Pension planning - back of an envelope.

[dvpower]

I'm looking for some very general advise on how to approach pension planning, particularly in relation to figuring out how much my pension pot will get me.

I'm currently in a DC scheme and I'm paying AVCs to the max of the Revenue rules. My most recent statement tells me that my pension pot is predicted to be about 750k by my normal retirement age (which in my current employment is 60). I've also got a couple or PRBs from earlier employments that should be worth around about 100k.

So that's 850k in total, but I'm very confused about the choices I have with that and what it will yield me.
As far as I can tell, I could take 200k of that as a tax free lump sum and then put the remaining 650k into a ARF and draw 4% p/a as an income from that. That would give me 26k p/a (I understand that I may have to put 63.5k into a AMRF, but I can still draw from that, so my net 26k remains about the same).
I'd very much like to retire early, but 26k wouldn't be sufficient. But I can use my lump sum to top me up until my contributory state pension kicks in.

My confusion is about the options between buying an annuity and drawing money from an ARF. Annuities seem to yield much less than 4%, but I guess they are less risky and won't run out. I'm also not sure if drawing 4% p/a from an ARF is sustainable for somebody retiring earlier than the normal retirement age?

 

[50andOut]

When is "early"?
what amount would be sufficient?

the 4% is considered a safe withdrawal rate when looking at 25 year retirements, the longer you add to that timeline the riskier it becomes, you really need to look at your expected expenses in retirement and how much you need each year.

There are many many threads on here about annuities vs ARF's - annuities are considered terrible value at the moment due to the historically low rates - this could change in 10/15/20 years so need to consider how far you are from retirement to not rule out.

50ando

 

[dvpower]

I'd very much like to retire at 60 (and hopefully enjoy a retirement of >25 years), so taking 4% might be risky, but I understand that Revenue will deem that you have taken 4% for tax purposes, so it isn't efficient to take less?

As to what amount would be 'sufficient'; that's a difficult one to answer, it's a trade off between an early retirement and the quality of life that brings and the quality of life that a reasonable income would bring. The ballpark number in my head is about 40k, and I'm just about there with the state pension and income from an ARF.

That brings me to another question - I presume its possible to buy an annuity with some of the pot and to draw down the rest from an ARF? But if I have annuity income (or other income), will Revenue continue to deem that I am taking 4% from my ARF?
Or If my ARF isn't performing as expected, because of inflation or poor market performance, is there an efficient way of taking less out of it?

 

[LDFerguson]

Some random but hopefully relevant points: -

I presume its possible to buy an annuity with some of the pot and to draw down the rest from an ARF?

Yes it is. For example, you can buy an annuity with the €63,500 otherwise required to go into an AMRF (in lieu of going into an AMRF at all). Or you can use any portion of your "ARF amount" to buy an annuity.

But if I have annuity income (or other income), will Revenue continue to deem that I am taking 4% from my ARF?

The annuity doesn't help you here. The 4% imputed distribution requirement applies to any amount you have in the ARF, regardless of what you have aside from the ARF.

Or If my ARF isn't performing as expected, because of inflation or poor market performance, is there an efficient way of taking less out of it?

No. The value of the 4% will drop if the value of your ARF drops, but you still have to take it out, or face taxation on a notional 4%. (After you hit 70, the requirement goes up to 5%.)

While buying an annuity is a one-time, irreversible decision, going into an ARF is not. Annuity rates at 60 are currently poor but they get better as you get older and shuffle ever closer to the grave. So it's possible to have an ARF for the first 10 or 20 years of your retirement and then buy an annuity with whatever funds you have left in the ARF at that point. An ARF requires ongoing management and monitoring to avoid it bombing out. You might be up for that at age 60 but less so at 80. This is a complex area which needs consideration of many things. For example - your family can inherit unused funds in your ARF after you die. Aside from dependents' pensions, they cannot inherit funds from an annuity.

Regards,

Liam
www.ferga.com

 

[dvpower]

Thanks for the replies - very useful.

It's only when I put it into a spreadsheet that it becomes very apparent that an ARF will either give you a great income forever or be depleted quite quickly or give you an ever reducing income, depending on its investment growth rate.

Is there a growth rate, or a reasonable range of rates that should be considered when planning this?

 

[50andOut]

I use an estimated 3% return on my future estimated ARF pot. Purely a guess, based on past returns and assuming i'd still maintain a large equity weighting. Others have suggested the returns would keep in line with inflation, so ignore and just assume spending stays flat along with zero returns for ease of calculations.

 

[Ravima]

fund values fluctuate. they will go up and down. sometimes they might go down for a few years, depleting your fund, other times they go up for a few years increasing the fund. If you can take the fixed percentage every year, well and good. Another option is take the 4% in the bad years and perhaps a little more if there is a very good year. You need the money for 20/30 years. No need to plan to pass it on as it is yours. many are concerned about holding values to pass to others - no point really!

 

[dvpower]

Unless returns on the fund are very healthy and inflation is very low, then taking 4% p/a results in an ever depleting pension income e.g. a fund of 1m will pay 40k in year 1, but by year 15 it only pays about 22k (with zero growth) or about 34k (with 3% growth); neither of these figures accounting for inflation.

It's inevitable that you need to eat into the fund capital, and then the rate of growth and the rate of inflation have a large bearing on how long it takes for the fund to reduce to zero.
Is there a case to be made with planning to buy an annuity at some point, when there's still a chunk of money in the fund, but you're elderly enough that annuity rates are now attractive?

 

[Homer]

You have the option at any time to buy an annuity with some or all of your ARF. As others have said, annuity rates are not currently attractive, primarily because of low bond yields, although improvements in longevity are also a major contributing factor. As you get older, the impact of underlying bond yields becomes less and future life expectancy comes into play to a greater extent.

It’s possible (some would say likely) that annuity rates will improve at some future date, either because of increases in bond yields or possibly because of reductions in overall life expectancy. Tying to guess when this might happen is in some ways akin to trying to ‘time’ the markets with your investment strategy, although with not quite the same level of day to day volatility.

Regarding drawing down an income from your ARF, I can never understand why people seem to assume that it makes sense to draw down a fixed percentage of your fund. Doing this will mean that the income you receive will vary from month to month, making financial planning somewhat problematic. My view is that it makes much more sense to draw down a fixed amount each month, based on what you need. If you retire before the State pension kicks in, you could draw down an additional amount in order to ‘balance the books’ until the State pension becomes payable.

If the amount you decide to draw down in any year is less than 4% of your fund in total, your ARF will automatically pay out to you in December the difference between 4% and the amount you have drawn down so far, unless you specifically instruct them to do otherwise. As you will be taxed on the shortfall if you draw down less than 4% in total, it makes very little sense not to allow the fund manager to do this. But the way it works means that you don’t have to worry about drawing down enough. This will be done automatically for you.

Regarding how long your fund will last, this is impossible to predict with any degree of confidence. It will depend on a number of factors including what level of income you need to draw down (bearing in mind that you may from time to time need to draw down additional lump sum amounts to cover unexpected expenses), the investment strategy you follow and market conditions at the time you purchase the ARF and the subsequent performance of these markets. And the other variable is that you don’t know for how long you are going to live and whether you might face significant additional expenses (e.g. nursing home) towards the end of your life.

All of the above uncertainties would tend to point people towards purchasing an annuity if they weren’t such exceptionally bad value at present. Not only are you locking in bond yields of close to (or possibly less than) zero, but annuity pricing also includes a loading for expenses, uncertainty (primarily around longevity, but also reinvestment risk) and for the profit that the insurance company is expected to provide for its shareholders. And of course, you would lose the flexibility to be able to draw down additional funds to cover short term needs and your pension would die with you, leaving nothing for your dependants (unless Included as a dependant under your annuity).

However, your pension lump sum could be used to cover additional unexpected expenses or to cover some or all of the shortfall until your State pension kicks in. Although this approach could also be taken in conjunction with an ARF investment strategy.

I’ve strayed into the annuity vs ARF debate a bit more than I intended, but It’s probably no harm to have a brief summary of some of the pros and cons. Best of luck with whatever you end up doing.

 

[Homer]

I appreciate that the above response doesn’t really help the OP to calculate what level of fund they should target based on a particular planned retirement age. But it would be possible to work out how much you would need based on a specific set of assumptions, including what rate of investment return you want to assume (your guess is as good as mine), what level of income you need to draw down each year, any inflation adjustment you want to build into the income requirement and how long you would like the fund to last.

If you want to specify the parameters, I’m happy to run some figures for you to give you some idea of what would happen if the assumptions you specify are borne out in practice.

 

[Colm Fagan]

For what it's worth, I've now had an ARF/AMRF for just under 10 years and have withdrawn around 5.5% on average of the value of the combined account each year. It is now worth over 50% more than when I started. That's despite suffering a 9% drop in the first year (2011). I haven't made any wonderful investment decisions in the period (other than not putting my Tesla shorts into my pension account ). The main rules have been to keep costs low and to invest as much as possible in equities. I'm budgeting my expenditure on the assumption that I'll earn over 5% a year on average for the rest of my days and have allowed for the possibility (risk?) that I'll live well into my 90's. If inflation increases, I'm hoping that the decision to invest in real assets will mean that the nominal return will also increase and allow me to withdraw more. I don't know if that's any help/consolation. As always, I'm just telling my experience, not advising others to follow the same path.

 

[dvpower]

If you want to specify the parameters, I’m happy to run some figures for you to give you some idea of what would happen if the assumptions you specify are borne out in practice.

I've moved off the back of the envelope and into a spreadsheet, but to be honest, over what I hope to be a very long retirement, the numbers vary dramatically when I plug in different expected growth rates and different inflation rates.
Inflation has been particularly low over the last number of years and I wouldn't rely on that continuing ad infinitum. Stock market returns are probably more dependable over the long term, but you never know when we're going to be hit by another long 70's style stagnation or another GFC.

A few things have become clearer for me:
- fund growth matters a lot over time and you can trade potential growth for more certainty by choosing the investment mix.
- I'd take a fixed amount, rather than a percentage, and this would increase year on year to account for some inflation, but wouldn't be less than 4%.
- I need to make sure that whatever I take between when I retire and age 66 pays PRSI that is reckonable for the contributory OAP, so I can get the full rate on that when it becomes payable.
- I need to fund the shortfall in that period, primarily with the tax free lump sum, but I should take enough in the early years both to get the PRSI stamps and also to take advantage of my full tax free allowance.

Anyway, its still a fair bit off and I should probably get back to earning the money to pay for it....