CAN YOU AFFORD TO RETIRE?

I recently started working with a 47 year old man who has been divorced for 10 years and has two children. He felt that his finances were out of control and wanted to plan for the future.

After sorting out his everyday expenses, we started long term financial planning.  I asked him whether he has a pension, to which he replied he does.  In 2008, a law was passed in Israel mandating that every employer had to pay into each employee’s pension fund; noncompliance means that legal charges can be – brought against them. When I asked how much was saved in the fund and what amount he expected to receive as a pension upon retirement, he looked at me blankly.  I told him that in my opinion, there is no difference between a salary and a pension.  He agreed that he would never take a job for 20 years – the minimum period of time he will probably be reliant upon a pension – without knowing the salary amount..

Statistics show that the average life expectancy today for men is 81 and for women, 84 – and this keeps going up in Israel.    Actuaries calculate that people currently facing retirement can expect to live until the age of 85 for men and 87.5 for women.  People in their 20s can expect to reach 90+. Based on a quick calculation on Google, my client can expect to live to the ripe old age of 86.

It is quite clear that pension planning is more critical for people who are working today than people who are soon to retire.  Old pension schemes were based on the assumption that people would live for about 20 years after retiring, while new pension schemes accommodate the increased longevity.

If longevity runs in your family and you are in relatively good health, how do you ensure that you will have enough money until the end of your days?  We are lucky that in Israel, regardless of how much money accumulates in either your Bituach Menhalim or Keren Pensia (the two popular pension schemes), you are guaranteed a monthly pension allowance, no matter how long you live.  This default in our pension plan is encouraged by the government via tax benefits for employers and certainly for the self-employed.  I would recommend that anyone opening up a new pension scheme ensures that the longevity clause is included.

As a Family Financial Advisor, I am fully aware that two financial goals – real estate and pensions – now need to be considered in long term financial planning. The emphasis in the 20th century was real estate; pensions in this century have now been added to the list. Please note, that they must not compromise one another.

In this article, I will explain the common mistakes that people make with their pension.  Keep in mind:  even missing one month of your pension contribution while employed can cost you thousands of shekels upon retirement.

The first common mistake is that people have no idea what pension plan they have or how much they can expect to receive as a pension, as with my client.  This information is crucial for financial planning.  Governments around the world have shaken off their responsibility for providing pensions.  The Bituach Leumi old age allowance is a pittance; no one can live off just this amount.

Therefore, making sure that you have a good pension scheme is now your responsibility.  Understand your pension policy.  Meet with your insurance agent once a year for an explanation and review of your policy in a language and terminology that you can comprehend.  Always take notes in this meeting.

The second mistake that I have found applies to everyone but especially to the self-employed.  In 2017, a law passed mandating that all self-employed people must pay into a pension scheme.  However, the self-employed do not save enough. The earlier you start saving, the more compound interest you can earn on your pension.  Yoram Leviant, a pension planning expert and a colleague of mine in the Israeli Union of Family Financial Advisors, explains that 50% of the amount that you will receive as a pension comes from the amount saved between the ages of 27-37.  Between the ages of 38-47, that declines to 25%; the remaining 25% is saved from 48-67 years of age.  Therefore, it is vital that every working person, whether just starting out or not, have a pension and maintain contributions throughout their career.

The third mistake is that when unemployed, or on unpaid vacation leave like during the Coronvirus crisis, people do not continue to make monthly contributions to their pension fund.  If the fund does not receive payments for a period of 6 months it becomes permanently inactive.  This means you will have to start a new pension fund when you return to work.  During the Coronavirus crisis, the government has extended this 6 month period that the policy can be frozen to 12 months.  IMPORTANT:  if this applies to you, the grace period will expire in March 2021 and action needs to be taken immediately. During the grace period most insurance agents will recommend that you just pay the risk portion (your life insurance), since this sum is normally quite low.  However, I recommend you also pay into your pension scheme. Let me illustrate the consequences of not paying into your pension fund.  The following calculation is prepared by Beni Schuri, also a member of the Union of the Family Financial Advisors.

Let’s say that your salary is NIS 10,000 and the combined monthly payment to your pension fund, from you and your employer, is NIS 2,083. If the fund does not receive any contributions for 6 months, the immediate loss is NIS 12,498.

Let us now calculate how much you will lose in the long term.

Your salaryNIS 10,000
Amount not deposited for the 6 month periodNIS 12,498
Age 57 – 10 years before retiringNIS 12,087
Age 47 – 20 years before retiringNIS 35,865
Age 37 – 30 years before retiringNIS 82,639
Age 27 – 40 years before retiringNIS 174,652

*Yield is calculated on the basis of the average of 7%

The current formula is that you receive NIS 500 in monthly pension payments for every NIS 100,000 accumulated in the fund. Therefore, not paying into the scheme has quite an impact on your monthly pension allowance. 

Also, it is imperative that when you start work again and especially now, after the coronavirus crises, you start paying into your pension fund immediately after the first month.  If you have an existing policy, the employer is required by law to pay into your pension scheme retroactively after the third month.  If you don’t have an active pension scheme or any pension scheme at all, a new pension policy needs to be opened, and the law does not require the employer to pay retroactively.  This means that you will lose 6 months of pension payments, which has a huge impact on your future monthly pension allowance, especially between at a young age, as illustrated in the chart.  If you were on unpaid vacation, your employer must deposit immediately from the date you returned back to work. Remember, wherever you work, whether you have an existing policy or are starting a new one, the pension should be paid from the first month and this should be stipulated in your employment contract.

The fourth and most common mistake is that people withdraw from their pension fund before retirement.  Here in Israel, the pension is divided into three parts:  Life Insurance, Pension, and a Severance Fund.  Together, the pension and severance fund comprise your monthly pension. If you are fired, the employer is required by law to pay severance.  If you quit, most employers will release the severance fund.  How much severance pay are you entitled to?  The formula is the last pay check multiplied by the number of years you worked.  For example, if you worked for 10 years and your last salary was NIS 10,000, you are entitled to NIS 100,000.  If you started at a lower salary, the compensation fund will not have the full NIS 100,000. People make the common mistake of withdrawing the amount in the severance fund to which they are entitled to from the current place of employment. 

Let me illustrate how important this is with a parable I heard as a child.  A farmer agreed with the lord of the manor that for every bushel of wheat produced, he would place a coin in a bowl so that they could count how many bushels there were.  Half way through the harvest, the farmer saw the bowl filling up. Angered at the sight, he said, “I need this money,” and took some of the coins back.  He did not replenish the coins taken and at the end of the harvest the lord of the manor counted the coins and paid the farmer a gold coin for every coin in the bowl.  By withdrawing the coins during the harvest, the farmer lost out in the long run. It is the same here:  do not withdraw funds from the severance fund, since you will receive less in your monthly pension upon retirement.

If you do have to withdraw from the severance fund, I would highly recommend going to the Income Tax Office to see how much tax you will need to pay on the amount.  Nobody likes to go the Income Tax Authorities, but here it can work to your advantage as they will do a Te’um Mas (tax coordination) to calculate how much tax you need to pay.  Research has found the people from the low social economic scale do not do this and they paid too much tax.

The last and final mistake:  when you leave your place of employment you will receive a 161 form from your employer. The 161 form proves that you have worked and that your employer made all the relevant financial contributions.  When you receive this form, put it in a safe, right alongside your will.  You will have to show all of the 161 forms issued during your working life to the tax authorities upon retirement.  Just try contacting the employer when the business has closed, so never throw away the 161 form. 

To summarize, in the 21st century pensions need to be pushed up to top priority in financial planning.  I suggest that you follow these tips.  If you are employed, check that your monthly salary slip reflects pension payment deductions, and make sure that the percentage is in compliance with your employment contract.  Every year, when you receive the annual pension report from the insurance company, make sure that the relevant amounts were deposited into your pension fund.  Also, when reviewing the report, check that you are paying the correct amount in management fees, since this also has a huge impact on your pension.  Remember to sit with your insurance agent once a year.  If you are self-employed, pay as much as you can into your pension fund and start as early as possible.

With my 47 year old client, I recommended that he sit with a reputable pension advisor to help him plan his pension, since there is no time like the present to start planning.  This meeting will enable my client to enjoy a financially secure retirement and live out the rest of his days in comfort, just as he deserves.  And so do you!