The demographics of the Spanish population, one of the oldest in the world, combined with the continued loss of its purchasing power, mean the future of our public pensions is uncertain. We should, therefore, be aware of the benefits of contracting a pension plan that guarantees additional income when we stop work. In this article we will try to throw some light on this type of product, resolving any doubts you may have.
Do you know how pension plans work?
The customer allocates a certain part of their income (in the form of monthly, annual or one-off contributions) to their chosen pension plan, in order to build up capital for their retirement. These contributions are reinvested in various products, taking the customer’s profile and the period into account. To better understand these concepts, we will consider three hypothetical cases:
Miguel, a 30-year-old engineer, has been working for 3 years. Aware of the uncertain future of state benefits, he decides to take out a pension plan. Given the long period before his retirement, he decides to contract a product geared to equity, i.e., one that invests in the main stock markets. These markets offer very good returns, which build up over time, but these products are more volatile than others, and are more appropriate for long-term investment. Over such a long period, any potential stock market corrections are likely to be diluted.
Javier, a 45-year-old sales representative, has been paying Social Security contributions for 15 years. A childhood friend who works in finance advises him to take out a mixed pension plan, one which combines investment in both fixed-income and equities. Fixed-income investments offer lower returns than equities but provide a high degree of security and stability by investing in public debt issued by key governments.
Luis, a 60-year-old lawyer, is aware that the pension to which he is entitled will not allow him to maintain his current standard of living, so he decides to take out a pension plan. Given the limited time frame, he opts for a guaranteed pension plan. Most of the capital is invested in the public debt of major global economies, guaranteeing that he will recover the capital paid in when the plan matures.
One of the unquestionable advantages of contracting a pension plan is the tax benefits. The capital contributed, subject to a cap of 8,000 euros per year, reduces your tax base and the amount of tax you have to pay.
Redemption of pension plans
When you reach the age of retirement, you can choose how to redeem the plan.
- As capital: The holder receives the full amount in a single payment.
- As income: This can be for a fixed period or for life.
- Mixed: A combination of the two above.
- In draw-downs: You freely decide the amounts and dates when you collect the payments.
Remember that these products are taxed as earned income. To minimise the tax payable it is, therefore, advisable to avoid redeeming the plan as capital.
The fundamental purpose of pension plans is to complement retirement pensions and for saving to help combat inflation, so redeeming your plan as income is the best option.