Do ARFs give better value than annuities?

QI’LL be retiring next year and had hoped to buy an annuity at retirement. However, annuities have become expensive given the ongoing recordlow interest rates, and so I’m considering going for an approved retirement fund (ARF) now. Do ARFs offer better value for money than annuities? What should I bear in mind before taking out an ARF to ensure that I make best use of the money in my pension pot? John, Co Kilkenny

IT’S difficult to advise on which option is most appropriate without knowing your specific circumstances. There are merits to both ARFs and annuities — depending on the level of certainty and flexibility you want with your retirement fund.

An annuity is a contract with a life insurance company which will pay you a guaranteed, regular pension income for life in return for you paying a fixed sum of money to an insurance company from your retirement fund.

The level of income you receive depends on factors such as interest rates, age and health in some cases.

An ARF, on the other hand, is a personal retirement fund where you can keep your money invested after retirement.

You can withdraw from it regularly to give yourself an income but as it is an investment product, the value of the fund may fall as well as rise.

I would recommend you contacting an impartial financial adviser who will discuss the pros and cons of each option.

To guide you in your decision, I would advise you to consider the following factors and how relevant they are to you.

First: Certainty of income. Income from an annuity is guaranteed; income from an ARF is not. With an annuity, you are guaranteed a level of income for the rest of your life.

However, once the entire value of your ARF has been withdrawn, the fund is said to have ‘bombed out’. So you could potentially outlive the value of your ARF, whereas the annuity will pay a fixed income for as long as you live.

Second: Flexibility. An annuity pays you a fixed income with no option of increasing that fixed payment. So if you ran into financial difficulty, for example, you could not increase your monthly or yearly payment. An annuity is therefore a relatively inflexible option.

With an ARF, on the other hand, you have more flexibility around how you use your investment fund — as you can take your money out as you need it and you can also decide where you would like your retirement funds invested, and what you would like to invest in.

Third: Investment risk. Such risk does not exist with an annuity but it does with an ARF. However, although there is investment risk with an ARF, if the investment does well, your fund could also grow substantially.

Fourth: inheritance. If you have dependants and pass away, the payments from an annuity may be guaranteed for a certain period only — whereas the value of your ARF on death would be paid to your estate.

Cashing in AVCs early

QI’M 40 and still don’t own my own home. I’m single so the only chance I have of buying my own home is to save a good bit of money. I stopped paying pension additional voluntary contributions (AVCs) recently so that I could concentrate on saving for a home. I have about €6,000 in AVCs and I’m considering cashing them in now to boost my savings. Is this wise? Joanna, Co Kerry

SORRY to tell you but you cannot access your AVCs until you reach retirement. There was an option to make a one-off withdrawal of 30pc of your AVC fund for a period of three years from 2013 to 2016 but this option is not available at present.

Lump sum for AVC

QMY WIFE and I will be 56 this year. We have paid off our mortgage. I have a defined benefit (DB) pension scheme with my employer — with 28 years banked. The scheme closed in 2013 and changed over to a defined contribution (DC) one. To boost my pension savings, I started an additional voluntary contribution. My wife and I also have savings in the form of low-risk investment policies which have been performing adequately over the years with modest gains — averaging 5pc per annum. Would it be wise to invest a lump sum of €40,000 (from our savings) into the AVC, in view of the tax benefits? It has been said to us that you risk losing your investment if fund values drop on particular days, and that it’s better to invest over a prolonged period of time such as monthly (by way of salary deduction). What would be your advice here?

Tom, Co Wicklow

AVCS are a great way to top up your pension fund in a tax-efficient way. To give a full answer, I would need to dig deeper into the value of your entire pension fund for the purposes of the standard fund threshold (the maximum pension an individual is allowed at retirement for tax purposes), your salaries and income tax position, and the fund choice within your company pension schemes.

Pension funds, like any investment, can fluctuate in value — certainly true of recent weeks. If you choose the monthly salary deduction method, you invest a smaller amount once a month and could therefore benefit from the average price over a period (this is known as ‘euro cost averaging’). You would also benefit from receiving your tax relief at source via payroll. If you pay the AVC by lump sum, you must file a tax return to claim your relief.

An AVC personal retirement savings account (PRSA) may also be an option to consider if you wanted to look at investment options outside of your company scheme.

PRSA and ARF strategy

QI’M self-employed and set up a PRSA a few years ago. When setting up my PRSA, I was asked to choose between an investment strategy for an ARF and an investment strategy for an annuity. I opted for the ARF. I’ve about 20 years to go until I retire. If I decide between now and then that I would prefer to get an annuity at retirement rather than an

ARF, can I change my mind or am I tied to the ARF option? Linda, Co Kildare

YOU are not tied to the ARF option at all — you can, of course, switch funds or strategies if you wish. Essentially, at present, you are in a ‘one-size-fits-all’ investment strategy. With the ARF strategy, you will be invested in aggressive funds — with a high equity content up to your retirement. The annuity option, on the other hand, would de-risk as you approach retirement — with a bias towards traditionally lower-risk assets (such as bonds) when you are five years or less to retirement.

I would suggest contacting your financial adviser or pension provider directly if you wish to change the strategy.