Pension cut by negative rates and tax bill
Q I recently retired after 40 years in the public health service. I opted to take out an Additional Voluntary Contribution (AVC) to have as security for my wife and family should anything happen to me.
Prior to retirement, I was advised my AVC was worth €90,000. I then met a financial adviser and was advised I could draw down €9,000 and put the remainder in an ARF or an annuity fund. I opted for the ARF. Only now do I realise that if I wish to withdraw money from the ARF, it will be subject to tax at 40pc, PRSI and USC (Universal Social Charge) - reducing my €81,000 to €40,500. To make things worse, I recently received a letter from the company with whom I have the ARF informing me that since Jan 1, 2018, negative interest will apply to my account balance. My adviser has said that I could avoid these losses by investing €65,000 in a German property fund. I am at a loss as to what to do. Can I invest this €65,000 in an Irish government bond, such as a National Solidarity Bond - or would I still be liable for the tax, USC and PRSI?
If your intention is to use this fund to provide an inheritance for your family, then holding as much of the fund as possible in the ARF could be a very tax-efficient way of leaving an inheritance. However, there is an "imputed distribution" applied to the ARF each year, which means that it makes sense to draw that amount from the fund each year.
The income from your ARF will be subject to your marginal rate of income tax, PRSI until you reach State pension age, and USC. So, assuming that your income exceeds the cut-off point for the standard rate of income tax, you could have to pay deductions of almost 50pc as you say.
If you were to die, then the funds within your ARF could be passed to an ARF in your wife's name tax-free or passed directly to your children.
Income from an annuity would also have been subject to income tax and USC. It is likely that the ARF provided you with the best option to provide an inheritance for your family.
It sounds like your funds are invested in a cash fund and it is true that those funds are currently providing negative returns. This reflects the fact that interest rates in most banks are near zero and I believe that some of the most creditworthy institutions can charge to hold funds, as they present a very low credit risk. You will only be able to avoid a reduction in your ARF if you move to a different fund that generates an investment return in excess of the fees being deducted and the amount being paid as drawdown each year.
You need to balance your desire for a return on your funds with the investment risk you are prepared to take and your adviser will be able to help you with that decision. Investing in a property fund would bring increased risk, but also possibly bring returns to your fund. There are a few key questions to ask on your German property funds.
First, is the fund leveraged (or geared)? If it is, it means the fund has borrowed money and it may have to repay interest and principal to the lenders before you would get any return, which means you have a higher risk of losing all of your investment.
Second, will the fund hold a variety of properties to spread the risk and are those properties of a high quality? Remember that, as the investment will be solely in German property, it is fully exposed to the fortunes of that market.
Third, what are the conditions to access your investment? Some funds may not let you withdraw until a specific time in the future. This is particularly important if you think you may need the funds in the near term. Fourth, do the fees for investment seem reasonable? Fifth, what return is it expected to generate?
The property fund could be a profitable investment. However, it would be unusual to place such a large proportion of your investment in a single fund focused on one particular asset class. We suggest that you look at a more diversified portfolio spread across a number of different asset classes. Your ARF provider is likely to have a range of funds to meet that need. Speak to your adviser about what your long-term objective is for your ARF and examine the options available to improve the returns on your funds.
Unfortunately, the State savings funds or solidarity bonds are only available as investments outside of your pension, so would only be available if you withdrew your funds from the ARF. You could invest in an Irish government bond, although similar questions would remain as to whether that is sufficiently diversified and what the expected returns are after costs.
Drawing down pension at 50
Q I worked with a leading financial institution from 1998 until I took voluntary redundancy in 2015. I benefited from a defined benefit pension scheme at the company until it was disbanded for a hybrid type scheme just before I left. I joined at the age of 22 in 1998 and my pension documents refer to my deferred pension retirement date as 2041, when I will be 65. I understand that with defined contribution pension schemes, you can draw down the retirement benefits from your pension at the age of 50 - on agreement from the trustees of the scheme and from your former employer. Could I do this with my pension?
You are correct that Revenue will allow you to draw your pension from the age of 50. However, the key question is whether the scheme rules will permit you to draw it down. In most cases, trustee consent is required to start your pension before the normal retirement date - which looks to be 2041 in your case.
As your pension is a hybrid, it will have both a defined benefit and defined contribution element. There would not usually be any issue taking a defined contribution pension early, as you only avail of the fund in your retirement account. However, for a defined benefit pension, permitting people to retire early can have knock-on financial implications for the other members of the scheme, as pensioners have a higher priority in the event of a scheme wind-up. For this reason, it is unfortunately very common at the moment that early retirement is not allowed from many defined benefit schemes.
As you have both types under this pension, you can only draw your pension when both the defined benefit and defined contribution are permitted to be paid, as Revenue requires all pensions from the same employment to be taken together. Therefore, you are dependent on both sets of trustees allowing you to retire early.
I note that you are 42 at the moment - therefore, it may not be possible to get a definitive answer from the trustees now as to what they would permit in eight years' time. However, you should ask them if early retirement before age 65 is available. You can also ask for an estimate of the pension available if they did permit you to retire early but there is no obligation on the trustees to provide estimates of early retirement benefits at different ages.
If you are in poor health and unable to work, then some schemes provide an early retirement pension even before the age of 50.
If retirement is available before the age of 65, whether you take your pension early or not depends on your needs at the age of 50 compared with your expected needs in the future and the cost of taking the pension early. Your pension is likely to be materially lower (possibly more than 60pc lower) if you start at the age of 50 rather than waiting until age 65. However, this reduction varies from scheme to scheme, so you need to assess it based on the actual amounts.
Taking a pension early can be attractive, as the pension would be paid for longer, but ultimately the value for money you get depends on how long you live and the reduction to the pension for drawing it early.
Trevor Booth is head of financial planning with Mercer
Sunday Indo Business