How do I choose between taking an annuity or ARF when I retire?
I’m 64 and I’m about to retire soon. I’m on a defined contribution pension scheme with my company, and my employer’s pension provider is asking me to choose between buying an annuity and an approved retirement fund.
I find the subject too complex and I’m afraid if I make the wrong choice that it will affect my financial wellbeing in retirement. How do I choose between an annuity or ARF?
– Jim, Co Wexford
How you draw down your pension is one of the biggest financial decisions you’ll make – and one with which many employees get far too little assistance.
Annuities are simple…
On the one hand, an annuity is simple. In exchange for your retirement fund, a life assurance provider will provide you with an income for the rest of your life and you will know how much you’ll receive each month.
An annuity can be customised to a certain extent: for example, you can set it to grow with inflation, or to pay a pension to your surviving spouse.
…and better value than in recent years
Annuity rates have risen by around 40pc over the last year, in line with rising interest rates, and a 66-year-old retiring today can receive around €5,300 per year for every €100,000 in their pot. So even if you’d dismissed the idea previously, it could be worth revisiting an annuity now.
…but Approved Retirement Funds have advantages
Annuities have some major drawbacks when compared with an approved retirement fund (ARF).
Here are three reasons an ARF may be preferable.
1. Potential to grow your fund
By keeping your pension pot in an ARF after you retire, you can benefit from potential continued tax-free increases in its value, whereas the value of an annuity, once purchased, is final. In retirement, your investment timescale is often longer than you think – maybe 30 years, or more. You can take advantage of that by investing your ARF in a wide range of assets with the aim of growing your pension pot over the medium term, even as you start to draw it down.
2. Keep control with an ARF
An ARF enables you to keep control over your pension – you decide where it’s invested, how much to draw down, and when. It’s worth remembering that if you purchase an ARF now, you have the option to convert it into an annuity later. This hybrid approach works for many people early in retirement.
You might be happy to manage your ARF now with a view to preserving its value. In 15 years, that might seem less attractive. At that point, it might make more sense to hand over your fund in return for a guaranteed income for the rest of your life. And because you’ll be older, you’ll receive a better annuity rate and create certainty around your income from that point on.
3. ARF money doesn’t extinguish on death
Unlike an annuity, the value of an ARF does not extinguish upon death; the remaining funds become part of your estate. That means you can leave them to your spouse or partner, or other beneficiaries.
Annuity or ARF? it’s a combination of head and heart
Deciding how you take up your retirement benefits is a combination of head and heart. You’ll need to weigh up the advantages of certainty and simplicity against the potential to preserve and increase wealth. Your health, your wider financial position, and what – if anything – you want to leave, will also play a part in your decision.
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This is adapted from a Moneycube.ie column which appeared in the Sunday Independent on 2 April 23.