Whether you are a business owner or PAYE worker, you may be considering making a lump sum contribution to your pension plan between now and the end of the year. With higher market volatility, interest rates and inflation, you might be less certain than usual about how to proceed. We recommend that you take the time to understand what you are investing in, before deciding how and where to invest a sizable lump sum pension contribution.
If you have an investment plan in place, it may be time to make some tweaks. However, if you don’t currently have an investment plan, you should put one in place that is aligned to your financial goals, before investing any monies.
We’ve set out below four areas to consider before making a lump sum pension contribution.
1. Consider your overall financial plan and investments
Now may be a good time to take a fresh look at whether your portfolio matches your real risk tolerance, and whether or not the current market volatility is putting your financial and retirement goals at risk. 2022 has been a particularly volatile year in investment markets, with strongly negative returns for most asset classes, leaving many investors feeling understandably nervous about investing while this high level of uncertainty remains. However, if your investment plan is robust and you have a long-term time horizon, volatility can be viewed simply as a market condition that arises from time to time, and indeed can offer an opportunity to buy assets at reduced prices.
2. Pension tax relief – use it or lose it
Pension contributions are timebound when it comes to tax relief. If a contribution is made by 31st October next (or 16th November if you file your return of income and make the appropriate payment though ROS), relief can be claimed against your 2021 income. If you miss these deadlines, you will forego the opportunity to claim in that year. This is a very valuable benefit to lose and one not to miss because of current market uncertainty, as you are investing for the long-term.
Pension contributions are one of the last remaining payments that qualify for marginal rate tax relief. In addition, your funds grow free of taxes and unlike other investments are not levied with Exit Tax (41%), CGT (33%) or DIRT (33%). The impact of this is that any savings that you can afford to put aside today get an immediate positive return of up to 40%, by way of the tax you would otherwise have paid on them, and this bumped up amount then has the opportunity to earn positive returns that will compound over time.
3. Always clarify the charges
What can seem like small charges now can have a significant impact on your outcomes over time. If you are a business owner and in control of putting your own pension plan in place, don’t forget to focus on value for money, just as you do with other areas of your business. A pension plan is a product, and like any other products, they vary in cost. You need to examine all the costs – product costs, investment costs and adviser charges. These can add up and have a significant impact on your returns over the long term, particularly in times of negative returns.
Vanguard, who are one of the largest global providers of passive investment products, recently published a good hypothetical example of the impact of investment costs over time. In this example, if you have $100,000 invested, it could grow to $430,000 without any investment costs. But if you pay 2% a year in fees and charges, this growth would be restricted to $260,000. i.e., you would lose about $170,000 to costs. This shows the extent to which costs can really matter over time, so it is worth ensuring that you either look at them yourself or get an independent adviser (i.e., someone who you are paying) to look at them for you.
4. Having an investing strategy is key
One of the fears of lump sum investing in volatile market conditions is the fear of markets falling immediately after you invest.
Euro-cost averaging is the strategy of spreading out the investment of your money periodically, buying at regular intervals and in roughly equal amounts. When executed in a structured and disciplined way, it can have significant benefits for your investment portfolio as you are buying at various price points and so smoothing out your entry price into the markets. Many of our clients also have strategies in place that allow them to invest higher amounts after markets have experienced big falls, which can feel uncomfortable in the moment, but can add value over the long term.
It is our experience that having a plan in place provides a degree of comfort, but it certainly doesn’t eliminate the fears associated with making investments at any time, and especially during highly volatile times like the present. Potential investors need to remember that while investments should ideally be considered and planned, they are rarely risk-free, and the future is never certain.
Although availing of tax reliefs may be the primary driver of your decision to make a pension contribution at this time of year, it is important to understand what you are investing your money in, and if these investments are aligned with your retirement plan and goals. For many of our new clients, we often find opportunities to significantly reduce the cost of their pensions and investments, which over time can more than pay for the advice they receive.