Let’s face it, pensions are boring, complicated and full of jargon. Unfortunately they are also very important to our wellbeing so whether we like it or not, it’s important to know the basics.

If you have a private pension (ie, 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 and/or an Approved Retirement Fund (ARF). An Annuity is a pension product where you buy a (taxable) income for life in return for a once-off upfront payment – I explained more about this in a previous blog, What Is An Annuity?

So then, what is an ARF?
An ARF is a retirement fund where you can keep (75% of) your pension pot invested after retirement. Instead of a set Annuity payment for life, you decide when to withdraw funds as (taxable) income. Key point – unlike an Annuity, any money left in the ARF fund after your death can be left to your next of kin.

Advantages of an ARF
  • You keep control of your retirement fund – a major plus if you are in poor health (as an Annuity dies with you) and/or want to leave your money to your dependants after you die.
  • 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, growth in your ARF is tax free, but withdrawals are taxable.
  • You can always use your ARF to buy an Annuity later on, if you decide that you need a secure, regular income – you may be able to get a higher Annuity rate (ie, a bigger income) later on for the same lump sum as you will be older.
Disadvantages of an ARF
  • Your retirement money is not guaranteed to keep its value because the assets in which your ARF is invested may not perform as well as expected – whereas the Annuity income is set in stone.
  • 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 charges.
  • There is no guarantee that your ARF 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 withdraw 4% to 5% each year and tax you on that amount whether you like it or not.

To conclude, if and when you face the choice of Annuity versus ARF, it is important to weigh up the pros and cons of both, and consider your total financial and personal situation (perhaps with the help of a financial advisor) before you make a final decision.