Approved Retirement Funds (ARFs) are personal retirement accounts where the pension pot stays invested after retirement. They offer flexibility regarding drawdown rates and the prospect of investment growth. However, because markets can go down as well as up, they are by no means a risk-free investment.
“An Approved Retirement Fund allows you to keep your pension savings invested after retirement rather than converting them into a guaranteed income. It is typically used by people with defined contribution pensions,” says Linda O’Farrell, senior financial consultant, private wealth, at Marsh Ireland.
“You choose how the fund is invested and how much to withdraw each year, subject to Revenue’s minimum withdrawal rules, which currently range from 4 per cent to 6 per cent depending on age and fund size. Withdrawals are taxed as income, so the pace of drawdown matters. Any balance left in the fund usually passes to your estate, although tax may apply depending on who inherits it.”
Their main benefit is flexibility. “Beyond the minimum withdrawal, you can decide how much to take and when, which can help match income to spending needs at different stages of retirement. An ARF also offers the potential for investment growth because the fund stays invested. That can help support income over a longer retirement and offset inflation,” she points out.
READ MORE
But because an ARF remains invested, its value can fall as well as rise. “If markets fall early in retirement while you are drawing an income, you may be selling investments at low prices to fund your spending, leaving less in the fund to recover when markets rebound. This is known as sequencing risk,” she explains.
A second factor is longevity – both the fund’s and your own. “If you withdraw too much, or the fund does not grow enough, your savings may not last as long as you do. There is also behavioural risk. It is natural to feel anxious during a downturn, but moving out of markets at the wrong moment can turn a temporary fall into a permanent loss,” she points out.
These risks are typically managed through diversification, ensuring you have an investment mix suited to both your time horizon and risk tolerance, holding some cash for near-term spending and reviewing withdrawals regularly.
The main alternative to an ARF is an annuity, where the pension fund is used to buy a guaranteed income for life from an insurer. The income will depend on age, health and annuity rates at the time. It removes investment risk, but also flexibility and the chance of future growth.
Most retirement decisions begin with the tax-free lump sum of up to 25 per cent of the fund capped at €200,000 over a lifetime, taken first before deciding what to do with the balance – an ARF, an annuity or, in some cases, a taxable cash lump sum.
“Some retirees combine options, using the State pension or annuity income for a secure base and an ARF for flexibility. At retirement, the right decision is rarely the same for everyone, which is why personal financial advice matters,” she points out.
Very specific rules apply. “While ARFs offer significant flexibility, Revenue rules require a minimum annual distribution for tax purposes each year. This is based on 4 per cent of the fund each year from age 61, and 5 per cent from age 71. For ARF holdings exceeding €2 million, the minimum withdrawal rate increases to 6 per cent. Amounts withdrawn from an ARF are generally subject to income tax, USC and, where applicable, PRSI,” explains Claire Nolan, pensions specialist at Davy.
A key benefit of an ARF may be the legacy implications. “On death, the fund will typically transfer tax-efficiently to a surviving spouse or civil partner,” explains Nolan.
“Where an ARF passes to a child aged 21 or over, a 30 per cent income tax charge typically applies, with no inheritance tax liability arising in most cases. Where children are under 21, normal Capital Acquisitions Tax (CAT) rules apply.”
As with any investment product, when choosing an ARF, it’s important to be comfortable with it.
“Your investment strategy should reflect your financial goals, income needs and tolerance for risk. While markets can experience periods of volatility, ARFs are generally intended as long-term investments. With inflation, interest rates and geopolitical events often dominating the headlines, it can be tempting to react to short-term market movements. However, history has shown that staying focused on your long-term objectives and avoiding knee-jerk investment decisions can often produce better outcomes,” says Nolan.
Annuities still hold appeal, not least because they provide a guaranteed income for life, regardless of market conditions.
But for many, the flexibility of an ARF is key.
“Unlike an annuity, which pays a fixed income, an ARF allows retirees to decide when to withdraw income and how much to take. This can be particularly useful if spending needs vary throughout retirement,” says Rav Vithaldas, partner and pensions assurance leader at EY Ireland.
He too highlights the potential estate planning advantages.
“Any remaining ARF value upon death can generally be passed to beneficiaries, subject to relevant tax rules. It can be transferred to a spouse tax-free, where the ARF continues in the spouse’s name. This contrasts with many annuities, where payments cease on death unless specific guarantees were purchased, which is usually more expensive,” he explains.
All retirement planning decisions should be carefully considered.
“An ARF is subject to investment risk. Unlike an annuity, an ARF does not provide a guaranteed income. The value of investments can rise or fall, and poor market performance can reduce the fund’s value,” he points out.
“There is a risk of outliving the fund if withdrawals are too high or investment returns are lower than expected. This is particularly important given increasing life expectancy.”
The timing of market downturns can have a significant impact too. If withdrawals continue while markets are falling, the fund may recover more slowly and could be depleted sooner.
“Inflation can also affect the fund over time. Retirees may need to increase withdrawals over time to maintain purchasing power. Higher withdrawals can place additional pressure on the sustainability of the fund,” says Vithaldas.
There are also ongoing costs and decisions to consider. “ARFs involve investment management charges and require ongoing decisions regarding asset allocation, withdrawals and risk levels. Some retirees may find this responsibility challenging,” he cautions.
In Ireland, individuals aged 71 and over are generally subject to a 5 per cent imputed distribution – a mandatory minimum withdrawal requirement. When combined with typical annual management charges of between 0.5 per cent and 2 per cent, a fund may need to generate approximately 6½ per cent just to maintain its value, he points out.
By contrast, your annuity converts pension savings into a guaranteed income for life, or for a specified period. “It provides certainty and removes investment and longevity risk, although flexibility is limited and there is generally little or no residual value for beneficiaries,” he adds.
The answer, depending on your situation, might be to try to get the best of both worlds.
“Many retirees choose a hybrid approach, using part of their pension fund to secure a guaranteed income through an annuity while placing the remainder in an ARF for flexibility and growth potential,” says Vithaldas.
