The extension of Approved Retirement Funds (ARFs) to all members of Defined Contribution pensions has changed the pensions landscape for employees who are members of their employer’s pension scheme. No longer is there a requirement to hand over your fund at retirement to purchase an annuity. The capital value that you have accumulated throughout your working life can become your fund to provide you with flexible income options in retirement. Moreover, any funds remaining on your demise become an asset of your estate.
So how can the pension increase your net worth?
Traditionally members of their employer’s pension scheme had to take up to 1.5 times their salary as a lump sum on retirement. The first €200,000 of this was tax free. The balance was used to purchase an annuity with an insurance company. This provided an income for your life, and if required you could opt for a reduced pension to provide for a spouse’s pension on your demise and/or annual increases on the pension in payment.
Since 2011, employees also? – ‘as well as company owners’? have had more choice than ever at retirement. Alongside the traditional annuity option, they now also have the option to take up to 25% of the value of the fund as a lump sum and the balance transferred to an Approved Retirement Fund (ARF).
The ARF option keeps your pension invested, and gives you the flexibility to dictate your retirement income. The amount you receive will be determined by the fund’s performance and your needs. ARF income isn’t guaranteed for life, however there’s no cap on how much you can withdraw at any given time – provided funds are available and you have a minimum guaranteed income from other sources such as the State Pension.
Capital Invested v Annuity Purchase
The main difference between an ARF and an annuity is ownership of the capital sum built up in the pension at retirement. After you have taken your lump sum, the capital is invested in the ARF. How you invest your ARF will depend on your personal circumstances including life expectancy, your retirement goals and risk appetite – but you own and control the capital. With the annuity, you hand over the capital to an insurance company in return for the promise of an income for life. With that in mind, let’s look at some of the differences between an ARF and an Annuity.
The ARF is widely considered to be more flexible than an annuity, but it can carry greater risk. With an ARF you can move your money into one or more funds and adjust the amount and frequency of your withdrawals.
It’s possible to apply a test and learn approach based on fund performance, and your retirement income has the potential to increase. However, if your fund isn’t managed carefully your money could run out in retirement.
Annuity
An annuity provides certainty of income in retirement, but lacks the flexibility ARF drawdowns can provide. Once you purchase an annuity there’s no turning back – income amounts and payment frequency are set in stone so it’s essential to ensure you purchase the right annuity to suit your needs.
Longevity
ARF
With an ARF there are no guarantees the income you draw will be stable for an extended period of time as when you reinvest your pension savings they become vulnerable to market performance.
Annuity
Annuities, on the other hand, can be used to guarantee an income for various periods of time. A lifetime annuity is used to provide a regular income for life, and will continue paying out no matter how long you live.
Inheritance
ARF
On your demise any balance remaining in the ARF can pass to your estate. If it passes to your spouse, they step in to your shoes and can continue to draw an income from the ARF. If it passes to your child, it is taxed depending on whether they are under or over age 21 and is no longer within the pensions system.
Annuity
The type of annuity you purchase will determine whether it continues to pay out after you die. If you purchase a single-life annuity it will only pay an income to you, the sole beneficiary, and after you die all remaining funds will be kept by the insurer. However, if you purchase a joint-life annuity you can nominate a spouse or partner to receive income payments on your behalf until they die.
The changes allowing employees take ownership of the capital in their pension fund at retirement have been in place for almost a decade now. However, many employees do not fully understand the options available to them at retirement and how the value they have built up tax efficiently in their pension can become a personal asset in retirement. If you want to leave a cash lump sum to your family should you die early in retirement, or if you want flexibility over the income that you draw down in retirement, you should consider an ARF at retirement.
Own Your Pension Fund at Retirement – To discuss the options available to you and how they might affect your retirement objectives, please contact us at 01 2375500 or email justask@harvestfinancial.ie.
This marketing information has been provided for discussion purposes only. It is not advice and does not take into account the investment needs and objectives, financial position, risk attitude, liquidity needs, capital security needs and/or capacity for loss of any particular person. It should not be relied upon to make investment decisions.
