Pensions are boring and complicated but, like it or not, they are a key part of our financial lives. I’ve covered the basics in my Pensions Made Simple blog so now I want to talk about a big decision that you will have to make at retirement – the choice of ARF or Annuity?

If you have a private pension (meaning anything other than the State Pension) you can generally take up to 25% of the value of the fund at retirement in the form of a tax free lump sum. So what happens to the remaining 75%? You will normally then have a choice between an Annuity or an Approved Retirement Fund (ARF).

What is an Annuity?

An Annuity is a pension product where you buy a (taxable) income for life in exchange for a once-off upfront payment (of your remaining 75% pension pot).

What is an ARF?

An ARF is a retirement fund in which you keep your remaining 75% pension pot invested and you decide when to withdraw funds as (taxable) income.

Why choose an ARF?
  • You retain ownership of your retirement fund and any money left in the ARF after your death goes to your next of kin – a major plus if you are in poor health (as an Annuity dies with you).
  • You have flexibility in terms of when and how much you withdraw from your ARF in retirement – but you must take an annual minimum of 4% in your 60s and 5% after that.
  • You can choose how to invest your ARF and select investments that suit your needs and attitude to risk. Remember, ARF investment growth is tax free, but withdrawals are taxable.
  • Annuity rates (and therefore income) are extremely low at present and considered to be very poor value.
  • You can use your ARF money to buy an Annuity later on (and secure a regular income) and perhaps get a higher Annuity rate (bigger income) for the same lump sum as you will be older.
Why choose an Annuity?
  • Your Annuity income is guaranteed for life, which you can rely on when budgeting for retirement spending.
  • Your ARF funds could run out in your lifetime if you take out too much income or if investment performance is poor or if you live longer than expected.
  • You will have to pay ongoing ARF / investment / management charges.
  • There is no guarantee that you will be able to buy you a higher Annuity pension later on – annuity rates could be even lower in the future.
  • Revenue automatically assume that you withdraw 4% to 5% each year from an ARF and tax you on that amount whether you like it or not.

In conclusion, going the ARF route will be the wiser option for most people in this era of historically low interest rates. Nevertheless, if and when you face the choice of ARF or Annuity, it is important to weigh up the pros and cons of both, and consider your total financial and personal situation (preferably with the help of a financial advisor) before you make a final decision.

And if you like this article, try this one: 5 Retirement Myths