Working for the present but with an eye on the future

The life-cycle hypothesis has gained in importance in the past two decades in light of an ageing population and its potential implications on social security benefits and the impact from a macroeconomic perspective. There were times when providing for the future beyond retirement was not on top of the agenda. This occurred primarily due to a different culture and different micro economic circumstances. As years went by, the working population when compared to the retired population started shrinking as life expectancy rose, cost of living increased and the period of financial dependency of the younger generation on their parents was extended.

Undoubtedly, the increase in cost of living was exacerbated by the sharp increase in property prices. This made it very difficult for anyone to be able to buy property without resorting to loan financing. In turn, the latter, decreased the level of disposable income and made it more improbable for the younger population to think about and be able to save for retirement. As a matter of fact, at this day and age, a considerable portion of the current working population is solely dependent on the Pillar I pension (State pension) as the main source of income upon retirement. The maximum state pension in 2019 for those born after 1962 is €16,129. Given that the maximum state pension in Malta is calculated as 2/3 of one’s salary, anyone earning more than €24,194 will be short of the 2/3 pension.

If one had to project himself at retirement, loan repayments and assistance to financial dependants could be over by then, but other expenses would remain unaltered while medical expenses are likelier to increase the older one grows. This makes it highly probable that sole reliance on the state pension would hinder the retiree from enjoying and maintaining a good standard of living.

In order to entice citizens to build up their own pension pot to help them in retirement, while relieving pressure on the indispensability of the state pension, the government introduced and is constantly ameliorating voluntary Pillar II and Pillar III pensions. The first step was the introduction of Pillar III pension which enables anyone to set up his personal pension plan while benefitting from a 25% tax refund on contributions made up to a maximum of €2,000 per annum, that is, €500. More recently, Pillar II was also introduced and this enables employers to voluntarily offer a tax free fringe benefit to employees by setting up an occupational pension scheme. Furthermore, any contributions made towards such a scheme by employers and employees alike will benefit them reciprocally. Apart from increasing the chances of retaining talent at the firm, employers will benefit up to a maximum of 60% in tax credits on contributions made of their own accord and these can be carried forward indefinitely. On the other hand employees will benefit from a tax refund of up to 25% on their contributions towards this scheme. Employees who are already in receipt of a tax refund through the private pension are still entitled to another refund from an occupational pension scheme. The contributory capping on which benefits are applicable for the Pillar II pension are identical to the one used for Pillar III, that is, €2,000 per annum.

Both for Pillar II and Pillar III, the retiree will be eligible to take a 30% tax free lump sum when crystallizing the pot, while the remaining 70% is retrieved during the course of retirement either in the form of an annuity or programmed withdrawals. In contrast to Pillar I, ultimate beneficial owners of Pillar II and Pillar III schemes who pass away before crystallizing the plan, will leave the accumulated pot to the nominated heirs.

At any point of the life-cycle, private pensions are however not the exclusive form of savings that one can consider in light of eventual retirement. It is in fact highly recommended for one to have other investments that are easily accessible at any point prior to retirement and which could potentially be more growth oriented than a Pillar II or Pillar III pension. Subsequent to the assessment of one’s risk profile followed by an in depth analysis of the individual’s investment objectives and financial sustainability, it is then an Investment Advisor’s job to recommend a portfolio of assets which is tailor made for the specific needs of the investor. Such investment portfolio could be made up of monthly contributions towards pension pots that would benefit the investor from the maximum eligible tax refunds in place at the time, as well as other monthly contributions towards collective investment schemes of varying strategies that are managed by professional fund managers. Needless to say, investing in different assets simultaneously, even if in small amounts, could be financially unsustainable for the young investor in the short term and therefore it might be advisable that the initiation of these happens in different periods.

The younger the age at which one starts investing, the greater the projected portfolio value that one can aspire to achieve by retirement. Likewise, the lower the percentage of disposable income one would need to invest in order to reach the desired financial goals. This is primarily due to potential cumulative gains aided by enhanced cost averaging brought about by investing relatively small amounts at different prices and market cycles. Despite this, it is never too late to start investing, irrespective of one’s age. Thinking about retirement and actually doing something about it takes you half way – sticking to the plan and maintaining ongoing commitments takes you past the finishing line.

David Baldacchino, MSc Wealth Management (Edinburgh), B.Com (Hons) Banking and Finance (Melit.), DipFA, is an Investment Advisor at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on Tel: 2122 4410, or email [email protected]