Inflation and the Impact on Your Retirement Nest Egg

The news media of late has reported on various indicators like the Consumer Price Index (CPI) showing the inflation rate receding from its recent highs. However, looking back to the mid 1960’s to the early 1980’s, inflation came in waves. History shows that it is possible that inflation will not recede in a linear fashion in the coming months and quarters. Waves of inflation could be milder in their impact on the economy and markets, yet still cause investor nervousness by raising uncertainty about the direction of economic growth, inflation, and central banks’ policy responses. 

With this in mind, there are a number of key questions to consider carefully to help protect your retirement nest egg.

So how does Inflation impact my nest egg? Consider the following example:

You have €300,000 in your pension. With a 4% p.a. inflation rate this would be worth €202,669 in 10 years.

– That’s a real loss of purchasing power of over €97,000

Just to keep pace with inflation of 4% you need a fund of €447,249 after 10 years.

The situation is exacerbated if you retire your pension and are taking the 4% income per annum from your post-retirement fund. The capital value will be further eroded, and clearly, this is not sustainable into the longer term.

What can you do to combat inflation? The main ways you as a pension holder can influence the value of your pension is to look at how much you are contributing to it, what your investment objectives are, what your investment time frame is and what level of risk you want to take to achieve your investment objectives.

Contributions are a tax efficient way to boost your pension

One of the most efficient ways to do this is pre-tax and through a self-directed Personal Retirement Savings Account (PRSA) or Master Trust Pension. Straight away there is tax relief at your marginal rate of tax which is significantly higher than the rate of inflation. Tax relief is granted on personal contributions at your marginal rate based on your age. For higher rate taxpayers every €1000 contributed to your pension you get €400 in tax relief.

Figure 1: Maximum personal contributions allowable for tax relief

With the recent changes in legislation employer contributions to a PRSA is no longer a Benefit in Kind (BIK) for an employee and employer contributions to a PRSA are not limited by age related limits. It also means that employee contributions to PRSA’s aren’t restricted by any employer contributions paid. So, this allows employees to contribute more and claim tax relief via the PRSA. So, not only can the employer make unlimited employer contributions to the PRSA, they can also claim corporation tax in the accounting period in which the contribution was made.

What are your investment objectives?

Contributions alone may not be enough to build a sufficient fund to see you through retirement. There are a wide range of investment opportunities for you to avail of through your pension. Diversification – where rather than putting all of your eggs in the one basket you invest in a range of different investment assets and types, thereby smoothing out and reducing the investment risk – can be a key strategy.   Fortunately, our ITC self-administered vehicles can hold a vast array of assets such as residential and commercial Property, investment funds, structured products and physical precious metals held in storage.

What is your time frame and risk profile?

A pension holder in their 60’s who is looking to retire soon may have a different investment time horizon to a pension holder in their 40’s. Similarly, the person closer to retirement may have a different risk profile to someone who is contributing to their pension with the aim of growing it in anticipation of retirement.

The important point is that inflation should be fully factored into any investment plan you decide upon. Your financial plan should be reviewed regularly with your financial advisor. This will allow you to assess your progress, make any necessary adjustments and then confirm that you are on track to meet your agreed upon financial goals for your retirement nest egg.

Source: Steven Garavan ITC Business Development Manager, 13th of May 2024.

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