I was at The Killers in Malahide Castle on Wednesday evening. It was a brilliant gig on a gorgeous summer evening. The first song of the encore was The Man. I loved the lyrics, and it was coincidental that I had two meetings this week where I met the man and the woman. They had gas in the tank and money in the bank. Both had pensions and it was my meeting with the woman that was very interesting, and we look at it in more detail. My meeting with the man was more than informative too. In a life lessons way and we will come back to that in the future.
Dolly Malone was about to draw down her pension and wanted to go through her options. We will look at
- Dolly’s background
- Annuity Option
- ARF option
- What option for Dolly?
Dolly was in a lead role in a US multinational for 22 years and left the company 6 years ago. The company had a very good pension scheme and Dolly paid extra into her pension during the later years. She is 62 now. In 2021 she accepted an offer from the company to transfer her pension to a Personal Retirement Bond [PRB]. Her main reasons for doing this were
- She wanted to look after her own pension
- The company had offered her a cash bonus to take the money out of the company scheme
- She wanted to draw down her pension early. If she stayed in the company scheme, she would have to wait until 65 to access it
The value of the transfer into the PRB was €1.1 million. She put this into a cash fund knowing that she wanted to protect the value before deciding what to do with it. The PRB provider wrote to her with the various options, and she wanted to go through these to see what was best for her. She is married and her husband has a very good pension.
Lump Sum and Pension
Dolly’s final salary before leaving the company was €120,000. Based on her years of service and final salary she could get a tax-free lump sum of €114,000. This would leave €986,000 for investment into a pension. This is where a life company like Aviva, New Ireland, Irish Life, etc, offers you a set % to give you a pension for life. The rates offered by her life company were
- 4.13% – guaranteed period of 5 years
- 2.64% – guaranteed period of 5 years and increases by 3% each year
- 4.10% – guaranteed period of 10 years
- 2.62% – guaranteed 10 years and increases by 3% per annum
- 3.92% – guaranteed period of 5 years and 50% dependents pension
A guaranteed period means if you die before the end of the period the company will continue to pay your pension. They will pay this to your Estate to the end of the set period.
Guaranteed period for Dolly
So, €986,000 at 4.13% will give Dolly an annual pension of €40,720 per annum. She will have to live for 24 years, until 86, to get her own money back. Whenever she dies the pension is gone. If she opts for the guaranteed period of 10 years at 4.1% that will give her an annual pension of €40,426. She could be willing to accept a lower pension now knowing that it will increase by 3% each year. At 2.64% she will get an annual pension of €26,030. It will take 15 years for this pension to get up to over €40,000. That doesn’t make sense. She has no dependents, and her husband has a very good pension. If he was to get an extra €20,000 in pension about 45% of that would go in tax.
Another option the life company gave her was not to take a tax-free lump sum and to invest the full €1,100,000 into a pension. The rates were the same as above. With the 4.13% rate, it would give her €45,430 per annum. About €5,000 more in annual pension. But Dolly would pay tax on this at 45% so the net would be €2,750 extra income each year. It would take her 41 years to earn the tax-free lump sum amount. Again, not a sensible option.
Lump sum and ARF
Again, the lump sum will be tax-free. But under this option, the lump sum is 25% of the pension value. 25% of €1.1 million is €275,000. Of that €200,000 is tax-free. The excess of €75,000 is at 20% so a tax bill for Dolly of €15,000. She ends up with €260,000. The net lump sum is over twice as much as the lump sum from the previous option. Should she go for this there will be €825,000 left in her pension pot. She has two choices for this
- Invest it into an ARF
- Take a cash lump sum subject to taxes
An ARF is an Approved Retirement Fund. It is a long-term pension plan where you invest your money with one of the life companies. The key difference is that an ARF is your asset so you own it and can pass it on to your spouse or children. Or even the home for bewildered cats! There are some rules with ARFs, and the main ones relate to drawdowns. You can draw down a minimum of
- 4% per annum up until the age of 70
- 5% per annum from 70 onwards
ARF summary for Dolly
If you don’t draw down anything the fund will still pay tax on 4% or 5% of the value. So, you may as well take the money. 4% of €825,000 for Dolly is €33,000. This is income and is liable to tax, but not much.
The investment goal is to protect as much of the capital as possible. If you draw down 4% or 5% each year the plan is to invest in assets that will give you a return of 5% plus per annum. Remember you are taking 4% or 5% of the value of the fund and the life company is not guaranteeing you a set income. Should the ARF value fall to €600,000 your 4% is a pension of €24,000. Hence, you carry the investment risk.
If she took all the €825,000 now, she would be left with €429,000. This is based on a 48% tax rate.
The first €36,800 of your income is at the lower rate band of 20% If Dolly goes the ARF route her pension will be €33,000. Her taxes will be as follows
|€33,000 x 20%||€6,600|
|Less Personal Credit||€1,700|
|Less PAYE Credit||€1,700|
|Net Monthly Income||€2,419|
This is an effective tax rate of 12%. She can also use her €260,000 after-tax lump sum to supplement her income. When Dolly dies, she can pass the ARF onto her husband at no tax cost. The ARF will continue as an ARF, and he will get a 4% or 5% pension or more each year. When the husband dies, and it goes to the children then taxes come into play. In most cases, children will be over 21, and Income Tax of 30% applies. It is no longer an ARF at this stage but a cash value. If children are under 21 then it is liable to inheritance tax thresholds. If the bewildered cats home get it, they will pay 30% Income Tax too.
She will get the state pension at 66. Combined pensions then will be €46,000. It will push her into the higher tax bracket, but she will still be better off.
Dolly went for the higher lump sum and the ARF route. She gets a much higher lump sum. Plus, the ARF is her asset that will provide her with a very good pension. She didn’t want to give her money to a life company and take her chances. The fear of the life company walking away with a large chunk of your hard-earned savings isn’t a risk she wants to take. She is willing to take on the investment risk of an ARF and hold onto ownership of the asset.
Her effective tax rate will be low on the ARF income. She can supplement her income with savings and a much larger lump sum. And the state pension will give her extra income in 4 years. She’ll have gas in the tank and money in the bank. She’s the man.
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