Why it’s important to take ownership of your pension planning!
Although everyone has a different view of their ideal lifestyle and retirement; I do get asked the same question quite a lot from clients. How much should I have in my pension fund at retirement age? This question seems to be most pertinent for family business owners.
My reply is usually “if you want to have income for life at retirement age of €50,000 a year then you better try to have at least €1 million in your pension fund”.
I think that once people understood what they need and why it is needed they can take the necessary ownership of their pension planning, and that really is so important. Everyone must be on the same wavelength.
My parents were one of the first people that I can remember to take ownership of their pension planning from an early stage. They started a business back in 1989 and they also have two daughters (my sisters) one who is still actively involved in the business. They understood that small family businesses are not really very saleable especially if you have sons or daughters working with you in the business. They knew too that they would need to have sufficient independent income outside of the business to fund their income in retirement.
I remember my Dad telling me of a conversation he had with a customer of his who also had a family business. This customer was older than my Dad and he asked him how much he had in his pension plan. The customer didn’t know and Dad was amazed at this. He said to him “you probably could tell me how much your shop took in the till yesterday”! His customer agreed. Dad replied that what he took through the till in Instant Knockout his shop really didn’t matter as the only important money ultimately for him was what he had accumulated in his retirement plan as that was the only way he would ever be able to retire from his business. I see it all too often that people spend more time working in their business and they forget along the way that they need to become financially independent of their business if they want a decent retirement lifestyle.
When people are young it is naturally difficult to get them to focus on something which is so far out there into the future. Trying to get a 25 year old to start a 40 year savings plan even with tax relief is not an easy task but it will be absolutely magic for them if we can help them to make it happen.
Let me give you a few numbers to explain what I mean. In this example I am assuming a net annual return of just 5%. This is a hypothetical return and in a 40 year period there will be plenty of years when the fund will rise and fall in value. However; a well-diversified fund, over this time frame could do much better than that.
Surprisingly to most, to start off a pension plan for a 25 year old targeting a fund of €1,000,000 at age 65 requires only a gross figure of €655.30 invested each month……..such is the power and magic of time and compound interest!
As tax relief is allowed on pension contributions within certain limits our 25 year old could get tax relief if paying tax at the standard rate of €131.06 per month (€524.24 Net figure). If tax is being paid at the high rate then tax relief of €262.12 per month would apply (€393.18 Net figure). Even more importantly, if our young person is a company director he can have his company pay into a pension plan on his behalf effectively turning company profits into personal wealth.
If our young person feels that a monthly gross payment of €655.30 is too high and not affordable then we must find a target fund they are comfortable with. How about €500,000 at 65? This will require only €327.65 gross per month. If still too much we might reduce our target fund to €250,000 which will require just €163.83.per month.
Assuming now that we are in agreement to go ahead and that amount is achievable we now set up a pension plan to invest that amount each month. We now have achieved two things. We have got them to start planning (the only real mistake they can make is doing nothing) and we have given them a target to aim for and most importantly they now start understanding ownership of their retirement fund.
We realise that this original target fund of €250,000 is on the low side but we will then explain that at least once every year we will be back to meet with them to see how did the fund perform and maybe next year if they can afford it we will put the next piece of their retirement planning jigsaw in place and bring the target funding to perhaps €350,000 or the €500,000 level.
As one of my personal heroes Benjamin Franklin once said “If you fail to plan, you are planning to fail!”