Retirement represents decision time on pension investment options

Retiring used to be easy. After paying into a pension plan for years, you either received a defined amount based on salary and years’ service or invested in an annuity which paid out a fixed amount.

However, since 1999 there has been another option – the approved retirement fund (ARF). Suzanne Cashin, head of retirement asset services at Brewin Dolphin Ireland, explains: “Rather than purchase an annuity or pension, an individual can take the balance of their pension fund in cash – subject to income tax under Schedule E – or invest it in an approved retirement fund or approved minimum retirement fund [AMRF], as appropriate.

“These options, which apply to that part of a pension fund remaining after the drawdown by the individual of the appropriate retirement lump sum, are collectively referred to as the retirement options.”

Drawdown

“When they brought in the ARF it gave you an opportunity to take your lump sum but then invest the balance in an investment vehicle. Before February 2011, only proprietary directors with 5 per cent or more shareholding could access the ARFs, so it was seen as an elitist vehicle. They’ve opened it up since then and everyone has the ARF option at retirement,” says Paula Finlay, director of pensions at Davy.

“The basic rules of ARFs are you access the lump sum and transfer the residual balance into an ARF product and once it’s in there it’s a post-retirement structure, so you can’t make any further pension contributions into an ARF,” says Finlay. “From age 61 onwards, you’re forced to take an income from the ARF of 4 per cent per annum up until age 71, when it increases to 5 per cent.

“The good news,” Cashin says, “is that all investment returns in an ARF are tax-free, so if you invest in shares, the dividends are flowing back into the ARF tax-free, or if an investment is sold there is no capital gains tax.” However, drawdowns are taxed as income, and subject to PAYE, PRSI and USC or depending on the recipient’s age.

Minimum requirements

When ARFs were originally introduced, the government was worried people would withdraw all their money at once and be left with nothing, so instituted the AMRF, to ensure a minimum level of income in retirement. Stephen McCormack, head of financial planning at, Willis Towers Watson, says, “If the individual doesn’t have a guaranteed income of €12,700 at the point of retirement then the first €63,500 must be invested in an AMRF until such time as the individual satisfies the requirement. Guaranteed income includes the State pension and any other pension/annuity which is guaranteed payable for life.

“The State pension, which only becomes payable at age 66, currently satisfies this requirement but for those individuals who draw down benefits before age 66 they must set up the AMRF as they are not in receipt of it at the point, unless they have another private pension which satisfies this rule.” Once the State pension becomes payable at 66, the AMRF effectively becomes an ARF and is subject to the same income drawdown requirements, he says.

Pros and cons of ARFs

Cashin explains how the combination of “historical low returns on bonds and cash deposits alongside the increased life expectancy rate of retirees” have resulted in all-time low annuity rates. “As a result of this, many clients are opting for the ARF, with the benefit of knowing that if in the future annuity rates increased, or their circumstances change, that the ARF can always purchase an annuity, but if they opt for an annuity then there is no option to change this at a future stage.

“We have seen historically good returns on all investments over the last 10 years, which means that for most ARF investors who have invested in a fund with equities they have not been eating into the capital value of their funds to meet the mandatory ARF drawdown that they must take each year if they are over age 61.”

The other benefits are flexibility and control over the post-retirement ARF, the potential for the fund to continue growing due to investment, and the fact that the recipient can choose the level of income they want to take each year, subject to a minimum annual withdrawals, and that when the ARF holder dies the residual fund can pass to a spouse or civil partner tax-free who can continue to manage the ARF investments and take withdrawals.

One of the few downsides, according to McCormack, is the possibility that the pot could run out. “Depending on the amount you draw down and how it performs it could bomb out and leave you with no capital and then the income payments would stop.” Advice is essential, he says. “Post-retirement funds need as much if not more advice on an ongoing basis to ensure the funds that you’re in are still fit for purpose.”

How to best invest

When planning how to invest the ARF, McCormack says it’s important to think about risk versus reward. High risk can lead to high reward, but investments can go down as well as up. “The best approach is to make sure the ARF you’ve chosen fits into your income expectations. Bearing in mind the minimum may not be as much as you require. Make sure the underlying investments are fit for purpose and fit in with your appetite for risk.”