It was interesting to read recently that the UK Government has made a decision to allow people to have a choice of
1. Buying an annuity at their selected retirement age
2. Investing their retirement fund and managing it themselves to provide income in their retirement.
It is a major change in legislation and opens up many opportunities and also presents many serious challenges. I thought that for my limited (but very important and highly valued) UK readers a little look back at the Ireland experience might be of interest.
In a nutshell now in the UK, as in Ireland, when we reach our retirement ages and if we have a retirement savings fund, we have the choice of investing the fund ourselves in a special personal retirement fund or as before we can transfer the fund to a life insurance company and an agreed income/annuity will be paid to us for as long a we live.
This income will be paid whether we live for ten years or forty years. On death the income dies too! Sometimes for a reduced income/annuity payable to us a percentage of our income will be paid to our spouse if they outlive us. This reduced income will be paid as long as they live.
In Ireland in 1999 some 15 years ago the then Minister for Finance, Charlie Mc Creevy introduced legislation that allowed retiring people in Ireland to continue to buy an annuity or to invest their pension/retirement pot in their individual Approved Retirement Funds called ARF’s for short.
At City Life we arranged our first ARF in 2000 and many more since then as most people prefer to manage their own money in the hope that when they go they will leave the balance of their nest egg to their husbands/wives and then hopefully if there is anything left, it will pass on through their wills to their children or whoever else they might want to leave it to. Because of this fundamental change, for the first time ever, a retirement fund became a way of leaving money to our children.
At the introduction in Ireland the amount of money we could have in our ARF was basically unlimited and was a tax exempt fund. Naturally this proved a serious attraction to the wealthy and ARF’s of in excess of €10 million were common as they were a great way of legitimately transferring serious wealth into a tax exempt fund. At that time there was no requirement to take income from the fund.
Naturally it didn’t take the Irish Revenue long to cotton on to what was happening and the maximum ARF allowed was limited to €5.4 million then reduced further to €2.3 million and at the end of last year the maximum fund allowed was reduced to the current level of €2million.
If our funds were over any of these limits when the rules were changed we were allowed to maintain what we had, providing we applied for and received a Personal Fund Threshold from the revenue.
In addition to reducing the maximum Approved Retirement Fund we also have in Ireland a required Minimum Fund of €63,500 that we must maintain till we are 75. All of the rest we can spend if we want to but it will be subject to tax at our highest rates and currently in Ireland that could be as high as 50% so if possible we do not go down that route.
In addition to reducing the maximum funding levels the revenue also decided that even if we decided not to take income we would be deemed to have taken income and would pay tax in any event. Very quickly every one of our customers decided to take the income!
This deemed distribution started at 3% p/a and is now 5% so basically everyone in the country with an ARF is taking 5% pa from it irrespective of the growth and naturally this is presenting us advisors with a very serious challenge.
On average in Ireland I would estimate that the annual fund management charge is around 1.5% pa. 1% goes to the insurance company/fund manager and 0.5% to us the ARF advisor who sets up the fund in line with our customer’s attitude to risk and advises on the fund managers to manage the money and who then rebalances the ARF on a regular basis to make sure it is always matching the risk profile of our customers.
Each year therefore a total of 6.5% will be withdrawn from every ARF in the country irrespective of attitude to risk or fund performance. Every ARF in the country is now in the high risk category irrespective of our customer’s attitude to risk as it is not possible to guarantee a capital value and withdraw that level of income.
Lets say an ARF was invested in property and equities back in 2007 before the property and equity crashes of 2008 and the funds fell by 50% and 6.5% income was taken as well…utter destruction of what took a life time to accumulate.
I make this point as I think forcing people to take income of 5% each year is too high and is generally unsustainable.
If our customers have a low risk tolerance and require a low risk investment strategy that will give a low return of say 2% to 3% it is quite possible that their ARF will fall by 3% to 4% each year. I would therefore favour a return to the deemed distribution income figure of 3% which would give our customers the choice of a lower risk portfolio of investments and would protect their spouses/partners better and allow them to pass on something of value to their children when they are gone.
Looking back at the last 15 years or so since ARF’s have been introduced in Ireland, I think that they have been an outstanding success and probably less than 3% of our customers who have reached their retirement ages have elected to buy an annuity rather than invest in an ARF.
The fact that the residual balance of an ARF can transfer tax free on death to our spouses is of major importance in the providing of ongoing income to them. In addition our children can receive the residual balance on the second death, less tax of 30%, which is a great incentive not to buy an annuity. This after tax payment to children is really important if they have to pay inheritance taxes on other parts of the estate that they will inherit at the same time.
And the final question I suppose you might ask is “how are we getting on with the management of our customers ARF’s and are their values being maintained”?
Well the one thing we will always say to our customers is that if 6.5% pa has to come off their funds each year we guarantee that there will definitely be years in which their funds will fall in value. We also advise them that if they instruct us to invest their funds in bank deposits and government gilts that their funds will fall in value every year and that is certain.
Thankfully over the last few years our customers have come with us on the ARF journey and our process of matching their investments with their attitude to risk. They now hopefully understand a lot more and whilst not ever enjoying seeing their funds fall in value they now understand that it will happen from time to time. Thankfully also since 2009 we have enjoyed a good recovery in equity and property prices. This has been a great help in maintaining our customer’s values.
In the words of our friend Caroline Banks in England soon to become only the second women president ever of the MDRT her typical clients just require a positive return on their investments of 6% every year with a capital guarantee.
Best of luck Caroline all of your Irish friends wish you well.
Ted Dwyer Family Business