Irish clients who are taking their retirement benefits and moving from ‘pre’ to ‘post’ retirement will often end up investing a large portion of their pension in an Approved Retirement Fund (ARF).
An ARF has some clear advantages over the alternative option, which is using the pension fund to purchase an Annuity – a fixed pension payable for life. Flexibility of income withdrawals, control over how your pension fund is invested, and a potentially advantageous impact on the value of your estate are some of these apparent advantages.
However, the ARF option
does not come without some potential disadvantages.
The ARF becomes a source of
income in retirement and the investment performance of the fund will impact
income levels and the residual value in the ARF. If charges and income
withdrawals consistently exceed the investment return; the value of your ARF
will decrease and eventually the fund will run out.
For some clients a low risk investment portfolio likely to produce a return that leads to a reduction in the value of their ARF over time will be appropriate. Other clients will accept a higher level of investment risk – and more fluctuation in the value of their ARF – aiming to achieve a return that meets income withdrawals and charges.
As well as Investment Risk, Sequencing Risk is another key consideration for ARF investors. Unlike with a pre-retirement pension; an ARF is a single investment and further ‘top-ups’ to the fund are uncommon.
Sequencing Risk is created by the particular sequence in which ARF portfolio returns are generated (i.e. weak or strong years for performance) and withdrawals are made from the fund. The timing of returns and withdrawals can have a significant impact on a client who depends on the income from their pension fund and is no longer contributing new capital that could offset losses.
Sequencing Risk is highest
in the earliest years of ARF investing, when both the portfolio value and the
client’s time horizon are at their greatest.
From the outset, it is crucially important that the aims and ambitions for the ARF investor are agreed and set out clearly. The principal items to be agreed include the level of income required in the future, the timing of that income and the level of annual savings that might reasonably be made outside the ARF on an ongoing basis.
As always, our advice when advising potential ARF clients is to stay balanced (through diversification), stay flexible (through appropriate liquidity) and most importantly, to stay invested.
