Making sense of your Pension Options
So you have decided to retire and need to find out what you can do with your pension fund. Where do you start ?
The first step is to work out how much money you need to maintain a basic standard of living before adding on luxury items like holidays and one off future payments like buying a new car or paying for a child’s wedding. If you don’t do this you run the risk of overspending and potentially running out of money, or the opposite, under-spending and depriving yourself of a better life in retirement. There are various tools that a Financial Planner will use to forecast your income and expenditure into retirement.
Once this is done, there are a number of different options to consider along with steps that can reduce the amount of tax that you will pay. Before you start it’s worth taking time out to consider what you want to do in retirement. (Download a copy of Rewire don’t Retire)
Retirement Lump Sum
With Personal Pensions and PRSAs, 25% of the value of your pension can be taken as a retirement lump sum to a maximum of €500,000 (25% of the €2million Standard Fund Threshold ). The first €200,000 is completely exempt from Income Tax and the balance, up to €300,000, will be taxed at 20%
This option is also available for members of Defined Contribution Occupational Pension Schemes, provided the scheme allows it. Members of DC Occupational Pension Schemes also have another option when it comes to taking a Retirement Lump Sum which is based on the number of years service completed with their employer and their final remuneration as defined by the Revenue Commissioners.
The maximum retirement lump sum under this method is 1.5 times final remuneration to a maximum of €500,000 where the first €200,000 would be tax free and the balance , up to €300,000 will be taxed at 20%. If you chose this method you are compelled to buy an annuity with the balance of your pension fund.
Annuities – Guaranteed Income for Life
An annuity is an insurance policy issued by a life insurance company. The life insurance company guarantees to pay a specified level of income for the life of the individual in return for the lump sum.
The Annuity rate is the percentage you receive on the lump sum that you handed over to the Life Insurance Company and is determined by your current age, life expectancy and the prevailing interest rates on longer term fixed interest bonds.
There are a number of other annuity options that can be added onto your annuity
- Inflation linked annuity where the pension you receive will increase every year
- Joint Life Annuity where a spouses or dependents pension will be paid on your death.
- Guaranteed Period where the annuity will be continue to be paid for a period in the event
Sample Annuity Rates (March 2016 Irish Life)
Annuity rates have fallen over the last 30 years as Life Expectancy has increased and interest rates on bonds are at historic lows.
Taxation of Annuities
Annuity income is subject to income tax and the Universal Social charge. There is no PRSI payable on annuity income.
The main advantage of annuities is that they provide you with a guaranteed fixed income for life. The main disadvantage is that you may die before you have received back, in income, all of the money you handed over to buy the annuity.
Annuities should always be considered at the point of retirement and if you opt for an Approved Retirement Fund you can always revisit annuities later in retirement as you can purchase an annuity with money from your Approved Retirement Fund.
Flexible Retirement Options
Approved Retirement Fund (ARF)
An Approved Retirement Fund is a tax exempt post retirement investment account. It can accept transfers of all or part of your pension fund after taking your retirement lump sum.The ARF is owned by you personally and will form part of your estate in the event of death.
ARFs have become popular as it allows you to retain control of your pension funds in retirement along with the advantage they can be passed onto your next of kin followed your death. They also allow you defer the decision of having to buy an annuity which is particularly relevant at the moment as annuity rates are so low. The main disadvantage is that you have to continue making investment decisions in retirement and you may also run the risk of the pension fund “bombing out” unless the fund is growing at a higher rate than your withdrawals.
Approved Minimum Retirement Fund (AMRF)
Before investing in an ARF you need to meet the following criteria
- Be in receipt of a guaranteed income for life of at least €12,700 a year. ( the individual state pension can be included in the calculation)
If you don’t meet this criteria you must invest €63,500 in an Approved Minimum Retirement Fund. It must remain there until you meet the income criteria, reach age 75 or in the event of your death. After age 75 an AMRF will automatically become an ARF. The idea behind the AMRF is to encourage you to keep some of your retirement savings for the later stages of your retirement. Only one withdrawal of up to a maximum of 4% of the value of the AMRF can be taken each year.
ARF Imputed Distribution
The inputted distribution on an ARF is a compulsory withdrawal that you have to take from your Approved Retirement Fund every year from age 61. The current rate of withdrawal is 4% and this increases to 5% from the year the ARF holder turns 71. The rate is 6% for those with a fund greater than €2million.
Other points about ARFs & AMRFs
Once a AMRF becomes an ARF the inputted distribution rules will apply.
You can use your AMRF and ARF to purchase an annuity
You are allowed transfer all or part of your ARF to another ARF with another company.
Top it up with another pension at a later stage.
Transfer all your AMRF to another AMRF. A partial transfer is not allowed as you may only have one AMRF.
If you have a PRSA you will have the option of taking your retirement lump sum and then leaving the balance of the fund in the PRSA. This is called a vested PRSA. The same rules apply to a vested PRSA as apply to AMRFs & ARFs. If there is a requirement to keep €63,500 untouched (as with an AMRF) this is often referred to as a restricted fund within the vested PRSA.
Taxation of Withdrawals from ARFs, AMRF & Vested PRSAs
Income Tax applies to all withdrawals from ARFs, AMRFs and vested PRSAs. Depending on your income from age 65 you may be fall into the Exemption Limits for Income Tax. A single person can earn up to €18,000 per annum without having to pay income tax
PRSI is applicable depending on your age . 4% PRSI would become due on withdrawals before at 66. There is no PRSI liability from age 66 onwards.
Universal Social Charge
USC is payable depending on your circumstances.
If you are over age 70 or hold a medical card you will pay USC at the following reduced rates with the exception of those earning more than €60,000 per annum.
CTA Download our guide to