This article is all about how to maximise ARF investments, or in other words how to get the most out of your ARF, but before starting to explain this, let us backtrack just a little.
There is much to understand and consider in choosing to take your retirement benefits in the form of a tax-free lump sum and a regular retirement income.
One option for people with defined contribution pension plans is to purchase a retirement annuity, but this relies on prevailing high-interest rates and carries the risk of renouncing your hard-earned pension fund to an insurance company in death.
Thankfully back in 1999, the then Minster for Finance introduced the Approved Retirement Fund (ARF) to allow pension fund holders access to tax-free cash and to re-invest their funds, take an income, and pass on the balance of their fund to their family, or other beneficiaries on their demise.
When can you set up an ARF?
In general, monies held in a pension from previous employment, or under an Executive Pension Plan can be accessed from age 50, meaning that you can avail of your tax-free lump sum and leave the balance to grow tax-free in an ARF until age 61 when you must start drawing a minimum income of 4% per annum.
Pension plans funded during periods of self-employment can be accessed from age 60, with the same tax-free cash and ARF options. It is also important to understand that when setting up an ARF, you can retain the option to continue working.
Finally, it is also worth mentioning that ARF retirement options are also available to holders of accrued AVC funds, where a pension adjustment order grants it, or where benefits are transferred to an ARF on the death-in-service of a member of an occupational pension scheme.
How to Maximise ARF Investments
The key to getting the most out of an ARF is to put it to maximum use in terms of income level, income duration, and income tax efficiency, and the key to supporting this is the careful consideration and selection of the underlying ARF investments i.e. the assets held and the cost of holding those assets.
Income Duration
ARF Asset
An ARF is designed to last at least 23 years from age 61 to age 84 assuming only the investment management charge (AMC) was met by investment returns when accounting for the minimum withdrawal rates of 4% per annum from age 61, increasing to 5% from age 71 of the original sum invested.
However, it is possible to achieve a strong level of capital preservation by achieving average annualised returns, in excess of the AMC and the annual withdrawal amount combined, even when you account for inflation.
ARF Size
The ideal retirement income is 2/3rds of your final salary at retirement, but it would be our view that most people, if unincumbered by a mortgage or other debt, can live comfortability on a gross income of 50% of final annual income. Which can take into account your ARF but also the State Pension and any other income streams.
Other Assets
Some people will have sufficiently large ARFs to live off the minimum distribution rate, together with the state pension, whilst others may have rental or other income. Others still may plan to downsize from the family home to realize additional cash, everyone is different.
Tax Planning
Your Income
One of the pluses of an ARF is that it enjoys tax-free investment growth, and it is only the withdrawals that are subject to PAYE. As of January 2024, you can earn up to €42,000 PA and stay in the lower 20% tax bracket resulting in a net income of just over €3,000 PM.
Beneficiaries Income
Another big bonus of holding an ARF over a retirement annuity is that on your demise, your spouse can take it over, free from any inheritance or other taxes. Just like for you, PAYE is only payable on the withdrawals.
If, however, it ends up being the case that your children will inherit your ARF, benefits payable to a child over the age of twenty-one, are subject to income tax at a rate of 30%, regardless of the size of the fund, with no other taxes payable.
Investment Strategy
The key to holding the right ARF assets is diversification, simplicity, and most importantly control of the charges.
When speaking with any advisor they will talk about investment risk levels and ESG preference, but what is key to understand are the following points:
- To protect the value of your ARF over the long, you will need to manage its volatility, which in turn helps you to maintain a more consistent income.
- As a starting point, most ARF investors should typically invest in ESMA 4 medium-risk, diversified multi-asset funds, with a targeted average annualised gross return of 5% – 6% PA.
- When constructing an ARF portfolio is not only charges and past performance that maters plotting average volatility against average returns is essential.
- Individual assessment is paramount and tailored and adjustable ARF portfolios deliver the best results and should be reviewed and rebalanced on an annual basis.
- Overcomplicating it will only prove time-consuming and expensive, choose a single well-chosen ARF insurance product provider and a low-cost specialist financial broker.
- High charges will suck the life out of your ARF, remember every basis point saved, means a greater return on your chosen funds’ performance. A maximum all-inclusive annual management charge of up to 1.00% PA, should be agreed upon and less again for investable funds exceeding 500K.
- Although passive funds are cheaper, combining active funds helps manage volatility. This means investing across active and passive, growth and value, cognisant of recency basis and broader behavioural basis, adjusted to individual risk tolerance, with a level of downsize protection and currency hedging.
The big ARF Questions
Is it possible to maintain the original value of my ARF despite withdrawals and charges?
- Whilst you can’t guarantee the actual lifespan of your ARF, it is possible to put investment strategies in place to aim to retain its value, if only allowing for minimum withdrawal levels and charges. The value of your ARF will rise and fall as a result of market performance, meaning that you would need to achieve a consistent net return annualised return of 5%, or higher when accounting for inflation. Key to protecting your fund value is a well-constructed low-cost ARF portfolio, that is reviewed annually.
How long might my ARF last if I want my withdrawals to increase with inflation?
- It may be necessary to increase the income manually every few years to maintain your standard of living, while it is also possible to set desired income levels as opposed to a fixed percentage. Key to this is limiting the cost of your ARF in terms of its annual management charge. Here is an example for illustration assuming a 1% AMC (remember this could be as low as 0.75% dependent on fund choice):
- A client establishes a €1M ARF @ age 65
- They set an investment strategy aiming for growth of circa 5% net per annum.
- Rather than taking the minimum withdrawal levels they want a set income.
- They start with an income of €45,000 above the 4% minimum figure.
- They also choose to set 1.5% per annum increases to counter inflation.
- By age 71 they are already above the 5% per annum minimum taking €52,224
- 1.5% annual increases in income continue every year with change.
- The projected residual value of the ARF is c. €338,439 @ age 85
- If they had only taken minimum withdrawals, it would be c. €805,300 @ age 85
If I already have an ARF that I’m not happy with, can I switch providers?
- If you’re not happy with the investment performance of your ARF, the first thing to do is to have another broker audit its charges and then review its underlying funds. More often than not, we find ARF holders being overcharged and under-supported, and unfortunately being recommended the wrong overly volatile funds, with poor long-term alpha performance. You can most definitely change ARF providers, but the first thing to do is transfer the broker agency to amend the investment strategy, and then once any early exit charges have elapsed you can move provider.
Takeaway
Managing risk, meaning not just slotting into your ESMA risk level, but choosing an advisor that examines your recommended ARF portfolio’s volatility is essential. Multi-asset funds offer a diversified portfolio across asset classes, professionally managed to reduce volatility and improve risk-adjusted returns. Each asset class, typically, has its own risk-reward matrix and correlations are divergent.
Every ARF investor must be assessed and advised on an individualized basis, but the key to any ARF is to aim to preserve your original capital invested for as long as possible, which can only be best achieved by:
(A) Minimising the charges (low AMC) + 100% allocation.
(B) Smoothing volatility (well-constructed robust portfolio)
(C) Reviewing returns and needs annually.
How I can help
Ken O’Gorman – Chartered Banker, QFA, SIA, RPA
All of my ARF clients receive a personally tailored approach that factors in their retirement goals, personal circumstances, and risk tolerance, but also ensures fair value under a carefully monitored ARF portfolio.
To arrange your free no no-obligation consultation by phone, video conference, or in-person contact us today, call: 01 845 0049 or email me directly: ken@onequote.ie
