Is there a case for not taking the tax-free lump sum but putting it an ARF instead?

[Bluefin]

https://m.independent.ie/business/m...ways-the-smartest-thing-to-do/a512610867.html

Interesting article in today’s Sunday independent

 

[Brendan Burgess]

...it’s important to challenge the automatic assumption that opting for a tax-free lump sum at the start of retirement is the best strategy.

Fully agree. We should always challenge conventional wisdom but that does not mean that conventional wisdom is wrong.

Leaving a lump sum invested can provide better inflation protection through continued equity exposure, while lump sums in deposit accounts lose purchasing power over time.

This is faulty reasoning. There is nothing stopping someone who withdrew the tax-free lump sum from investing it in equities. He should not be comparing the returns on an equity portfolio with the returns on a deposit account.

Option A : Taking a lump sum

The median outcome over a 25-year retirement period showed a lifetime income of about €1.2m from the ARF alone. And the ARF maintained a median value of €1.3m at the end of this period, providing a substantial amount to leave as an inheritance.

Option B: leaving the lump sum invested

Our analysis suggests a lifetime income of €1.64m from the ARF, with the median fund valued at €1.8m upon death.

Well of course. If you leave more money invested in a pension fund, of course you will generate a higher return.

The comparison should be simpler and on the €250k alone.

Scenario A: Leave €250k in the pension fund. Let it grow tax-free and then take it out taxed at 40% (most likely as the example is a €1m pension pot)

Scenario B: Take out the €250k which is €240k net. Let it grow subject to Income Tax and CGT and see which has the better return.

 

[Brendan Burgess]

And should he not mention that you do not have to make a decision at age 65?
Can't you leave the pension fund sitting there growing tax-free and then make the decision on the 25% at age 70?

Brendan

 

[ClubMan]

He should not be comparing the returns on an equity portfolio with the returns on a deposit account.

Whatever about the press article, the original blog post linked above didn't seem to do that - although I found it a complex read and ended up only skimming most of it because I couldn't understand the details and the gist...

Edit: oh, the blog post link was removed or else this thread was split from another one or something... Here is the post in question:

Take Your 25% Tax Free Lump Sum, Or Not?? Blog 171

www.informeddecisions.ie

And this one seems to be in a similar vein:

Should You Take 25% Tax Free Lump Sum From Pension? #230

www.informeddecisions.ie

 

[ClubMan]

Can't you leave the pension fund sitting there growing tax-free and then make the decision on the 25% at age 70?

As late as 75 for personal pensions and (non AVC) PRSAs and 70 for most or all occupational schemes as far as I know.

 

[Brendan Burgess]

Whatever about the press article, the original blog post linked above didn't seem to do that

You are right. It was far worse.

We'll assume that you use €50k of the cash to buy yourself or a loved-one something nice such as a holiday/gift/car etc.

You bank the rest in a deposit account for use over the next 10-15 years. Interest rates are on the floor but you manage to secure 1% per year net from a State Savings Account.

So he is comparing €190k in a deposit account at 1% with an investment of €240k in equities at some unspecified rate.

 

[Brendan Burgess]

This reasoning seems wrong to me as well but I am open to correction.

As you are entitled to the State Pension (€243 Gross) and your partner is classed as a ‘Qualified Dependant’ (€162 Gross), you have a joint income of €21,080 per year from State Pension.

Once you take your Tax Free Lump Sum and start taking the 5% from your ARF (€37,000), you now have a total income of €58,080. As a result of Nil PRSI, Tax Band, Joint Assessment and Tax Credits your total tax liability on that combined income is in the region of €9,800 per year. Your effective tax rate, therefore, on all incomes is approximately 17%.

How is a married couple taxed and USCed on an income of €58k? Is the following roughly correct?
€53k @25% = €13k
€5k @45% = €2k
Total = €15k
Less credits: €6k
Tax: €9k

So the extra income on the €250k left in the ARF will be taxed at a marginal rate of 45% and not 17%.

 

[Brendan Burgess]

My tentative conclusion is that it is better to take out €250k now and pay €10k tax on it

Than to leave it in an ARF and, while it will grow tax-free, you will pay 45% tax on any extra income it generates.

Brendan

 

[Brendan Burgess]

Of course, you would be financially better off leaving it in an ARF than taking it out and blowing it.

 

[ClubMan]

Wouldn't a more meaningful comparison (whatever about it being a meaningful real world strategy!) be the returns on the 25% lump sum left invested inside the pension versus invested outside the pension in a similar asset mix? Maybe something like this...

Key Post - Which is better gross roll up or CGT investments?

From Steven Barrett: https://www.bluewaterfp.ie/investments/which-is-better-gross-roll-up-or-cgt-investments/ Assuming 5% dividends a year and 5% capital gains - net of all charges! After 8 years: 1. CGT Fund at 28.75% tax: €179,005 2. Deemed disposal €169,789 3. CGT Fund at 52% tax...

www.askaboutmoney.com

 

[GSheehy]

(Without acesss to the article)

Where the rules allow it, transfer the fund to multiple (say 10 X €100,000) competitively priced PRSAs and mature them to Vested-PRSAs (meaning it's the same product and you're not buying an ARF, as you don't have to) as needed, taking just 25% of the individual pots on each occasion that you 'mature' the individual PRSAs and only generating the income off (say) €75,000 each time. If you were 60, you could mature these, as needed, over the next 15 years.


Gerard

www.prsa.ie

 

[CharlieMac]

Scenario B: Take out the €250k which is €210k net. Let it grow subject to Income Tax and CGT and see which has the better return.

If the TFLS was taken out and put in some investment subject to CGT then do you have to pay CGT on any gains first and then income tax on whatever money you withdraw to spend?

If so I'm going to have to re-read about 3 times how it could be more tax efficient to take the TFLS instead of leaving it in an ARF. Especially if you don't really need the money up front for anything in particular.

 

[CharlieMac]

Oh I suppose Brendan meant income tax due on dividends paid on shares held outside a pension fund

 

[Brendan Burgess]

What happens if you leave the TFLS in the pension fund?
It will grow tax-free.
But when it's taken out, it will be taxed at you 45%

Ah, you have to take 5% of it out anyway each year from age 71 which makes it worse again.

 

[Fortune]

My tentative conclusion is that it is better to take out €250k now and pay €10k tax on it

I did some very rough calculations comparing taking a €200k lump sum and investing it in a life assurance company fund with 4% p.a. withdrawals from each (same funds in an ARF as are in a Life bond product). Assuming the same growth in each, the ARF withdrawals would need to have an effective tax rate of <10% to equal the life assurance option's outcome after 5 years I was too lazy to deal with 8 year deemed exit tax.

 

[ClubMan]

I did some very rough calculations comparing taking a €200k lump sum and investing it in a life assurance company fund with 4% p.a. withdrawals from each (same funds in an ARF as are in a Life bond product).

I don't understand. What exactly is being compared here? Taking the TFLS and investing it outside any pension wrapper versus putting the same amount in an ARF? If the latter involves tax free growth and both involve the same tax on withdrawals how could the non pension option be better from a purely financial point of view? Or am I misunderstanding something here?

 

[_OkGo_]

My tentative conclusion is that it is better to take out €250k now and pay €10k tax on it

I don't think it's a tentative conclusion at all, it should be a nailed on certainty.

The author uses some really poor assumptions and comes out with the wrong conclusions.

The "tax free growth on gains" is very misleading in this context. That is great while building and contributing to the pension but it is not completely true during drawdown.

The simplest way to think of this is access to the original capital. I can either have €250k in my hand or leave it in the pension.

Assuming the TFLS is invested in an identical ETF outside of the pension and grows to €320k after 5 years.You now decide you need it all for a major capital spend (house renovations)

In the TFLS scenario, after 41% on the gain, you are left with €291k. To take the €320k out of a pension would result in both the capital and gain all being taxed at roughly 45% so you get €176k into your hand.

Even if the TFLS was left to rot on a low deposit rate, you are still coming out with way more than the pension alternative.

 

[Ciru75]

I don't understand. What exactly is being compared here? Taking the TFLS and investing it outside any pension wrapper versus putting the same amount in an ARF? If the latter involves tax free growth and both involve the same tax on withdrawals how could the non pension option be better from a purely financial point of view? Or am I misunderstanding something here?

But they won't have the same tax on withdrawals. You pay your marginal rate on the full amount you withdraw from the ARF, including the 250k you start with. If you take it tax free and invest it, tax is only charged on gains made in the investment.

 

[Fortune]

Taking the TFLS and investing it outside any pension wrapper versus putting the same amount in an ARF?

Yes

If the latter involves tax free growth and both involve the same tax on withdrawals how could the non pension option be better from a purely financial point of view?

Both have tax free growth, however the entire amount withdrawn from an ARF is taxed, while only the growth element of the life assurance policy withdrawn is taxed.

 

[ClubMan]

Both have tax free growth, however the entire amount withdrawn from an ARF is taxed, while only the growth element of the life assurance policy withdrawn is taxed.

But they won't have the same tax on withdrawals. You pay your marginal rate on the full amount you withdraw from the ARF, including the 250k you start with. If you take it tax free and invest it, tax is only charged on gains made in the investment.

Thanks - I was overlooking this key (and probably obvious) point.