- Friday 20 March 2020
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How is your ARF Pension Affected By Current Equity Markets?
For all sorts of investors, these last few weeks have been a time of extreme anxiety and worry. Despite the ‘technical’ reassurances we get from market history, which shows us that an eventual (and often quite dramatic) reversion to positive returns is inevitable, it can still be very difficult to see beyond current losses and fears that they may be long term and terminal.
The group most affected by market losses of this scale are usually those, ironically, with the most cautious view of risk and often the largest amounts at risk – retirees. In recent years, as most people choose to move away from the Annuity income option presented at retirement and instead opt for the Approved Retirement Fund (ARF) approach, a new generation of long term investors has arrived to the market, often without sufficient guidance about ‘Bomb-Out Risk’ or understanding of what type of ‘Drawdown Strategy’ is appropriate, now and in general. With that in mind, the following is a short Q&A for ARF (and other pension) holders to explain what options you have.
Remind Me, What is an ARF Pension?
- At retirement most private pension holders are offered a choice to take a fixed, guaranteed income for life, known as an Annuity, or transfer the balance of their pension (after withdrawing the Tax Free Lump Sum) to an Approved Retirement Fund, from which you must take a minimum of 4% every year (5% from age 70).
Why would I choose an ARF over an Annuity?
A Couple of reasons:
- At present, Annuity Rates (the level of income your fund will give you) are terrible. A pension pot of €250,000 might only pay you €7,500 per year.
- Most retirees prefer the flexibility that an ARF gives. You can take as much or as little (with the 4% minimum) as you like, which better suits the average post retirement lifestyle. Indeed you can fully cash in your ARF if you like (though that wouldn’t be advisable)
- On death, even within the first year, the annuity goes with you. Your spouse may get a % for their lifetime, but after that it’s gone. An ARF is fully transferrable to your spouse and forms part of your estate on death.
So, it’s a no-brainer then, yes? Risk Free?
- Not quite. While you do get the benefits of flexibility and, usually, access to more income in your lifetime than an annuity can give, there are a few things to be careful of, as we are seeing now.
- First, you have to put €63,500 into an Approved Minimum Retirement Fund (AMRF), which you can’t touch until 75. That’s significant if you don’t have a big pot in the first place. Thankfully with recent increases to the state pension, this rule is less impactful for most people (your advisor should explain) but it is still worth noting.
- More significantly, owning an ARF introduces 2 concepts that you absolutely have to know. ’Bomb-Out Risk’ and ‘Drawdown Strategy’
- If you go with an ARF strategy, the state effectively says, ‘you’re on your own’. As I said above, you are fully entitled to immediately cash out all of your ARF pot (paying whatever income tax is liable by the way – all withdrawals from an ARF are considered income), spend it frivolously, albeit enjoyably, on horses and wine, and live out the remainder of your life as a pauper.
- Or, more likely unfortunately, you end up in a bad investment and the whole thing is wiped out.
- In both cases you end up in a situation where the ARF has not done its job of providing you with an income for life. This is the Bomb-Out Risk.
And What is a ‘Drawdown Strategy’?
- To avoid ‘Bombing Out’ of your fund you need a sensible strategy to ensure you get the most out of the pot for the longest possible timeframe, which, these days, could be 35 or more years in some cases.
- Ideally you will engage with a Financial Planner rather than just a pension salesperson. Building a financial plan on retirement is very sensible as you have one key question that needs answering by a professional – ‘how much can I spend so this lasts’?
- Based on your realistic needs, a yearly ‘drawdown’ of the fund can be agreed. After that it’s a question of building an appropriate investment strategy that delivers that drawdown.
So how do I Invest Properly?
- Whatever your income needs, an investment strategy should be robust enough to survive periods like the one we are going through.
- This means that there is sufficient cash or other low risk assets to provide the drawdown amounts, without you having to cash out of equities when they are taking a hammering.
- Ideally this means having some form of ‘Self Directed’ scheme, where the individual investments or assets can be accessed one at a time, rather than all together.
- Unfortunately most ARF Funds in this country operate within a single fund approach, meaning that, irrespective of your investment strategy, each drawdown will take money from the overall pot – all assets included. That can result in equities being sold at a time, like now, when the should be held.
If you have an ARF and you’re worried about the impact of the markets right now, speak with an impartial and/or fee-based advisor. You should have sufficient cash or bond reserves to cover income/drawdown over the next 12-18 months without having to liquidate equity assets at their current low prices, and should ensure that the instruction to do so is clearly given to the ARF company.
Contact us today if you have any questions about your ARF or other investment matters.