Approved Retirement Fund (ARF) versus Annuity – what should you do?
A few weeks back I penned a blog on your retirement options, you can read this here.
After you maximise your tax-efficient retirement lump sum you are left with a decision of:
- Invest in an Approved Retirement Fund (ARF) or
- Purchase an Annuity
Deciding on which option to opt for will have a significant bearing on your retirement.
With modern medicine and longer life expectancy, this means our retirement is longer, therefore we have longer to plan for financially.
Therefore it’s important to get this decision correct first time.
Both the Approved Retirement Fund and Annuity have advantages and disadvantages in their own right and are two very different options.
Your individual circumstances will dictate what’s the best option for you so as always – seek advice.
If you are approaching retirement or assessing your options, this blog will be of significant benefit.
If retirement is still a bit away for you, this will still be informative for you to see the potential end options for your pension.
Approved Retirement Fund (ARF)
What is an ARF?
An ARF is a tax-efficient post-retirement investment vehicle.
You transfer the balance of your pension after you withdraw your tax-efficient retirement lump sum to your ARF.
Investing in an ARF means you remain invested in the markets beyond retirement and you retain control of your fund.
This invests much like a pre-retirement pension, the difference being you are now drawing an income from it.
An ARF is typically available to the following:
- Members of an Occupational Pension Scheme
- Those who hold a Personal Pension
- Holders of a Personal Retirement Savings Account (PRSA)
- Those who hold a Personal Retirement Bond (PRB)
Approved Minimum Retirement Fund (AMRF) / Guaranteed Income Requirement
Before investing in an ARF, you must meet one of the following requirements:
- Have guaranteed income for life of €12,700 per annum* or
- Invest €63,500 in an AMRF
*The only form of ‘Guaranteed Income’ is pension income and the State Pension contributes to this.
Advantages of an ARF
- Flexibility and control of your income – subject to a minimum income drawdown of 4% of the value from age 61 onwards and 5% from age 71 onwards
- You can preserve the value of your capital (subject to investment risk)
- The ARF investment grows tax-free
- Your investment is matched to your risk tolerance and capacity and your individual investment & income objectives
- You can purchase an annuity at a later date if your circumstances change
- When you die the balance of your funds pass to your estate – it can be passed tax-free to an ARF in the name of your spouse/civil partner
Disadvantages of an ARF
- Investment risk – your funds will fluctuate in line with investment markets and your investment strategy
- Your ARF could potentially run out if you combine poor investment returns with high-income drawdowns
- Stock market volatility has an effect on your ARF
- Unlike a pre-retirement pension, as you draw an income from this investment, sequence of returns risk is a factor
- There is a requirement to manage the investment strategy and ensure income sustainability
- Ongoing annual management fees apply, typically between 1%-1.5%
What can an ARF invest in?
An ARF can invest in pretty much any asset class, cash, actively managed funds, passive funds, ETF’s, direct stocks and property.
Find out more about our investment philosophy.
ARF Income
Before age 60, there is no requirement to draw any income from your ARF.
From age 61, you must draw 4% of the value as an income to satisfy Imputed Distribution requirements.
From the age of 71, this 4% increases to 5%.
If your ARF is greater than €2,000,000, this minimum drawdown requirement is 6%.
ARF income is normally drawn on an annual or half-yearly basis, but a lot of advisors don’t say and as a result, clients don’t know that ARF income can be drawn per month.
Annuity
What is an Annuity?
An annuity is simply a product which in return for your pension fund pays you a fixed income for the remainder of your life.
This is provided by an insurance company, you give them your money, they pay you an income.
Those who have a really low appetite for investment risk would find this beneficial.
Annuity Terminology
Some common terminologies around annuities are as follows:
Single Life Annuity:
This is payable to the annuity holder only until the date of their death when it ceases.
Joint Life Annuity:
The annuity pays till the date of the annuity holders death and then pays to the surviving spouse, civil partner or dependent (nominated at outset).
The % paid to the surviving spouse, civil partner or dependant is typically 50% or 100% of the annuitant’s pension and is set at outset.
Enhanced Annuity:
In some cases, if an annuitant is in poor health, the annuity provider may pay an enhanced rate over and above the standard rate.
Indexation:
This is to protect against inflation. The annuity can increase each year.
However, in return for indexation, an annuity initially starts lower.
It can take over 20 years for an indexed annuity to reach the level of the annuity income if it wasn’t indexed.
Guarantee Period:
The guarantee period. Set at outset, normally 5 or 10 years.
This means if the annuity holder passes away within the first 5 or 10 years of the annuity, the annuity will pay to their estate until the 5th or 10th anniversary of the annuity and cease.
This guarantee period applies from the date the annuity commences, not the date of the annuity holders death.
Advantages of an Annuity
- Guaranteed income – You receive X amount of income per month/per annum for the remainder of your life
- No investment risk – stock market volatility won’t affect you
- Simple to understand
- Longevity – very good if you live long as it’s guaranteed for life
- Peace of mind if you are risk averse
Disadvantages of an Annuity
- Lack of access to capital – your pension money is no longer a personal asset
- Lack of flexibility – when the annuity is set up it cannot be changed in future
- The income ceases on death unless a spouse/civil partners provision is included
- Longevity risk – if you don’t live long the investment is lost
- Currently, historically low-interest rates are resulting in low income
Things to Consider
As I mentioned earlier, an annuity and an ARF are two very different options.
Here are some things to consider:
- What tax-free cash will you receive? – a quirk in pensions legislation means members of an occupational pension scheme may receive a higher tax-free lump sum from a calculation of salary and service with their employer which then forces them to purchase an annuity
- Do you have other income? – If you have other income – rental income as an example, this can reduce your reliance on a guaranteed income from an annuity
- How much income do you actually require? – What do you actually spend at the moment and how much income do you need (net of any tax) to match your lifestyle
- How long would your ARF last? – Because we’re living longer, we’re spending more. Your income drawdown and investment plan should match your objectives
Conclusion
This blog is a guideline only, to make you aware of the differences between and advantages and disadvantages of ARF’s and Annuities.
There is no one size fits all solution.
You should always speak to a fully qualified CERTIFIED FINANCIAL PLANNER™ to assist with your decision.
At Fortitude Financial Planning we have guided many clients through their options using our simple and jargon-free approach to advice.
Give me a call on 086 0080 756 if you require help or advice or drop me a quick e-mail.
Francis McTaggart CFP® SIA RPA QFA
Disclaimer: All content provided in these blog posts is intended for information purposes only and should not be interpreted as financial advice.
You should always engage the services of a fully qualified financial planner before entering any financial contract.
Fortitude Financial Planning Ltd will not be held responsible for any actions taken as a result of reading these blog posts.
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