informed decisions blog

Inflation and the Impact on Your Retirement Investment blog251

20th May 2024

Paddy Delaney

Today, we’re tackling a topic that’s been heavily addressed already, inflation – but in the context of how inflation impacts your retirement investment, particularly your pension assets. You may have noticed the Consumer Price Index (CPI) suggesting that inflation rates are easing off from recent highs. However, if we cast our minds back to the mid-1960s to the early 1980s, history shows us that inflation tends to come in waves. It’s not gone away – particularly for us long term investors!

This pattern suggests that inflation may not decrease in a straightforward manner in the coming months and quarters. While these waves of inflation might have a milder impact on the economy and markets, they can still cause investor nervousness by raising uncertainty about the direction of economic growth, inflation, and central bank policy responses.

With this context in mind, it’s worth considering how inflation impacts your retirement investment and what we can do to safeguard it.

Key Points

  • Inflation Impact: Understand how a 4% inflation rate can significantly erode your pension’s value.
  • Boost Contributions: Discover the benefits of pre-tax contributions to a PRSA for tax relief.
  • Employer Benefits: Learn about the new rules allowing unlimited employer contributions to PRSAs.
  • Investment Strategy: Explore the importance of diversification and regular financial reviews.

How Inflation Impacts Your Retirement Investment?

Let’s take a look into a practical example. Imagine you have €500,000 in your pension. With a 4% annual inflation rate, this amount would be worth €337,782 in 10 years. That’s a real loss of purchasing power of over €162,000. To simply keep pace with 4% inflation, you would need a fund of €745,415 after 10 years. 

The situation becomes even more challenging if you retire your pension and start withdrawing a 4% income per annum from your post-retirement fund. The capital value will be further eroded, making it unsustainable in the long term. This highlights why understanding the inflation impact on your retirement investment is essential.

In that scenario of 4% inflation rate, the real value of your pot falls at 9-10% per year, 4% to inflation, 4% to income withdrawal, and 1-2% to fees! How do you counter that??…

Combating Inflation: Key Strategies

1. Contributions: A Tax-Efficient Way to Boost Your Pension

One of the most efficient ways to enhance your future pension benefits is through pre-tax contributions to your own pension scheme – whether that is a group scheme, Master Trust, Executive Pension or Personal Retirement Savings Account (PRSA). Like a lot of things, the more you put in, the more you’ll get out, if done right!

If you make contributions yourself, you get tax relief at the rate you pay tax (aka Marginal Rate), which is significantly higher than the rate of inflation! For higher-rate taxpayers, every €1,000 contributed to your pension gives you €400 in tax relief, so you get €1,000 into the pot at a cost of only €600. It’s one of the final free-money deals dear reader!

Think about it: by contributing more, you’re not only saving for your future but also enjoying substantial tax relief now from our tax collectors 🙂

2. Leverage Employer Contributions

Recent legislative changes (which were a bit rushed) mean that employer contributions to a PRSA are no longer considered a Benefit in Kind (BIK) for an employee, and these contributions are not limited by age-related caps. It is open season, for now.

This allows employers to contribute and reward key employees. Employers can also make unlimited contributions and claim corporation tax relief in the accounting period when the contribution is made. This is a win-win situation, as both you and your employer can maximise contributions efficiently.

It has been such a change, that currently, a company can put an unlimited amount of money into any employees PRSA, and the employee is not liable to any BIK on that payment, and the employing company can claim full Corporation Tax relief on the contribution.

In this basis, it is said that if I had my own wildly cash-rich company, there would be nothing to stop that company putting say €2m into my PRSA today, and if my partner and children were employees, the company could put say €2m into each of their PRSAs today also!! We all have more pension pots than we’ll likely ever need done and dusted.

Employer Contributions – An Opportunity?

This is a far-cry from the old rules, whereby the amount that the company could put into our pensions was capped based on the salary we had, the amount of years we worked in the company and the amount of other pensions we had. This old way restricted the level of tax deductible contribution the company could put into our pensions in a given year. It was still quite generous, but nothing like what it currently is!

And I say currently. I’ve been hugely surprised since the day they formalised the new rules – I couldn’t believe that they opened the flood-gates on the contributions – I felt it was too good to be true for those that it was applicable to! And it seems that the tide might be turning and the gates might be creaking closed on this current opportunity. Irish Times recently wrote about the questions being asked about the current rule. Is it time to act if you have not yet?

3. Setting Your Investment Objectives

Contributions alone will likely not be sufficient to build a robust and productive retirement fund. A prudent investment strategy will be key to getting most of us to where we want to get to! And most pension schemes offer a decent range of options. Diversification—investing in various productive assets to access growth and flexibility, is a key strategy. 

We wrote recently in Blog 249 about the Risk of Ruin. This research by US academics pointed to the success and failure of various investment strategies over the long term, for pension investors. It pointed firmly to the fact that investors who chose a ‘high risk’ yet diversified approach achieved the best long term outcomes, and the lowest risk of their pension pot dying before the owners did!

And this applies to both your accumulation and your spending phase, if using an Approved Retirement Fund (ARF) type approach. Don’t blindly choose a ‘Default Investment’ (safer) investment strategy without doing your homework and understanding what it might mean in the long term for you and your legacy.

4. An Eye on Fees

We’ve said it before and we’ll say it again – fees matter!

Getting clarity on what fees you are actually really paying in most pension schemes is nigh-on impossible, still. There is no obligation on a pension insurance provider to tell you what fees they take from your pension. Amazing but true.

If, like us, you are using MIFID regulated firms for your pension assets (these are non insurance company providers basically) they do disclose the fees in full, they are obliged to under MIFID regulation. And I love it as it is hyper transparent – you can actually see the deductions each month, not ‘baked-into’ the unit price as they are on insurance pensions.

But asking the question of your provider is the starting point – the more they are asked, the more they have to up their game, eventually. When we see KID Documents showing 2%-3.5% for run of the mill insurance pension funds the alarms bells start going off. If you need to move providers to get a better rate, provided you can get access to decent investment options, it could well worth the hassle in doing so.

5. Regularly Review Your Plan & Actions

This might seem cliche, but regular reviews with your financial/tax/accountant partners will help you assess progress, make any necessary or advantageous adjustments, and ensure you are on track to meet your financial goals for retirement as efficiently as possible. In my experience at least every few years there is something that can our should be done to help improve your outcomes, based on what is happening in your life or in the rules around what can and can’t be done.

A Financial Review though should not be a trigger to buy more policies from anyone though – they are about ensuring all is on track, and if not, what ought to be tweaked. If every time you meet your advisor they are talking about some new product or policy that they think is great for you – tread carefully, or tread away and find a professional advisor.

Ultimately, staying proactive and engaged with your financial plan ensures you can adapt to changes and stay on course, and do so with confidence and peace of mind.

Final Thoughts

Navigating the waves of inflation requires careful planning and proactive management. By understanding how inflation impacts your retirement investment and taking steps to mitigate its effects, you can better protect your financial future.

Remember, a diversified investment strategy, regular reviews, and leveraging tax-efficient contributions are key components in combating the erosive effects of inflation on your retirement savings.

Stay informed, stay diversified, and stay in touch with your financial advisor to ensure your retirement nest egg remains resilient in the face of inflation.

I hope this helps.

Paddy Delaney QFA RPA APA




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