Why should you subscribe to a retirement savings plan?
A Retirement Savings Plan (RSP) is a financial product that aims to make your money profitable in the long term and with more advantageous conditions than other savings products currently available on the market. Investing in a Retirement Savings Plan is investing in a retirement supplement, with the advantage of having huge tax benefits.
This is one of those times of the year where various traditions are fulfilled. In addition to family parties, the bustle of gifts, Christmas dinners, cod and French toast, there are also Retirement Savings Plan. In a kind of fiscal tradition, it became “mandatory” to create a Retirement Savings Plan (RSP).
The offer is increasingly extensive and better, more competitive and efficient, which is positive for investors, but it also increases the difficulty in choosing. We are going to use this article to explain the functioning of PPRs, the various existing typologies, tax advantages, commissions and costs associated with investment in PPR and we are also going to make a first approach to the so-called European Retirement Savings Plan - the PEPP.
We have known for many years of the imbalance in public reform instruments, namely those associated with social security. We will hardly be able to obtain a retirement value compatible with the income we currently earn. In addition, we are faced with constant changes in the rules, the gradual increase in the retirement age and the lack of knowledge, inefficiency and lack of transparency in the system.
Thus, for those who are still in full professional activity, namely generations born in the 70s of the last century, it is increasingly important to complement this retirement system with autonomous and individual savings that allow for the much-desired financial independence and tranquility.
WHAT IS A RETIREMENT SAVINGS PLAN
A Retirement Savings Plan is a financial product, a kind of savings account, which can be built in the form of an insurance or investment fund (there is also the form of a pension fund), and which enjoys important tax advantages, with the main purpose of encouraging long-term savings.
Investors can be designated as participants, contributors, policyholders, policyholders and beneficiaries, depending on their position and the format of the Retirement Savings Plan.
RSPs allows investors to put their money to work, investing in a strategy that best suits their profile and goals and with enormous flexibility.
RSPs can be constituted by individual investors who wish to enjoy the associated tax advantages and long-term investment, but also by companies. It is increasingly common to see companies promoting complementary retirement schemes, contributing to the worker's well-being and functioning as yet another incentive and remuneration.
The benefits of financial investment through RSP can be seen at two levels: in the year of delivery (subscription) and in the moment of exit (redemption).
Right from the start, it guarantees another advantage which is tax simplification. When investing through a PPR, you no longer have to declare:
- Annex E - capital income,
- Annex G - equity income (capital gains)
- Appendix J – income obtained abroad.
- On subscription
In the year in which the PPR subscription occurs, it is possible to deduct 20% of the RSP from the investment made, with the following maximum limits:
- (euro) 400 per taxable person under the age of 35;
- (euro) 350 per taxable person aged between 35 and 50 years;
- (euro) 300 per taxable person aged over 50 years.
However, this benefit only occurs if it does not exceed the global collection deductions limit. This limit is directly related to the tax situation of the investor and the household. It depends on the IRS rank you are in and the amount of other expenses deductible from the collection such as education, health and housing expenses.
To explore this dynamic of deductions from the IRS collection and determine whether or not you will take advantage of this deduction, see this article on Savings Accounts, as I know if I will receive the RSP deduction.
If you are unable to obtain the deduction for the income tax collection related to the PPR subscription, you can always choose not to consider its inclusion in the income tax return. By default, applications made in RSP are filled in on the IRS declaration. Therefore, it is important to check whether or not you can enjoy this benefit. If you cannot, remove the RSP subscription from your IRR declaration and have the possibility to redeem the PPR at any time, within or outside the conditions established by law, without any penalty.
If, on the other hand, it manages to obtain the benefit of the collection deduction, it continues to be able to make RSP withdrawals without penalties, but only for reasons provided for by law, such as:
- Old age retirement;
- Long-term unemployment of the Participant or any of the household members;
- Serious illness or permanent incapacity for work of the Participant or any of the members of the household;
- From 60 years of age onwards;
- Use for payment of installments of credit agreements guaranteed by mortgage on property intended for permanent housing (but not for early amortization).
Regarding the tax benefits associated with the time of exit, that is, at the time of redemption or receipt of the RSP, the following table is presented:
The basic idea is to reduce taxation on capital gains income in the long run. And the reduction is significant, going from 28% to just 8%. In addition, it has the advantage of not having to immediately redeem the entire RSP, being able to make partial redemptions or dilute the receipt of the RSP through periodic income.
Tax benefits are not just visible in the investor sphere. Income from RSP funds is also exempt from income tax.
In this case, the scheme is also advantageous because under certain conditions it allows companies to consider the RSP investment as a cost of the year, benefiting from a direct reduction in the paid corporate income tax, as well as part of the contributions to social security, at the same time as the amounts invested in RSP are also considered exempt from IRS in the worker's sphere.
INSURANCE OR INVESTMENT FUND?
Retirement Savings Plan insurance is managed by insurance companies. The investor holds a policy, the assets of which are part of the insurer's balance sheet. In the case of PPR funds, such as Invest AR PPR or SMART Invest PPR that Future Proof markets through Banco Invest, management is ensured by a management company, which has a mandate to manage an autonomous asset, divided into units participation, and a defined investment policy. The assets are segregated and the investment fund units are deposited with a custodian, usually a bank.
Another difference between RSP insurance and RSP funds is the level of quotation. Investment funds normally have a daily quotation, that is, each day we can find out the value of our investment in the RSP by multiplying the participation units we own by the market quotation of the day. In the case of RSP insurance, this is not the case anymore. The policy may be valued on a broader basis.
It is also common to associate RSP insurance profitability with a share in the insurer's results, which are normally disclosed at the beginning of each calendar year.
Thus, Retirement Savings Plan funds present a structure more oriented towards the capital market, while Retirement Savings Plan insurance emerges as products considered to be more conservative. However, this is an apparent picture as the most important is the PPR's investment policy and strategy.
TYPES OF PPR AND OTHER FACTORS TO CONSIDER WHEN SELECTING A PPR
There are different types of Retirement Savings Plan
One way to classify them is according to guaranteed capital: With guaranteed capital or without guaranteed capital. It is important to mention that, when a RSP is characterized by having guaranteed capital, that capital is guaranteed by the company that is managing the RSP, that is, there is a credit risk of the insurance company or management company. In the event of insolvency or financial problems, this guarantee may no longer be enforceable.
Also within RSPs with capital guarantee, this guarantee can be given always, at any time, or periodically. For example, it can be an annual guarantee or after an investment period. Given the evolution of the financial markets, namely in terms of interest rates, the guarantee is an increasingly rare reality.
The guarantee of remuneration is also rare. In fact, the guarantee of capital and remuneration is a more common reality in RSP insurance. However, it is also in this PPR typology that costs are highest. There are many PPR insurances with subscription and redemption fees in addition to the fees associated with managing the investment.
In fact, the structure of commissions and costs should be one of the main points of analysis when deciding to invest in a RSP:
- Underwriting costs – there are RSPs that promote a fixed rate of return for the first year, but apply an underwriting fee. Attention should be paid to these aggressive sales strategies which, in most cases, harm the investor;
- Management costs: this includes fees charged by the insurer and management company and costs incurred to manage the investment;
- Redemption costs: these costs are more common in the first few years after the initial subscription, in order to encourage the investor to invest for the long term.
As a long-term investment, RSP can also provide various forms of payment. If in retirement, the investor does not want to fully redeem the RSP, he can do it partially through an income, regular redemptions or through a combination of the various possibilities.
In terms of subscription, RSPs are also very flexible. In some cases the minimum amount is €1 which means that, luckily, the vast majority of people can start their RSP. There are no excuses.
Then just adjust the value to your plan, your needs and possibilities, not forgetting that maxim: pay yourself first!
To choose the best RSP, you should take into account your personal situation, the prospects for the markets and the economy and the performance of the various RSPs on the market.
Through PortfolYou it manages to analyze some of the main RSP funds available on the market and their risk and return metrics, namely volatility, Sharpe ratio and the maximum fall indicator. The comparative analysis between the various instruments helps to understand whether the risk incurred was remunerated properly and whether the management fee is adjusted to the performance obtained.
It is currently possible to invest in dozens of different strategies:
- Mixed RSP, that is, strategies that invest in different asset classes such as equities, bonds, money market instruments or commodities. In this case, RSPs can take on different profiles: conservative, moderate, balanced, dynamic or aggressive;
- RSP that invest solely in an asset class such as bonds or shares.
Periodically assess the evolution of your RSP when compared to peers. At a time of such low interest rates and prospects of lower returns for the future, being invested in a RSP without satisfactory results can compromise your plan. And the legislation even makes your life easier, as it allows free transfer between RSPs without losing the benefits and seniority already obtained. Transfer costs are up to 0.5% in the case of a RSP transfer with guaranteed capital and free of charge in the case of RSP without capital guaranteed.
THE EUROPEAN RSP
Better known as the RSP European, the PEPP is expected to reach the market in March 2022. It is a new savings instrument for retirement, initiated by the European Commission, it can be marketed in any country in the European Union and it can also take the form of insurance, investment fund or pension fund.
The aim is to make it simple and accessible, flexible, transparent and adaptable to the reality of each country. Each PEPP may provide up to 6 investment options, taking into account the investor's risk profile. Transfer between country and service provider is allowed, as well as transfer between different profiles. More information can be consulted here.
Take advantage of the offer and make the best use of your savings. Establish a plan for the future and the long term, build an investment with periodic reinforcements and take advantage of the financial market.
As a result of the increase in average life expectancy and the decrease in the active population, it is estimated that in 2050 the average value of old-age pensions should drop to just over 40% of the last salary received (Ageing Report 2021).
Directly answering the initial question: it is fundamental. Retirement poverty is a possibility, even with the usual social security deductions. Take advantage of the advantages associated with RSP and the diversity of the offer. Do your homework and start your monthly long-term savings plan today on your way to financial independence and peace of mind in retirement.
Vítor is a CFA® charterholder, entrepreneur, music lover and with a dream of building a true investment and financial planning ecosystem at the service of families and organizations.