Uh oh, Barry is talking about pensions and retirement and all that stuff we should be thinking about but prefer not to. Fear not, if you are approaching retirement this piece will give you an easy to understand helicopter view of your options when you down tools and head for lazy days of retirement.
By now, most people are well aware of the Importance of putting aside money for their Retirement and the very attractive Tax reliefs available for doing so.
Many clients I talk to are still blissfully unaware of how they will actually access this money when they do finally reach their retirement age.
Questions such as, is it all Tax free? Do I have to buy an Annuity? Will I have to pay income tax when I draw down my pension? are not uncommon.
Deciding how to access your Pension Benefits is probably one of the most important financial decisions many people will make in their lifetime and certainly one that requires due consideration. Let’s face it, the options are unnecessarily complicated, and there are a bewildering range of products to choose from, not to mention the fact that you are expected to make these decisions during a period of change and upheaval in your life. In an effort to better help you understand your choices, below is a brief summary of some of the options available.
The Tax Free Lump Sum
Firstly, everyone is allowed to take a portion of their Pension fund as a Tax Free Lump Sum (TFLS), however exactly how this Lump sum is calculated may vary depending on your circumstances, if you have more than 20 year service then you have the option to take 1.5 X times your final salary as a tax free lump sum, assuming you have enough in your fund.
This can be a very efficient particularly if the fund is relatively small and close to the 1.5 X times Salary amount.
The alternative means to calculate a Tax Free Lump Sum option is 25% of the total fund value. This option is more common particularly for someone with a larger Pension pot, however some limits do apply. The “tax free” element of the lump sum is limited to €200,000. Any Lump sum which you take over and above €200,000 is taxed at a special rate of 20%.
Once tax free cash has been taken from the fund, the next decision is how to draw down the remaining funds. This is the more complicated part and depends on a number of factors. The main options are as follows:
An Annuity is when you pay over the remaining funds to a life assurance company and they promise to pay you a pre-agreed annual income for life.
The main advantage of an annuity is certainty of income while you are alive. You will never run out of funds and always have this income with an annuity, even if you live beyond 100. However, Annuity rates are linked to long term interest rates, so they are quite low at the moment and may represent poor value for many retirees.
For example, A 65 year old single male can expect an annuity rate of approx. 4%, (basic annuity rate with Aviva, no additional benefits). Adding any of the additional benefits will further reduce this rate. This means the life company will pay you a fixed income of 4% of the fund each year until death, in other words in this example you would need to be in receipt of the Annuity for at least 25 years (until age 90) just to recoup your own money.
The biggest risk with an annuity is if you live a short retirement life. If an individual dies soon after retirement then the entire fund might be gone, unless there is a ‘spouse’ pension or ‘guaranteed period’ included.
Approved Retirement Fund – (ARF).
The alternative to an annuity is an ARF. This is a post retirement investment fund that allows the individual to maintain control of their Investments, an ARF is treated like a post
Retirement pension fund. Any growth in an ARF is tax free however any withdrawals from the ARF is considered Income and will be taxed at your marginal Income tax rate. There must be a minimum drawdown of 4% pa from an ARF every year from age 61 (5% pa if you’re aged over 70) the main risk with an ARF is the possibility of running out of money. With an annual drawdown of 4% or 5%, it’s quite possible the fund could “bomb out” in as little as 15-20 years. Investment growth can protect against this longevity risk somewhat but also, any fall in investment performance could shorten this period.
If you choose to invest in an ARF at retirement then you may also have to invest €63,500 of your total amount into another fund called an AMRF (Approved Minimum Retirement Fund), this is only required if you do not have a guaranteed pension or annuity income of €12,700 per annum.
The €63,500 must remain invested in the AMRF until age 75. The idea here is to insure you have a protected minimum fund until age 75 which can then be used to generate a regular income thereafter
Segmenting your Pension
Another possible options which is not widely used but may be beneficial depending on your circumstances is to Segment your Pension. Simply put, this allows you to divide your pension pot into a number of smaller PRSA pots and retire each pot if and when you need it over a period of time. While there are a number of benefits to this approach there are also very strict criteria to determine who is eligible.
As you can see, Retirement drawdown is potentially a very complicated area and definitely one where you should seek professional advice, after all you only get one chance to do it right. Many of the decisions regarding how you access your benefits cannot be reversed so be sure to do your research in advance.
All details and views contained within this article are for informational purposes only and does not constitute advice. Wealthwise Financial Planning makes no representations as to the accuracy, completeness or suitability of any information and will not be liable for any errors, omissions or any losses arising from its use.
Good and all as Barry is and clear and all as this article is these are big decisions that need to be made. You know we always recommend people should engage would good advisors and financial planners. Approaching retirement is one of those times an advisor is worth their weight in gold. Go call yours and set up a meeting, don’t have one? Don’t worry contact Barry or pick one from our contributors page. Most planners offer a free first meeting.