Not everyone has access to sought-after Approved Retirement Funds, writes Laura Slattery

They are the envy of the western world, according to one financial adviser. Others point to the investment risks and the way they have helped the super-wealthy avoid tax.

Access to Approved Retirement Funds (Arfs) mean one very important thing: not having to buy a poor value-for-money annuity with the pension fund they have gone to the trouble of building up all of their working lives.

For about one-third of the people in occupational pension schemes, the amount of income they receive in retirement for the rest of their lives hangs on the annuity rate they get at the time they retire.

About 300,000 people in newer defined-contribution schemes are forced to use their pension fund to buy an annuity from a life assurance company.

Thanks to a combination of much higher life expectancy and lower interest rates, annuity rates have fallen dramatically since the 1980s, meaning the amount of guaranteed monthly pension a person can get with the same size fund has dropped.

But since Arfs were introduced in 1999, the self-employed holders of personal pensions, company directors with at least a 5 per cent shareholding and, more recently, Personal Retirement Savings Account (PRSA) holders, can avoid annuities. Instead, they can retain control over almost all of the pot of money they have prudently saved up.

Members of defined-contribution pension schemes have no such option.

It's a discrimination that is galling to many people. The Irish Association of Pension Funds (IAPF) last week called it "inequitable" and chairman Joe Byrne called on Minister for Finance Brian Cowen to introduce a level playing field.

The IAPF argues that unlike members of the defined-benefit occupational schemes, who have a pension based on salary and length of service guaranteed to them by their employer, defined-contribution scheme members must shoulder all of the investment risk in the period up to retirement.

In other words, if their pension contributions are wiped out by a fall in stock markets, it is they who suffer the brunt, rather than the employer having to make up the difference.

But suddenly, once they retire, they are deemed incapable of handling any investment risk for the 20-plus years that they will be drawing down retirement income, says Byrne.

"Worse still, they are locked into the financial conditions that prevail at the time they retire."

In one recent case, Byrne notes, a defined-contribution scheme member with a €900,000 pension fund was forced to buy an annuity, against his wishes, and ended up with a €30,000 a year pension - in other words, he got an annual return of not much more than 3 per cent on his fund and now has no pension fund left.

Admittedly this "return" will never falter, nor will the money ever dry up for the rest of his life. But he is denied the opportunity to get a far higher return on his investment through an Arf, under which he could invest in equities, bonds, property, cash and other assets, all while (hopefully) keeping the initial capital intact. He can then choose to draw down the money when he wishes, subject to income tax.

It should be a matter of choice, argues Byrne, who says he is "amazed" the restriction has not yet been legally challenged.

One reason for this is that defined-contribution schemes have only been around for about 20 years - not long enough for most of the people who joined the schemes to hit 65.

But the problem will become more common as time goes on.

Occupational pension scheme members can use the funds as a home for any additional voluntary contributions (AVCs) they have made, but they can't use their main pension funds.

This leaves them exposed to a relatively small annuity market, where from time to time some of the players will decide not to compete because they're not keen on taking on any additional long-term risk.

If the Government is worried about hundreds of thousands of employees blowing their pension funds in the first few, giddy years of retirement, there is one simple solution, according to Byrne: increase the amount people must set aside in an Approved Minimum Retirement Fund (AMRF).

At the moment, unless people buying Arfs have a guaranteed annual income in retirement of at least €12,700, they must ring-fence a sum of €63,500 in a separate AMRF. This money cannot be drawn down until they reach the age of 75, although the investment gains on the capital can be taken as income. When the Arf holder reaches 75, the AMRF automatically becomes an Arf.

With life expectancy creeping higher and later-life expenses such as nursing home fees capable of eating into a huge chunk of the fund, this money could still run out before the person dies.

But an AMRF of €200,000 or €300,000 could provide a bigger safety net, Byrne notes.

The one aspect to Arfs that the Government has acted on is their ability to act as too efficient a vehicle for avoiding tax: wealthy people who never need to draw down any money from the fund and could pass it on to their children.

For children under the age of 21 at the time of the Arf-holder's death, the Arf will be exempt from income tax and they should be able to avoid inheritance tax on a lot of it by using the tax exemption thresholds for inheritances passed between parents and children.

Children aged 21 and over are exempt from inheritance tax and only pay tax at the standard rate on the money.

From this year, however, it is no longer possible to keep the full fund intact without paying some tax. Arf-holders aged 60 and over will be deemed to have drawn down 1 per cent of their fund in 2007, whether they have accessed the fund or not, and will pay income tax on this amount.

This deemed withdrawal rises to 2 per cent next year and will settle at 3 per cent from 2009 onwards.

The new regime effectively forces people to make withdrawals from their Arfs in order to avoid a "double whammy" tax charge - a charge on when they are deemed to have drawn down the money and a charge on when they actually do.

It is a reasonable method of curtailing tax avoidance, Byrne believes, but the IAPF isn't happy that the tax kicks in at 60, an age when many semi-retired Arf-holders will still have income from part-time work and won't need to draw on the Arf for genuine reasons.

Senior executives who belong to defined-contribution occupational schemes are increasingly embarking on a series of complicated steps in order to avoid having to buy an annuity and gain access to an Arf.

These include leaving the company they work for and setting up their own business with a few years to go before retirement and transferring their pension fund from their former company's group scheme into a one-person scheme, which they can then wind up and switch into a PRSA, giving them the much-wanted access to an Arf.

This is the theory. In practice, it is difficult to do, says Ian Mitchell, managing director of Deloitte Pensions & Investments, as pensions providers are required to have €1 million worth of indemnity cover for each PRSA transfer that they do, in order to prevent mis-selling. "It's too many hoops," says Mitchell. "The simplest thing would be to change the legislation."