I’m approaching retirement and, as my pension fund has grown quite well over the years, I’m interested in taking out an approved retirement fund (ARF).
I have a query about the charges involved. A fund value of €1 million would give a pension of €40,000 a year, but you can expect to pay 1 per cent of the fund value or an additional €10,000 a year in charges.
As these charges will continue to be taken as you’re drawing your pension, they could realistically amount to hundreds of thousands of euro in total.
My pension fund has done well partly because I’ve kept costs to a minimum. So, I want an ARF with:
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- Exchange-traded funds (ETFs) from the major providers. There is a huge range of these, and typical annual costs are approx 0.1 per cent or lower.
- Execution-only. I will buy investment advice at specific times I feel I need it, rather than paying for it on an ongoing basis as part of a bundled offering.
ARF providers, however, all seem to charge a percentage of the fund value. It doesn’t make sense that drawing a pension from a €1 million fund should cost you 10 times more in charges than a pension from a €100,000 fund.
Do you know of an ARF provider with flat-rate charges, and can you recommend anything else I should be doing to minimise these charges?
KB
Approved retirement funds (ARFs) are one way a person can take their pension on retirement.
Your pension funds will have built up over your working life either in a pensions scheme attached to your workplace where you can be one of many members or small personal schemes. When it comes to retirement you have some choices about what happens those funds.
First, you can take a certain amount of your fund tax-free. That is generally a quarter of your fund up to a maximum of €200,000. If a quarter of your fund amounts to more than this, you will pay just the standard 20 per cent rate of income tax on anything between €200,000 and €500,000.
Some people, including those employed in the public service before a certain date, are entitled to take one and a half times their salary instead.
Thereafter, there are generally two ways of drawing down your income in retirement – an annuity or an ARF.
With an annuity, you hand your fund over to an insurance company in return for an agreed annual income for life. Generally an annuity will die with the owner unless they have made provision for a survivor’s payment to a spouse from the fund.
You can choose certain features – payment of a reduced pension to a surviving spouse, minimum term of payment so the fund pays out for a set minimum number of years even if you die earlier and a provision to allow for inflation, for instance. Each of these comes at a cost, reducing the amount you receive initially.
How much you receive will also be gauged by how much you have in your fund and your general health. Smokers and the less healthy, ironically, can get a higher payment as they are not likely to be needing the fund as long as someone who can reasonably expect to live close to 20 years in retirement.
ARFs were introduced widely in 1999 and have proved popular for several reasons, not least that the rates offered under annuities became less attractive.
They allow your pension to stay invested so that it can (hopefully) grow further and, among other things, they do not die with the holder. They can be left to a spouse, a child or children, or to some other beneficiary.
Each of those scenarios has different tax treatments that we will not go into here.
You clearly know all this but it is worth explaining in some bare detail as pensions have an awful habit of confusing most people out there.
Importantly in the context of your question, there are rules in place on the minimum you must draw down from your ARF each year – a percentage figure that changes with age and can also change with the sum in the fund.
Under the age of 70, you must draw down 4 per cent of the value of your fund each year (you will be taxed by Revenue as though you have even if you draw down less) – hence your €40,000 income from a €1 million fund.
Over 70, that drawdown rises to 5 per cent. And if your fund is over €2 million in value, you need to take 6 per cent each year.
The tax you pay is determined by your income from the fund – as it is for other citizens – but, with an ARF, the responsibility for deducting that tax falls to your qualified fund manager. This is the person you have an issue with.
Under the legislation, your ARF must be managed by this qualified fund manager and they are also responsible for the paperwork involved in setting up your ARF. Under section 784A of the Taxes Consolidation Act 1997, this qualified fund manager can be a stockbroker, a life company, credit union or bank.
Critically, you are also looking for ongoing growth in your fund and they are responsible for managing that. You are not just paying a fund manager to cover the costs of paying your pension monthly; you’re paying them to grow or maintain the value of the fund.
There is no provision for bypassing this fund manager so you are stuck with them. You cannot manage the fund personally.
And you are right. Income in retirement is limited and your capacity for future earnings is diminished, so it stands to reason that you would query or challenge significant costs.
As you say, a 1 per cent fund management charge translates as €10,000 lost from your fund if the fund is around €1 million in size. For most people, with more modest funds, the charge will amount to something in the single figure thousands – €1,000 a year on a fund valued at €100,000 for instance.
To put it in context, if you are in your sixties and your fund is less than €2 million in size, this charge is equal to a quarter of the income you are expected to live on for the year from the fund.
It increases the return you need to make on your remaining investments if the fund is not to be at risk of running out of cash before you die.
You are correct that 1 per cent seems to be the “average” fund management fee – although I have also come across significantly larger figures – but that is not to say that you cannot do better.
In general, the larger the fund, the more leverage you will have to negotiate down the percentage fund management charge. Certainly, with a fund of €1 million, you should be able to find a fund manager who will oversee the fund for a percentage charge closer to 0.5 per cent or 0.4 per cent.
Royal London, for instance, says it offers funds with charges ranging from 0.4 per cent to 0.9 per cent whereas someone like Zurich opts for a flat 1 per cent rate. What you get for each of these you would need to check for yourself.
I am not permitted under Central Bank rules to recommend any specific product as I am not a registered qualified financial adviser, just a journalist.
Of course, apart from the size of your fund, the charge will be determined by the type of investment you are considering. Those looking for very active management of their fund can expect to pay a higher charge all other things being equal. Clearly, investing in ETFs, which have low costs, should be at the lower end of the range.
The other thing worth saying is that choosing who should be your fund manager is not simply a hunt for the lowest fund management fee; you also want to be comfortable that the fund manager is going to deliver the best growth for your fund over time.
This can mean a trade-off. It may well be worth paying a slightly higher for someone with a better record of returns over the long term – bearing in mind the old investment manager get out that there is never any guarantee that past performance will be replicated in the future.
When looking at performance be very careful of managers that focus on particularly successful returns in recent years. You want a fund manager that can deliver returns across volatile market cycles – not just in an equity bull market.
You also want to check whether there are other charges connected with the ARF over and above the fund management charge. If you buy your ARF through a broker, for instance, they could be getting commission which will also eat into your fund. And there can be other charges associated with actual trading of investments within your fund.
The bottom line is that there is no way of self-managing your ARF, for instance tapping the industry on an execution-only basis when you want to make a change to your investments or actually draw down funds. You are obliged to use a qualified fund manager and their annual costs will reduce the size of your fund. You need to be happy that you have the lowest possible charges for the best possible investment returns.
That’s a tricky balancing act, one that can never be certain. What is true is that those prepared to do the work in comparing ARF fund managers are more likely to get a better deal.
