TANSTAAFL - Part II

In the first part of this post, I tried to show just how expensive “free” consulting might be for you. My point here is simple - financial brokers have to sell you certain products, because that’s the only way they get compensated.

I stopped at the point where I showed the (very significant) difference in the final amounts you could accumulate in a private pension (most likely sold to you by a financial broker) and an independent investment into low-cost ETFs:

As promised, I’d like to look even further ahead, into what happens when you already reach retirement age and you’d like to start taking out money, rather than investing further.

At this point things get a bit more complex since a few different parameters have to be compared. But we can boil it down to the following points:

• Total portfolio size: how much were you able to accumulate? In other words, what is your starting point in retirement

• Withdrawals/monthly allowance: in a real life scenario, how much does the total amount translate into?

• Tax: on the gross amount you’re getting/withdrawing, how much tax you need to pay?

Now in a bit more details:

• Total portfolio size: this depends of course on the type of investments you’ve made (or were made on your behalf), market performance during the entire period, and, very important, the costs associated with your investment. High fees and commissions directly bite into your returns. Remember, if the total costs are 1%, and the market’s return is 7%, your NET return is only 6%. Beyond costs and fees, there’s one more very important point which is often overlooked:

It doesn’t matter who is managing your private pension plan, they cannot generate better results than the ones you can generate yourself.

• Monthly allowance/Monthly withdrawal - this one’s extremely interesting:

  • Private pension: This amount is determined by the insurance company with whom you have the contract. A minimum amount is often guaranteed already upon signing the contract, but the final amount might be higher, depending on how well your investments performed.But it also depends on all sorts of mysterious factors which aren't transparent enough and leave the insurer too much freedom to consider all sorts of costs and through this, decrease the final amount you’ll get.

  • Independent investments: here, you have of course complete independence. This however also poses a challenge: how to determine how much you can withdraw? This biggest risk of course is depleting your portfolio too soon (i.e. you’re still alive and need money, but your portfolio is all used up), leaving you with a real problem.This topic alone is worthy not of just one post but many, but for simplicity’s sake we’ll assume a so-called “safe withdrawal rate” of 3.5% of your portfolio’s value when reaching retirement age.

• Tax

  • Private pension: One of the strongest sales arguments in favour of such plans: if you choose to get your money in the form of a monthly pension allowance at the age of 67, you’ll pay taxes on 17% of the amount that is paid out to you. You read it right, only 17%. The rest is tax free. Note: it’ll be taxed according to your personal income tax, not as capital gains tax.

  • Independent investments: this one’s simpler. You’ll basically be selling pieces of your portfolio on a regular basis, and paying capital gains tax on the profits. The good news: If you invest into ETFs that track broad stock indices, i.e. S&P 500 or the MSCI world, you’ll enjoy a 30% tax exempt on profits, meaning only 70% will be taxed. In other words, an effective tax rate of 18.46% on gained profits. And, there’s an initial tax-free annual amount of 1,000€ per person or 2,000€ for couples.

It turns out, that even with the very significant tax benefit mentioned above, independent investing will still provide you with a higher net monthly allowance:

Gross and Net monthly allowance - Private Pension Plan vs. Independent Investments

At the end of the day, the logic behind all of that is simple: A Private pension plan, or any other type of additional pension plan, comes with significant costs, simply because there's a company behind it that needs to make a profit. To compensate for those costs, at least one of two things need to happen:

• They either generate significantly higher returns than what you could achieve independently. That's not the case. or;

• There are significant tax benefits which you wouldn't get otherwise - as we just saw, there are, but they're not enough, and the end result is still not as good.

If private pension plans do not generate better results over time, and even with their tax benefits your net monthly allowance is lower, why would you choose such a plan?

Remember how we got here? private pension plans and other similar products are extremely expensive. They are offered by financial brokers because they get hefty commission on selling them, and in exchange, they offer you free consulting.

Remember, if you're not paying for it, you're the product.

THERE AIN'T NO SUCH THING AS A FREE LUNCH.