The agony and ecstasy of securing a good pension

From March 1. nearly 8000 public and civil servants who are taking the enhanced early retirement package, will be able to start enjoying their retirement with an income that will be worth 50% of their final salary, proportionate with their years of service.

From March 1. nearly 8000 public and civil servants who are taking the enhanced early retirement package, will be able to start enjoying their retirement with an income that will be worth 50% of their final salary, proportionate with their years of service.

Their biggest decision will be, what to do with the tax free lump sum part of their package. This is a ‘good’ worry, of course, and if they take proper, impartial advice and make themselves familiar with the technicalities of any account or investment fund they buy, their lump sum should be safe and a source of enjoyment.

The retirement endgame for someone in the private sector with a defined contribution pension – the kind that is based on the amount of money contributed into the pension fund over the years and the investment growth achieved - can be fraught with difficulties, notwithstanding their tax-free lump sum. Their choices are:

* To cash in their fund, but pay top rate tax on the proceeds. For example, if their fund is worth, €150,000 (after taking the tax-free lump sum) and they pay 41% income tax, they will be left with €88,500.

* To buy a retirement annuity pension income for life with the €150,000 and assuming a 5 year guarantee payment and a spouse’s two/thirds survivor pension, will receive an annual income of c€6,800 per annum.

* Or, they may be able to transfer their pension fund into an Approved Retirement or Approved Minimum Retirement Fund, (ARF/AMRF) from which they do not have to commit themselves to an income for life, but can draw down annual income (ARF only) or interest from the assets in the fund (AMRF). The attraction of this option is that any money left in the fund when you die does not revert back to the life assurance company as happens with annuity pensions. In other words, your estate/heirs inherit the fund.

ARFs are not suitable for every worker with a private pension fund. They are restricted to people with at least €18,000 of guaranteed pension income (including state or foreign pensions) or have €119,800 to purchase an AMRF or annuity. It is now more restricted to higher value pension holders who may want to keep working after their official retirement age, is happy to keep their money invested and/or doesn’t want to lock into a very low fixed annuity pension income.

The government also forces ARF (but not AMRF) owners to an “imputed distribution”, that is, to draw down 5% of the value of their fund every year on which they will pay income tax and USC. Add annual charges, typically 1%, and any other fees and it is absolutely necessary that the correct mixt of investments is chosen by the ARF holder.

(The regulations surrounding A(M)RFs are long and complex so I have posted the reference to them in the pension chapter in my TAB Guide to Money Pensions & Tax on my website )

Retirees with larger pension funds have favoured the ARF since they were introduced a decade ago, and many ‘self-administer’ them with an advisory firm. They are usually more aware of risks and rewards, “but nobody wants to lose their capital, not after building it up over a lifetime,” one advisor told me. “But finding returns that can produce a 6%-8% a year – to absorb costs, charges, tax, is not easy. Markets are volatile and fixed assets like cash or bond funds don’t pay those kind of returns and they are not immune from other shocks.”

All the major life assurers have ARF funds on offer and the risks vary. All good financial advisors are aware of them and can talk you through the pluses and minuses.

Most recently Canada Life has introduced a new ARF option – The Canada Life ARF with Lifelong Income Benefit, that is an interesting hybrid between an annuity pension for life and the ARF feature of a death benefit of the remaining value of the fund. It is available to people with funds between €25,000 and €1 million.

As with a traditional annuity, this ARF will produce a minimum guaranteed income for life by allowing a percentage of between 4% and 4.75% (depending on your age between 60-80) of the base fund value. This equivalent income is guaranteed, but could rise if there is better than expected growth from the investments that Canada Life will manage which they will lock-in for the client. Any fall in the fund performance is not passed on, but absorbed by Canada Life.

“The security of the fixed income for life, but still having access to the capital, especially after death, is a big attraction of this fund,” said the advisor, “but the capital can also be depleted if depending on the size of discretionary withdrawals.” The other risk, he said, is if the government keeps increasing the amount they demand must be “distributed” each year.

A hybrid ARF like this one – which has been imported by Canada Life from their Canadian operation – tries to address the fears about irregular pension income and the security of the capital, but it isn’t perfect, say advisors.

They all admit that getting a decent, safe return from a pension fund - especially when the retiree might live another 20 or 30 years - has never been such a challenge and priority in such turbulent financial times.

Getting it right, the first time, has never been so important.