Welcome to the episode which will hopefully finally banish any confusion about ARFs, or do I mean ARKs!?......
Apparently Noah's Ark was made of 'cypress wood' and was in the region of 500 feet long. It was said to have been quite a boat, large enough to hold 125,000 sheep if those were his orders! Anyone familiar with the story will know however that he was instructed to bring on only 1 mated pair of every animal that walked along the ground, and his own family. Poor Noah was given only 7 days in which to build this behemoth, and to ultimately save the animal kingdom, before the great flood arrived, no pressure!
If we were to relate this to our own financial lives it's fair to say that, unless you yourself are on the cusp of retiring, you have more than 7 days to build your own ark and save yourself from the flood when you stop working!! Let's discover a little more about Approved Retirement Funds (ARFs), and how they might be your ark when your own great retirement flood comes!
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What is an ARF?
Other than sounding similar to an ARK, it too can be a real saviour when you do stop working and your income from employer/business stops! Ultimately an Approved Retirement Fund is a vehicle in which you can park some or all of your pension fund into when you decide to retire.
How Do I Get Into The ARF?
We outlined in blog 15 & blog 16 exactly how you can get access to an Approved Retirement Fund when you decide to retire. Broadly speaking if you are in a pension which you have set up and contribute to yourself (Personal Pension or PRSA) or are part of a pension through your employer (Occupational Pension Scheme) then you typically will have access to a glorious and lifesaving ARF. Check out blog 15 & 16 for the low-down!
How Much Do I Need To Get Into An ARF?
Providing you meet the basic income requirement as outlined in Blog 15&16 you can invest funds in an ARF. Imagine you are 35 years of age, with no pension put in place up to this point, you have always felt that pensions were for old people, they are a crock, the charges are outrageous or that you will never retire! Whatever the reason you haven't done one previously. Having listened to the Informed Decisions Financial Planning Podcast you decide that the time is nigh, you don't want to be left out in the flood!
For illustration if you were to manage to invest €400 per month into a pension plan for yourself. We will assume you increase this by 3% per year in line with headline inflation rate. So in year 1 you pay €400 per month, in year 2 you will pay €412 per month and so on and so forth!
If you were to achieve a net return of 7% per year average growth (you will need to find a pension with low charges and go heavy on equities- staying invested when things get rocky- which they will- see here!).
If you were to do that, and to achieve that long term plan, you would have €796,681.27 of a fund when you get to 68! The bones of €800k!
Under current rules you could take €200,000 of that tax free for yourself and go nuts! You would have an option to put essentially the remaining 600k into an ARF and access it as you need it. How bad!?
You could then take funds from this 600k as you wished! Imagine you took the minimum 4% of this per year, equating to €24,000 per year, which in addition to the State pension would bring your total income to the €36,000 territory. This would mean you pay essentially minuscule tax on your total income....all totally above board and legitimately done.....so if anyone is telling you that pensions are a crock just tell them this!
Does This ARF Leak?
I'm sure Noah's machine which he cobbled together in 7 days and was 500 feet long must have had a few sprinklers in it, this ARF is the same! As you will have seen in blog 15 & blog 16 you are obliged to pay tax on all ARF assets.
Legislation introduced an annual taxable ‘imputed distribution’ which is charged to you and the value of assets in your ARF. This means that PAYE will be payable on an amount which is assumed to be taken out of your ARF by you. You will therefore likely take this amount out at a minimum each year. The rates?
- 4% for individuals between 60 and 69 for the full tax year
- 5% for individuals who are 70 or over for the full tax year
- 6% for individuals with combined ARF and vested PRSA values of more than €2 million and who are 60 or over for the full tax year
Yeah for sure, if you invest your ARF in equities there will be periods of volatility, where your fund will fall by 20-30% in any year. When it does this and you are drawing say 4% per annum from it, you are withdrawing as the value is falling, meaning you are selling units of your fund at a low-point. This is never a wise thing to do, so ideally have at least 2 years of income parked in a 'cash fund' or other which will be drawn from during these periods, and reverting back to your 'equities' portion when markets rebound.
Bomb-Out! This is an industry term for someone taking so much income from their ARF that the fund runs out well before they die, and their need for income passses. Ultimately this is where the ARF sinks and everyone drowns! How to counteract that? Invest it wisely, withdraw it wisely and don't allow yourself do silly things. Again, always best achieved with the support of a decent Financial Planner.
So What Is The Advantage of an ARF?
The advantages are many, and hopefully we have conveyed some of these already! The specific advantages will often depend on the individual circumstances and may differ from individual to individual.
One key advantage of investing funds into an ARF is that you can take money from your 'account' whenever you want or need it in retirement. As you have seen above this can mean you can draw the income in a very very tax efficient manner! Unlike the alternative 'Annuity' whereby you hand all your funds over to a company and they drip-feed a set income to you, the ARF remains yours and nobody else can touch it!
Even though you are retired you can (if you wish, and you might be considered mad not to!) continue to invest it in order to retain the purchasing power of your funds. If you are indeed in your mid thirties today you are expected to live until at least 80 years of age, so that's a good 12-15 years at least of retirement. Over a 15 years period inflation would erode the purchasing power by 35% if it was running at 3%, so you ideally want to keep up with that??
Also, the value in your ARF's can be passed on to family and loved-ones in a more tax efficient manner than some other forms of pension plans. For instance if your ARF funds are inherited by your children of over 21 years of age then they pay Income Tax at a rate of 30% on the benefit as opposed to 33% under the Capital Acquisition tax rules.
Should I Prepare my Own ARF?
Assuming you are a long term away from retirement age then you don't need to do anything as such. However as I always beat the drum for 'beginning with the end in mind' now might be the ideal time to find out what sort of a fund you are likely to have based on your current plans. If you discover that some small tweaks could help you line yourself up for a beautiful ARF then that could be a great outcome for you.
Either way, we hope that this has been of benefit to you. It may or it may not have been biblical and earth-shattering for you! If it has then please tell everyone you know about it, help us spread the Informed Decisions word! We are due to feature in the Sunday Times again next week, so keep an eye out there too!
Also, make sure to add your email to our growing community over here....so we can keep in contact with you directly......cheers!
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