Retirement Options Explained Part 2 of 3 – Approved Retirement Fund

Last week, we started Retirement Options Explained with Annuities. I am going to continue this week with telling you about the Approved Retirement Fund (ARF) option. The ARF was introduced in 1999 and has gone through a number of changes over the years.

What is an Approved Retirement Fund?

An Approved Retirement Fund is an investment just like your pension fund, except you can take money out of it. You can invest it in cash, equities, bonds, property – all the different funds that are available under a pension plan. And just like a pension plan, the fund grows tax-free but when you take your money out, you are taxed under PAYE.

As you manage the money yourself, there are no guarantees unlike the annuity option. If you take too much money out too quickly or your investments perform poorly, you may run out of money.

The Approved Minimum Retirement Fund

An Approved Minimum Retirement Fund (AMRF) was introduced at the same time as the ARF. It was introduced as a safeguard for retirees who will go out and spend all their retirement fund. If, when investing in an ARF, you are not age 75 or older and do not have a guaranteed income of €12,700 (which must consist of guaranteed pensions), you have to do one of the following:

  1. Purchase an annuity for that amount (or shortfall)
  2. Invest €63,500 into an AMRF
  3. Purchase an annuity for €63,500

In my experience, people usually go for option 2 and invest €63,500 in an AMRF. The rules of the investment is that you can only access 4% of the fund each year. When you reach age 75 or if you meet the €12,700 requirement before then, it converts to an Approved Retirement Fund and you can draw down as much of the fund as you like.

The AMRF itself is invested in the same manner as the ARF. You can choose your own investment funds and it grows tax-free.

Who can have an Approved Retirement Fund?

Originally, it was restricted to those with personal pensions, AVC’s and company directors with over 5% of the voting rights in their company. It was then changed to everyone who has a defined contribution pension plan. Member of defined benefit pension schemes are still excluded but if you transfer the value of a defined benefit pension to a Buy Out Bond, you can access the Approved Retirement Fund option through that.

How much can I take out of my Approved Retirement Fund?

From 1 January 2015, if you are under age 71, you must take 4% out of your ARF each year (it is valued as at 31 December of each year). If you do not want to do that, the Revenue will calculate the tax due on 4% of your fund and take it directly from your Approved Retirement Fund. If you are 71 or older, you must take out 5% of the fund. If your ARF is worth over €2m, you must take out 6% each year. This requirement does not apply to AMRF’s.

You can elect to withdraw your money at the end of the year or on a monthly basis where it is paid like a salary. It is important to have your tax credits applied to your Approved Retirement Fund so you don’t pay tax at the marginal rate on all of your withdrawals. If you wish, you can also cash it in at any time or take out lump sums and pay income tax on the withdrawal.

Warning: While legislation says you can take out lump sums whenever you want, the contract with your ARF provider might say otherwise. In a typical ARF contract, a provider will provide a bonus amount of 3% of the contribution, which the adviser may take as payment or add some or all of it back into the client’s policy instead. To protect themselves from having people getting this bonus and then transferring their money to another provider, most providers state that if you move your money in the first 5 years, a penalty will be applied. This allows them time to recoup the bonus money they have paid out. If you don’t want this penalty, tell your adviser at the outset.

Tax-Free Lump Sum

If you elect to take the ARF option, you will get a tax-free lump sum of 25% of the value of your pension fund up to a maximum of €200,000. For funds over €800,000, any lump sum over €200,000 up to €575,000 tax at 20% is paid.

The Pros

The Cons

You have control over your retirement fund.

Your retirement money is not guaranteed to keep its value because the assets in which your ARF is invested may not perform as well as expected.

You can pass the value of the ARF to your estate. This is important if you are in ill health or wish to use the ARF for inheritance purposes.

There is a risk that the ARF could run out in your lifetime. This could happen if you take income from your ARF at too high a rate, its investment performance is less than expected or you live longer than expected.

You have flexibility in terms of when and at what rate you draw on your ARF in retirement (subject to 5% imputed distribution)

Revenue will assume that you have taken 4%/5% from your fund each year even if you haven’t and you will be charged income tax and USC on that amount.

You can choose how to invest your ARF and select the type of investments that suit your needs and attitude to risk

You need ongoing investment advice.

Any growth in your ARF is tax-free but withdrawals from an ARF are taxable.

If you do not have a guaranteed income of €12,700 per annum, you must purchase an annuity to satisfy that requirement or invest €63,500 in an AMRF until age 75.

You can always use your ARF to buy an annuity later on, if you decide that you need a secure, regular income. By waiting, you may be able to get a higher annuity rate later on for the same lump sum, as you will be older.

There is no guarantee that your ARF will be able to buy you a higher pension later on than you could have bought at retirement. Annuity rates could be lower in the future than they are today.