# Concerned about parents' pension



## He-Man (13 Aug 2016)

My father is 59 and plans to retire at age 60 with a private pension retirement pot of 800k euro, which will be in a cash-based instrument when he retires. At age 67 he will receive a state pension of 23k euro per annum for the rest of his life. 

He plans to spend 50k per year when he retires.

Now regarding his 800k private pension, the following rules apply:

He can take 200k cash free at retirement or he can take 300k and pay 20% tax on the entire 300k. He is inclined to take the 200k, to bide him over until he reaches 67. (My concern here is that he is overspending on an annual basis and his 200k will not last 7 years, and that by taking it, he undermines the compounding potential of the overall 800k pot.)

Of the remaining amount, law states he must put 63.5k into an investment which he cannot access for 15 years (75 years old). He has no idea what to do with this as he has been using active funds for decades. I believe he should take charge of this and invest 60:40 stocks to bonds using self-selected low cost diversified ETFs. 

This leaves a balance of 800k minus 63.5k minus 200k = 536,500 euro, of which he must draw down 4% per year. This must also be invested in something and I would be inclined to think 55:45 stocks to bonds in self-selected low cost diversified ETFs. 

My other instinct is that by spending 50k per year, he will exhaust his pot and therefore needs to reduce this to 40k per year at least.

He's old school and can barely type a message on his iPhone. The idea of him managing his own fund using online tools etc. troubles me. I don't want to administer his pension in case things go wrong and it affects our relationship, but I also want him to avoid active funds. 

Any advice?


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## Marc (13 Aug 2016)

You are on the right lines with your thinking.

He needs to take some good fee-based advice free from the incentive effects of commission.

He needs to obtain an annuity quotation in order to establish a realistic base expectation of the level of income he should expect for life without fear of running out of money. It's not that much.

Finally if he does use an AFF for some or all of his retirement pot he needs to asset allocate across the pots taking account of the time horizon of each pot.

So if he is holding 200k in cash directly he should hold less cash and fixed interest in the ARF and considerably more equites in the AmRF.


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## Steven Barrett (15 Aug 2016)

Your dad has to have a good think about what he wants to do when he retires. 60 is a young age to retire, so he will have lots of energy and plans for things to do (I'm assuming health is good). As he gets older, things will get harder (my own dad says he finds long trips a bit more difficult, he's 71 now), so life will be more routine and costs will go down, so that €50k expenditure will reduce. 

When looking at a portfolio for his ARF, he also needs to look at capacity for loss; if the fund falls by x%, will it have a detrimental effect on his lifestyle? 

Your dad should be looking at lifelong cashflows to see if he has enough money to pay for his plans in retirement. When he has an idea of his cashflow needs, he can work back to see the return required to achieve his needs. He'll then have a better idea of the level of investment risk required. 

And on the €63,500, he doesn't have to put it into an AMRF. He can purchase an annuity with that amount of money (I have never seen someone go for this option). He can also withdraw 4% of this fund each year if he wishes. At 75, it automatically becomes an ARF. 



Steven 
www.bluewaterfp.ie


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## elacsaplau (16 Aug 2016)

He-man,

You pose a great set of questions. I understand your reticence in not getting directly involved in advising your parents but I have a sense that you will be a big help to them in making sure that they are presented with sensible options in a timely manner. The last part is important as, maybe, when your parents are better aware what their pension fund provides, your dad may decide to defer his retirement in order to achieve a more acceptable level of income.

Whatever retirement age is decided upon, ultimately the pension fund money (after tax free lump sums) will be applied:
- an annuity
- an ARF/AMRF
- A combination of the two

It may help if I set out what I would want to know from an adviser in deciding which option to take.

Let's deal first with the annuity. A pension payable to a 60 year old with a 58 year old partner which increases at 2% p.a. and continues to be paid in full after the first death gives an annuity rate of c. 1.7% -  In other words, for the €600k available to your parents have available after taking their tax free lump sums, they would receive an annual pension of €10,174 p.a.

So the question becomes - can a better outcome be achieved by going down the ARF/AMRF route? For simplicity, let's not get into the minutiae of ARFs v. AMRFs. The questions to be asked to the adviser - to which evidence based answers to the Irish retiree should be provided - are:

- what is a safe/prudent percentage to withdraw from the ARF?
- what evidence supports this withdrawal rate?
- how is the suggested withdrawal rate anticipated to deal with the low bond yield environment? In other words, what simulations have been done to test potential experience in a low interest rate environment?
- what initial asset allocation is proposed?
- what withdrawal strategies are to be employed (this includes information regarding which asset classes annual withdrawals are taken from? how funds are periodically rebalanced, etc.)

There is a lot of research available in other jurisdictions in relation to these questions. I am not aware what "best practice" looks like in the Irish context. My suspicion, however, is that in the Irish context, research and consequently advice, are seriously under-developed. I would be more than happy to be proven wrong! I would argue that in the absence to meaningful replies to these questions, the quality of advice available to Irish retirees is, to put it delicately, sub-optimal.

Finally, for the avoidance of doubt, safe withdrawal has nothing to do with the Billings method!!


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## Marc (16 Aug 2016)

This is a very high risk area for advisers and until recently there hasn't even been a specialist examination available to ensure that brokers have the necessary knowledge to conduct an analysis.

A substantial issue here is the requirement to take imputed distributions at a rate of at least 4%pa which may be (and often is) entirely inconsistent with the asset allocation of the investor.

We provide investors with real return (inflation adjusted) assumptions net of fees for all combinations of asset classes. We also compute risk of underperforming cash, inflation and risk of losing capital over various time periods for each portfolio.

But it always comes down to the simple fact that the State wants to tax your income and so you have to take at least 4% irrespective of whether you need to, or or if your asset allocation can support that level of income.

All ARF investors need to calculate a critical yield, net of fees that their portfolio must earn each year on average to match the annuity income forgone.

If an ARF case came in front of the courts or ombudsman I'd be looking for an initial annuity comparison to be on file and an analysis to be in the statement of suitability. Without the initial comparison, it is highly likely that the initial ARF sale would be open to attack in a complaint. The defence of; the client wanted an ARF, they didn't want an annuity wouldn't really work unless the client was an actuary or a doctor with an impaired life expectancy.

If an investor is not willing to take sufficient investment risk to match  the annuity income given up then arguably they would be better off purchasing an annuity with sufficient guarantees to offset the loss to the estate 10 year income or 100% spouses pension for example.


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## elacsaplau (16 Aug 2016)

Marc said:


> This is a very high risk area for advisers and until recently there hasn't even been a specialist examination available to ensure that brokers have the necessary knowledge to conduct an analysis. QUOTE]




Hi Marc,

Thanks for your reply. Alas, I think you have confirmed my suspicions! (Many) advisers are insufficiently qualified to compare A with B, (just 2 options……aaaggh) so hey, they'll sell A......._no one ever gets fired for selling IBM and all that! _Or they'll sell B and have an 'oul annuity quote on file. Not encouraging....

What has the industry done to improve outcomes for retirees? International evidence suggests that buying an annuity at the point of retirement is inefficient*. (There are strong arguments for buying a deferred annuity but such products are not even available in Ireland - an example of my suspicion that the market is under-developed here.) In simple terms, for those who retain ownership and responsibility for one's fund, the safe withdrawal rate in the US has long-time been seen as 4%, satisfying very rigorous back-testing. That said, many commentators now believe that this should be reduced to c. 3% to ensure safe future outcomes in anticipation of a combination of lower future equity and bond returns.

My sense is that Irish retirees are being very badly served by the industry. For example, the Society of Actuaries in November 2015 produced a 50 page analysis of the ARFs and annuities and in spite of having multiple pages of recommendations didn't even call for a change in the imputed distribution rates (4% before 70, 5% thereafter - their only recommendation being to remove the 6% rate in respect of funds over €2m!). The current imputed distribution requirements are simply nonsensical but will obviously continue when no one seems to be telling the Minister that they are nuts! Again, would be delighted to be proven wrong here!

*If we take the annuity example that I quoted in my earlier thread (taken this morning from the Irish Life site), and say that instead of taking an annuity, the couple withdraw the equivalent of the annuity amount each year and that for consistency that the amount withdrawn increases by 2% each year. Let's say that the couple get a 2% return on their fund, i.e. matching the annual inflation - in simple terms giving them a 0% real long-term return. In this scenario, their ARF would last almost 59 years (assuming uniform returns) and would provide value to the estate upon earlier death, whereby the earlier the (second) death the higher the residual value, etc.

The industry needs to get its act together. A couple with €600k in their retirement fund getting €10k a year in annuity income is simply not a good enough outcome. I know that some people will still go with the annuity approach but there must be better solutions available to the majority between the overly conservative 1.7% on the one hand and the 4%/5% _forced_ withdrawals on the other.


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## North Star (17 Aug 2016)

Hi He-man, For you father and yourself I suggest you split this into two separate pieces of work/analysis.

Step 1 - detailed review of all income/outgoings  assets and liabilities etc to determine whether or not your father can afford the level of income that he is looking at for the rest of his life. Base this analysis on realistic/conservative assumptions re rate of returns, longevity etc.

Once you have this 'central case' you can then run a range of scenarios e.g. what happens if I delay retiring till age 65? what happens if my income taken from pensions is €40k, €50k , €60k etc, what happens if risk assets have a large fall etc etc
This analysis will give you both a much clearer understanding as to the affordability of his retirement plans based on an assumed rate of investment return and the robustness of his retirement plan to shocks such as market falls. ( I strongly recommend that anyone approaching retirement should ensure that they have been given this level of analysis re their likely retirement income)
Any good adviser should be able to this for you on a fixed fee basis which should be both affordable and money very well spent given the funds under discussion and the critical importance of the robust retirement planning. Shop around for quotes.

Step 2 - Decide on an investment/asset allocation strategy that you believe has a high probability of delivering the required rate of return identified in step 1 ( This is the hard bit unfortunately...)

This should incorporate the Annuity versus ARF analysis, inflating annuity versus flat annuity, various level of spouse's annuity if applicable etc  and also looking at gradually migrating to annuities over time. As you father gets older the annuity rates available will increase and who knows maybe long term interest rates may increase at some point in the future. The comments below are only relevant for ARFs only

Elacsaplau's comments re sustainable drawdowns from ARFs are very valid with zero/negative interest rates, extremely low bond yields and somewhat elevated equity valuations - however for now we have to work with the minimum 4% drawdown till 70 when it steps up to 5%
Also as your father will be drawing down income from his ARF he needs to be aware of ' sequence of return risk' . This is the often overlooked risk that when drawing down income from an ARF if there is a market fall followed by a recovery, you end up with less income over the period and a smaller ARF value - which increases the risk that the ARF will be exhausted. Blackrock and GMO have good pieces on this. [broken link removed]
[broken link removed]

As bonds are currently very expensive and equities somewhat so, we believe this sequence risk is very relevant for all those looking at retiring in the next couple of years 

Lots of people who have a good disciplined long term buy and hold approach when building up a reirement fund overlook this risk and the option to modify their investment approach to suit their new ARF/drawdown needs

There is no silver bullet here and no risk free option to deliver a 4% return after costs, so your father may need to paln for his ARF depleting over time. I suggest you talk to a couple of firms and get their thoughts and recommendations as to how they suggest the required rate of return might be delivered over the long term and then your dad can make his hopefully well informed decision
I accept that this is a probably more work than you or anyone else would ideally like to have to consider, but for such an important issue, I dont think there is much alternative. Its good that you are helping your father here but I think it has to be his decision at the end of the day albeit with your very well intended support and assistance. 
  All the best Vincent


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## North Star (17 Aug 2016)

p.s  in a potential low investment return future - costs are an even more important consideration in any ARF investment structure/strategy.


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## elacsaplau (17 Aug 2016)

Hi North Star,

Excellent post. I should have said in my posts that, of course, a fee based (even fee only) advisor is the way to go and frankly, it would be a ridiculous false economy not to so do.

I tend to look at things from a theoretical point of view. Whilst I believe that the research is incomplete into the areas that I listed in my initial post (arguably best conducted in a separate thread), I agree with the points you make as a pragmatic solution to the real challenges facing retirees.

One question - is it pragmatic in practice to manipulate the 4%/5% by, say,
- looking at the €800k as a block of money (and saying that since €200k and €63.5k are not subject to imputed distribution, 4% of the balance is not too bad), or
- by splitting the fund into different segments and delaying the "retirement date" of some of the segments

In other words, are there any smart solutions to help minimise the 4%/5% elephant? [It really is so ironic the level of industry compliance around this. When ARFs came out first, the IAPF, wrongly, went baloobas at the introduction of choice to consumers - when there was no imputed distribution. Now, there's a ridiculous hurdle and hardly a serious mention. And this is not new. It's bad now but it was even higher (the 4% was 5% in 2010). Taking 5% early on in one's ARF, especially after the probable depletion of assets in the years leading up to 2010 was pure madness as North Star rightly has made clear in his "sequence of returns" comments and references.]

But, hey, let's do a report on pension scheme coverage or simplification or governance or compliance or whatever. Getting back to my example earlier, there must be a better way than the 1.7% v. 4% options - a happier middle ground.

Sorry if this is all a bit rushed.....if I had more time and all that!


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## elacsaplau (17 Aug 2016)

Hi North Star,

Excellent post. I should have said in my posts that, of course, a fee based (even fee only) advisor is the way to go and frankly, it would be a ridiculous false economy not to so do.

I tend to look at things from a theoretical point of view. Whilst I believe that the research is incomplete into the areas that I listed in my initial post (arguably best conducted in a separate thread), I agree with the points you make as a pragmatic solution to the real challenges facing retirees.

One question - is it pragmatic in practice to manipulate the 4%/5% by, say,
- looking at the €800k as a block of money (and saying that since €200k and €63.5k are not subject to imputed distribution, 4% of the balance is not too bad), or
- by splitting the fund into different segments and delaying the "retirement date" of some of the segments

In other words, are there any smart solutions to help minimise the 4%/5% elephant? [It really is so ironic the level of industry compliance around this. When ARFs came out first, the IAPF, wrongly, went baloobas at the introduction of choice to consumers - when there was no imputed distribution. Now, there's a ridiculous hurdle and hardly a serious mention. And this is not new. It's bad now but it was even higher (the 4% was 5% in 2010). Taking 5% early on in one's ARF, especially after the probable depletion of assets in the years leading up to 2010 was pure madness as North Star rightly has made clear in his "sequence of returns" comments and references.]

But, hey, let's do a report on pension scheme coverage or simplification or governance or compliance or whatever. Getting back to my example earlier, there must be a better way than the 1.7% v. 4% options - a happier middle ground.

Sorry if this is all a bit rushed.....if I had more time and all that!


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## Marc (17 Aug 2016)

I thought I had already made this point about having a consolidated asset allocation that considers the overall portfolio by blending the asset allocation of each account.

I've written a detailed guide on this subject which we give to all prospective clients and advisers who use our portfolio service.

I cover the critical yield calcs, bomb out risk using stochastic analysis, capacity for loss calcs, the iterations between using a phased retirement approach, tax free cash options and asset allocation across multiple pensions with different time horizons.


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## North Star (18 Aug 2016)

Hi Elacsaplau, 
In relation to your specific query, in our analysis we split the various assets into different draw down profiles depending on when they have to be be drawn down ( because of Revenue rules) i.e ARFs and AMRFs from age 75, and those assets that need to be drawn down ( i.e. to meet income needs if ARF and other pension income e.g state pension dont meet all income requirements in any given year). In He-Mans original post, unless  there are other assets, the original tax free lump sum may need to be partially drawn down each year until the state pension kicks in. 
Having additional assets not subject to the annual draw down rules are very helpful in mitigating ARF depletion risk. This is why in Step 1 outlined above we would look at the various option available to each client which would hopefully ensure that they retain a stock of liquid assets outside of pension/ARF structures which are available for either unanticipated expenditure or to partially hedge against ARF depletion. This can often lead to a more considered review of a)should I delay retiring if possible and b) exactly what level of income will I need and how is my expenditure profile likely to evolve over time.

Generally we recommend an annual review of the Step 1 analysis to make sure that the plan is still on track and if we have deviated from the original plan what is a sensible response. This isn't a perfect solution to the ARF draw down risk you have highlighted, but we believe the above to be a sensible and pragmatic approach to reducing or managing that risk.


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