My finances, my projects, my life
April 14, 2021

Retirement savings plan: multiple ways to achieve your goal

  Compiled by myLIFE team me&myFAMILY February 26, 2021 48

The goal is to financially secure your standard of living in retirement.

Proper preparation is needed to financially secure your standard of living in retirement. In addition to the state pension and a supplementary occupational pension scheme from your employer, personal retirement savings plans are an attractive option.

The question is which personal pension plan is the right one. If the goal is to provide additional income that is as secure as possible, there are various ways of achieving it.

Tax-efficient products

One particularly attractive option from a financial point of view is the retirement savings plan. Residents of Luxembourg (or cross-border commuters subject to a tax regime equivalent to that of a resident) have the option of saving for their pension. Such a plan is taken out with an insurance company or a credit institution and governs the contributions, which are made on a monthly, quarterly, annual or even arbitrary basis. There are substantial tax breaks throughout the term (at least ten years). Since the 2017 tax reform, there is an annual tax allowance of EUR 3,200 on the premiums (or contributions) paid. If a couple takes out a second plan, they benefit from another tax allowance of EUR 3,200 on top of that. Therefore, couples are eligible for a maximum tax allowance of EUR 6,400 per year.

By taking out a second plan, couples are eligible for a maximum tax allowance of EUR 6,400 per year.

On retirement (at the age of 60 at the earliest), the savings are paid out either in the form of an annuity, half of which is tax-free, or the entirety is paid out in a lump sum. This lump sum is taxed at half the standard rate of tax. Alternatively, you can opt for a mix of lump-sum payout and annuity. In this case, the beneficiary decides how high the proportion of lump sum or annuity is to be. Except in the event of serious illness or disability, if the saved amount is cashed in early a withdrawal penalty will apply and the entire amount withdrawn will be taxed at the normal rate.

One of the special features of retirement savings plans is that there are clear rules for investment products and policies. To put it plainly, in selecting the products in which the capital is invested, the provider must adhere to clear guidelines. In principle, there are two approaches: maximum security and return-oriented. This is where the beneficiary’s financial situation and risk tolerance play a crucial role. In general, older beneficiaries should opt for solutions with low risk. In fact, the legislator has set upper limits for exposure to the equity market depending on age in order to compel beneficiaries who are nearing retirement to exercise a degree of caution.

Guaranteed capital…

The safe option is a plan with a guaranteed capital amount at the end of the term and low return. With this option, the beneficiary gets the benefit of a guaranteed minimum interest rate on their savings and thus a secure result, regardless of fluctuations on the financial markets and other developments, such as payouts on with-profits insurance policies. The guaranteed minimum interest rate applies for the entire term. Beneficiaries know exactly what awaits them in retirement and the minimum amount they will receive. So, the retiree can embark upon this new life stage completely at ease and with no surprises, which is a positive prospect. However, in times of low interest rates the rate of return will tend to be very modest or non-existent. For that reason, you need to hope for high profit-sharing bonuses. More dynamic and higher-risk approaches hold greater promise from a financial point of view.

…or return-oriented

Retirement savings plans where the return is linked to investment funds do not guarantee a certain investment or savings outcome. These products are linked to the performance of the financial markets. This flexible and dynamic option holds the potential for strong returns. However, the financial risk is borne by the policyholder alone. The money paid in, that is, the premiums, are invested in the insurance company’s own investment funds or in other funds. However, such investment products must meet certain criteria. The insurance company or financial institution must offer the client a product that invests solely in the money market and is denominated in EUR (money market SICAV [open-ended investment company]). This reduces the speculative risk. Furthermore, the provider must suggest investment products (investment funds or undertakings for collective investment – UCIs) that feature a mix of equities and bonds. The higher the proportion of equities, of course, the higher the speculative risk. As already mentioned, the investment policy of such products is subject to certain and absolute caps.

Which option is the correct one? In the end, it comes down to your personal risk profile, financial situation and expectations.

To ascertain which option is the correct one, people saving for a pension should talk to their banker (as an approved sub-broker) or insurer. In the end, it comes down to your personal risk profile, financial situation and expectations. By setting upper limits for exposure to the equity market depending on age and profile, the legislator has, to some extent, already answered the question as to which approach is best.