Pension power
As life expectancy increases, careful monetary planning is becoming more and more important. The Approved Retirement Fund is an option that should be available to more, writes Shane Gill
Looking ahead: model Nikki Bonass pictured with her mother Maggie Twomey at the recent launch of pensions research published by Zurich Life, which showed that almost 60pc of 24 to 34-year-olds surveyed had not started a pension
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One of the less publicised aspects of the Commission on Taxation report was a recommendation that the Approved Retirement Fund (ARF) option become more widely available.
The report gives further support to the concept of self-managing your pension assets as a viable alternative to the traditional annuity.
An annuity is a product sold by an insurance or other financial services company. In return for handing over a one-off payment, the company then pays over regular sums until you die.
An ARF, meanwhile, enables an individual to hold pension-fund assets in a tax-efficient manner after retirement.
The ARF option is available to individuals with personal pension plans, personal retirement savings accounts (PRSAs), to proprietary directors in most cases and on additional voluntary contributions (AVCs) to company pension plans.
Provided an individual is in receipt of an annual annuity for life of €12,700 per annum, or can set aside €63,500 in an Approved Minimum Retirement Fund (AMRF), an individual can opt to transfer their accumulated pension fund entitlement to an ARF.
ARFs are provided by qualifying fund managers (QFM) appointed by the Revenue Commissioners.
Options
Withdrawals from the fund are subject to tax, and, where no withdrawals have been made in a given tax year, a distribution of 3pc is deemed to have been taken and tax is payable.
To illustrate the two different options I will use a simple example of an individual, aged 60, retiring with €1m in his personal pension fund.
The current annuity rate is approximately 6.5pc for a male, therefore a life assurance company will in exchange for a €1m up front premium agree to pay a gross annual pension of €65,000 paid monthly, subject to income tax deduction for life.
A guaranteed five-year payment period is included and continues until death whether in five or 50 years' time.
The Central Statistics Office life expectancy tables published earlier this year state the life expectancy of an Irish man aged 60 is 20.56 years.
Using this timeframe, the life company pays out an estimated €1.3m based on a fixed pension of €65,000 a year for the 20 years against the original €1m premium received.
This illustration ignores any investment income earned by the life company on the upfront premium received.
Clearly, death in the early years will result in a significant profit for the life assurance company, whereas living to the age of 100 could result in a net loss.
On the other hand, the ARF option requires the retired person to prudently invest the €1m to ensure that a combination of the annual investment income from their investment portfolio together with capital drawdowns can provide a cash flow that approximates to the annuity for at least 20 years and conservatively beyond.
The best outcome for our retired person is, of course, one where his ARF is invested in a robust manner that delivers an average annual return of 6.5pc a year during his lifetime.
In this win/win scenario the income is drawn down every year while preserving the capital which is then available to next generation upon death.
A similar mandate has been successfully achieved by David Swenson of Yale, while somewhat challenging to replicate, his endowment fund has nonetheless not only delivered substantial income annually to the university but has also increased in value.
It is also worth noting that much of this success is attributed by Swenson to the ability of the fund to take a long term, 20 to 30-year investment view.
Another way to assess the value of an annuity is to understand the return or income being offered from a risk-free investment.
The current yield or income available on a 20-year German government bond is 4.14pc.
Therefore, the €1m placed in the annuity, is being given up to achieve an additional 2.36pc per annum. This highlights the difference in possibilities between the two.
The ARF does bring with it a real risk that a combination of poor investment decisions and large capital drawdowns would result in the fund being exhausted before death, leaving the pensioner reliant on the State.
The annuity removes uncertainty and guarantees a defined level of income until death, but at the cost of the loss of capital.
The ARF offers the possibility to preserve wealth while still achieving a reasonable income level of income.
In practice, the differing personal circumstances of a client, including his wealth, health and lifestyle, will dictate whether the ARF is appropriate, but the bigger question facing the Irish Government is whether the ARF option should be open to everyone.
I believe that it should, but would increase the minimum capital thresholds and guaranteed minimum retirement income levels before widening the availability of ARFs.
My role is to preserve my clients' wealth, not the profits of life assurance companies.
- Shane Gill is an associate director of Key Capital Private, and a qualifying fund manager.
Irish Independent
