Pension Options for Retirement
What Are My Pension Options for Retirement
In previous blog posts I have discussed many topics covering investment performance, charges and commissions and the impact on pension funds. However, one of the most important financial decisions any investor will make is how to draw down their pension when they retire. The options are complicated, and there are a bewildering range of products to choose from. I will attempt to simplify the process in this blog to allow a quick reference for this important decision.
Any individual can retire from age 60, assuming they are in a strong enough financial position to do so. There are certain circumstances where you can access AVC’s or retire earlier than 60 but I will leave that for another blog. Just before this retirement date, there will be a Personal or Company Pension Fund which has been built up over a long number of years. For a self-employed individual the number of years’ service is not that important, but for an employee it can be critically important. I will assume for this blog that we are looking at Defined Contribution, as Defined Benefit pensions have less choice and a much simpler decision at retirement.
Draw Down Options
A) Tax Free Lump Sum
Firstly, Tax Free Lump Sums (TFLS) are limited to €200,000. The next €375,000 is taxed at 20% so the total limit is €575,000.
“An Employee has the option to take 1.5 Times Salary if they have more than 20 Years’ Service, and they have enough in their fund.”
This can be a very efficient way to take pension benefits, particularly if the fund is close to the 1.5 Times Salary amount.
The alternative Tax Free Lump Sum option is 25% of the fund value. For larger funds this is the more common option. The same limits apply.
Once tax free cash has been taken from the fund, the next decision is how to draw down the funds. This is the more complicated part and depends on a number of factors. The main options are as follows:
Annuity – You pay over the remaining funds to a life assurance company and they promise to pay you a pre-agreed annual income for life. This pre-agreed amount can include a wide variety of additional options, such as a ‘spouse’ annuity, annual increases and guaranteed payment periods. The main advantage of an annuity is certainty over income while you are alive.
“You will not run out of funds and always have this income with annuity, even if you live to 100.”
Annuity rates are linked to long term interest rates, so they are quite low at the moment. A 65yr male can expect an annuity rate of just over 5%, (Nil Commission, basic annuity rate with Irish Life, no additional benefits). Adding any of the additional benefits will reduce this rate. This means the life company will pay 5% of the fund until death. The main disadvantage with an annuity is a short retirement life span. If the individual dies soon after retirement the fund is gone, unless there is a ‘spouse’ pension or ‘guaranteed period’ added.
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 fund. Firstly, unless there is already €12,700 of guaranteed pension income in place, the first €63,500 must be invested in an Approved Minimum Retirement Fund (AMRF). Only the growth on this can be accessed before 75. The remaining fund is invested in an ARF and there has to be a minimum drawdown of 5% from this fund every year. The main risk with an ARF is the possibility of running out of money. With a min. drawdown of 5% per annum, the fund could be gone in 20 years. Investment growth can protect against this longevity risk but also, any fall in investment performance could shorten this period.
The commissions available on Annuities and ARFs can be significant, as can the on-going charges, so I would strongly recommend you talk to a fee based advisor before making a final decision.