax purposes, the payout period of the annuity cannot be planned for before the purchaser is at least 60 years old. An annuity that meets these requirements must be submitted for registration for income tax purposes in order that the premiums paid can be tax deductible.
Once registered, a positive result is that the annual premium is allowable as a tax deduction to a prescribed maximum. The negative result is that the purchaser cannot access the funds in the annuity before retirement age without incurring a tax charge.
3. Retirement saving can be made through a Registered Retirement Savings Plan, RRSP, where up to a prescribed maximum saved annually may be tax deductible. Insurance companies, commercial banks, and other financial institutions offer the RRSP product.
The RRSP can be attractive to workers even at the start of their work careers as one early withdrawal is allowed from the fund provided that it does not exceed $25 000, and that the funds withdrawn are invested in a first home for the RRSP owner. Just like any other registered product no other tax-free withdrawal is allowed until retirement age.
In all three cases, taxes will eventually be payable on the resulting annuities at the typically lower incremental tax rate of the pensioner.
• The next article will consider other saving vehicles towards a comfortable retirement.
• Louise Fairsave is a personal financial management adviser, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances.