Defining the benefits

No matter how far away from retiring you may be, it’s never too soon to start thinking about your pension. And if you’re close to retirement, you may have questions about what happens when you do retire – depending on the pension plan you have.

To define benefits, or not

The two types of pension schemes available are defined benefit and defined contribution, although defined benefit schemes are mostly being phased out. A defined benefit scheme (DB) is also known as a final salary scheme, says Bernard Walsh, head of pensions, Bank of Ireland. “Scheme sponsors [usually employers] commit to paying a percentage of your final salary in line with your service in the company. The decisions around investment, administration, fees and charges all lie with the employer. From an employees’ perspective, they have little or no responsibility, other than deciding how they want to draw down their benefits at retirement.”

A defined contribution scheme (DC) is the more common version these days, says Walsh. “An employer commits to making a specified contribution, often matching an employee’s contribution, up to a predetermined level. The scheme member usually has a choice of investment strategies and is responsible for the outcomes they achieve. From an employers’ perspective, it is a more “hands-off” approach but they remain responsible for the operation of the scheme, timely remittance of payments and the governance of the plan.”

Joe Hanrahan, head of retirement and financial planning, RBC Brewin Dolphin, says if you’re in a DB, you don’t have to worry about the stock market and what you’re getting paid. “However, DBs have been under a lot of stress in the past couple of years, and many have closed down. Employers are just not in the position to keep them going.”

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Decisions decisions

So, can someone choose which scheme they join? “The short answer is no,” says Chris Carlile, principal, Mercer Private Wealth. “It is your employer that decides what retirement benefit scheme you are eligible to join.

“In Ireland currently, there are now far more defined contribution schemes than defined benefit schemes. Because of the fluctuating costs of providing the benefits, many employers have either closed their defined benefit schemes to new employees due to the cost of maintaining them.”

However, Connolly says you can influence the choice by choosing your employer. “Broadly, you can be fairly certain that any new private sector employment will have a DC scheme attached [if any], and all public sector employments have a DB entitlement.”

Annuity or ARF?

An Approved Retirement Fund (ARF) is an investment vehicle for your pension pot when you have retired and drawn down benefits, says Walsh. “You usually have a wide choice of investment strategies. Typically, you draw down from your ARF to fund your living expenses in retirement. However, any withdrawal you make from your ARF is subject to income tax at your marginal rate, USC and PRSI [if applicable]. You can draw down your ARF funds on a regular and/or ad hoc basis. A minimum withdrawal is assumed for tax purposes even if no withdrawal is made in any given year, ie, you must pay income tax, USC and PRSI [if applicable] on a minimum specified percentage of your fund, known as the ‘imputed distribution’ each year. Typically, you need to withdraw 4 per cent each year.”

The key differences between an ARF and an annuity are flexibility and risk, says Carlile. “An annuity converts the money in your retirement fund into a guaranteed taxable income payable for your lifetime, fixed on the date you buy the annuity. There are several different variants of annuities available.

“For example, many people buy annuities that increase the income each year to protect against inflation, or that provide an ongoing income for their dependant in the event that the dependant lives longer. However, upon the death of the surviving dependant, there may be little or no return for other dependants and there is no balance for your estate to inherit.”

Carlile says an annuity may be suitable if you want certainty of income for the rest of your and your dependant’s lifetime and do not want to run the risk of your pension benefits falling in value. “An ARF allows you to preserve, manage and control your retirement fund. You can invest your money into suitable assets and decide how much taxable income you want to withdraw each year, subject to the minimum withdrawal once you are aged 61 or over. It does not provide any guaranteed income, therefore you must be willing to tolerate the investment risk, but any balance in your ARF on death is payable to your dependants.”

Choosing which to invest in is very much a personal decision and is driven by your health, your other assets, your attitude to risk, your succession plans, and your appetite to accept that you will not have access to the capital in your pension fund if you buy an annuity, says Connolly.

Making the decision

Hanrahan says there are quite a few variables to look at before a client makes a decision. “I like the idea of having the State pension, it’s often overlooked and even dismissed. It’s a fantastic grounding income to have.

“Typically you have a person with a lump sum, fixed income pension and an ARF, which gives income but can be passed to spouses and children. In terms of approaching the decision, one of the things we think differentiates people is the capacity to invest and how appropriately to invest.”

Connolly says the need for advice before, at the point of, and after retirement is critical. “There are so many nuances and rules that you want to ensure you choose the option that best suits your particular circumstances and requirements.”

It makes sense to put your money in the hands of professionals but getting good advice at the outset and throughout the life of your pension journey is equally important, says Walsh. Spending an hour of your time once a year with your adviser can help you to stay on track and give you a far better chance of achieving the outcomes you want and the goals that you have hopefully written down.