Would an annuity suit me better than an ARF if I live into my Nineties?

The biggest advantage of buying an annuity at retirement is that you are guaranteeing a level of income for the rest of your life. Stock image

Q. I’m in my early Sixties and will retire in a few years. I’ve been paying into a work pension (defined contribution) for most of my working life and I’m not sure whether to go for an annuity or Approved Retirement Fund (ARF – post-retirement investment fund) when I retire. There is a history of longevity in my family – my mother lived until she was 100; my father lived into his late Nineties. In the event that I live into my Nineties or even longer, which would suit me best: an ARF or an annuity? I’ve heard that annuities are good value if you live into your Eighties or longer. By contrast, I’m worried that if I went for an ARF and lived into my Nineties (or longer), the money in the ARF could be exhausted by the time I get to my Eighties or Nineties. My husband is also due to retire soon – and he has a defined benefit pension through work. Peggy, Co Cork

A. The biggest advantage of buying an annuity at retirement is that you are guaranteeing a level of income for the rest of your life. As you correctly state, the longer you live, the better value you will receive from buying an annuity and life longevity fits with your family history. The annuity income that you would receive is dependent on your pension pot at the point of retirement, the rates available to you on that date and whether or not you get a guaranteed payment built into the annuity to cover the eventuality of you dying soon after retiring – so that your beneficiary or beneficiaries would receive that payment for some time after you die.

The income you receive from an annuity will be fixed and you have no flexibility around the investment of the income. An annuity rate is used to calculate the amount of income that will be paid following the investment of a lump sum in an annuity. There are several determining factors for low annuity rates, one of the most important being prevailing interest rates, which are currently at historical lows.

I would be of the opinion that with your family history, it would be much more beneficial for you at the point of retirement to invest in an ARF instead of an annuity.

Investing your ARF into a cash or similar fund would be consistent with your fears of running out of money with an ARF. Zero growth in your ARF, with a minimum annual drawdown of 4pc, would quickly see the valuation decrease and your stated fear of running out of money would become a real issue.

Alternatively, investing your ARF in a well-diversified portfolio with a predominant exposure to global equities over the period that you are planning for will give you every chance of covering your annual imputed distribution (4pc – rising to 5pc when you turn 70).

Importantly with an ARF, the value does not die with you – it is preserved and passed to your estate. The ARF can pass tax-free to your husband or can be passed onto your children, though your children will have to pay 30pc tax on it.

A decisive point to also factor in is that your husband will be in receipt of a defined benefit pension which will give you a guaranteed level of income – I would see this as giving you even more reason to pursue the ARF option.

Getting out of financial rut to buy own home

Q. I’m 45-years-old. I’ve rented since my late Twenties. I’ve never been good at savings – though I’ve never missed my rent or been out of work. I’m single and very much on my own when it comes to my finances. I’m on a salary of €40,000, I haven’t had a pay rise in about ten years and I’m not optimistic there will be one on the cards any time soon. I never received anything by way of inheritance or financial gifts from my parents. I’m worried about what will happen to me in retirement as I think I have left it too late to buy my own home. I don’t have much by way of pension savings either so I’m at a loss as to how I would afford rent if my only income is the State pension. Do you have any advice around how I can get myself into a better position financially so that I could buy my own home? Una, Co Kerry

A. Based on the figures that you have provided, I calculate you have a monthly net income of €2,673 with the likelihood that this will remain static for the near future. The first thing that I would suggest doing is a simple budget to identify exactly where your money is going each month. There are plenty of free budget tools available online which will help you with this. On completion, you can identify areas where you can save money on.

The next step is then to identify your financial goals over different time periods. You have clearly identified two straight already: buying a home and providing for retirement. As a first-time buyer, you will need to build up a deposit of 10pc of the purchase price. Rather than worrying about not being able to buy a property, ask yourself where you can afford to live, would you be content living there and would it fit with your lifestyle.

Calculate the deposit you would need – this is a goal that you can start building towards. No matter how small, start saving towards this now by consistently having money leave your account before you access it each month. Rather than being negative about your situation, I would suggest that you try to flip this into realistic alternatives and work towards these alternatives – even if that may not have been always your dream outcome. On achieving this goal, your main stated fear of how to house yourself will be removed.

Parallel to this, start investing into a pension fund now. You will receive tax relief on contributions at your marginal rate of income tax. Even if this investment is only a minimal amount, investing this in a well-diversified portfolio over a twenty-year period will improve your situation at retirement.

Tidying up pensions

Q. I currently have two pensions. One is a Personal Retirement Savings Account (PRSA) which was set up in a previous job – and which I have since ceased making contributions to. The second is a work pension (defined contribution) where I’m paying in 5pc of my salary – with my employer matching that contribution. To clean things up, should I transfer my PRSA into my work pension? Tom, Co Wicklow

A. Having all your pension funds in one pot is efficient from an administrative perspective, particularly as it is quite common for people to lose track of different pension investments with employment changes being more common. It may not be the most efficient method of planning though.

You don’t mention your age. If you are coming towards retirement age, you may wish to access some of your retirement funds. If all your funds are tied up in one pot, you will have fewer options around your planning and it is worth keeping this in mind if you move towards amalgamation. There should not be any exit penalties or exit fees applicable on a transfer of a PRSA into a company pension. Compare the fees on the two plans. It may be that a group structure is more efficient cost-wise and that this benefit outweighs the other considerations to factor in.