Critique of Potential ARF Asset allocation

[Steven Barrett]

This comment has prompted me to articulate a thought I’ve had a few times. If your ARF funds are significantly down and you don’t want to crystallise the losses, do people (aged 61+) ever just stop withdrawing a pension income while waiting for fund values to recover and just accept the tax cost of deemed distribution (4 or 5%)?

I have never seen someone do that. And while I don't have an exhaustive list of who does and who doesn't, I know some life companies will only pay out the imputed distribution each year and do not allow the option of "just pay the tax".

Thanks for that.

I’d be interested in your opinion on sequence of return risk with regard to ARF.

Sequence risk is at its worst if you do not do anything to mitigate it. Most ARF holders take their income as a % of ARF value. This is automatically adjusting their income based on value. This reduces the risk of policy burnout.

The 4% rule take 4% of the original investment sum as a fixed amount and inflation proofs it each year. So if you have a period of high inflation and falling values, this is when you run the biggest danger of causing irreparable damage to your ARF.


Steven
www.bluewaterfp.ie

 

[S class]

If your ARF funds are significantly down and you don’t want to crystallise the losses, do people (aged 61+) ever just stop withdrawing a pension income while waiting for fund values to recover and just accept the tax cost of deemed distribution (4 or 5%)?

There is always the option to suspend drawdowns for a period during the year.
When you resume drawdowns for the remainder of the year the monthly drawdowns will be larger for the remainder of the year in order to satisfy the deemed distribution level.

This strategy could be used after a major panic wipe out of the stock markets.
The COVID wipeout was a recent example of this. The markets reduced by approximately 50% and regained all losses in a matter of months.

I suspended drawdowns on the basis that either the panic was overdone or if correct I might be dead in a few months.

 

[Deauville]

There is always the option to suspend drawdowns for a period during the year.
When you resume drawdowns for the remainder of the year the monthly drawdowns will be larger for the remainder of the year in order to satisfy the deemed distribution level.

This strategy could be used after a major panic wipe out of the stock markets.
The COVID wipeout was a recent example of this. The markets reduced by approximately 50% and regained all losses in a matter of months.

I suspended drawdowns on the basis that either the panic was overdone or if correct I might be dead in a few months.

I like that idea.
Thanks for sharing it.

My plan is to
Set up ARF December 2024.
Therefore no distribution in 2024.
Use a portion of my TFLS as a replacement for ARF income for 2025.
4% distributions in December 2025 to use as income during 2026.
In doing so, I’ll in effect be in a position to decide on asset usage to provide distribution for any year I continue the strategy.
For example if growth assets were significantly down, one could use fixed income or cash if appropriate.

In November/December 2025 check markets and decide what fund/funds to use for distribution. And so on for as long as using strategy.
Set a reminder on calendar each year.

Another advantage being that the ARF has an extra year at least of potential growth.

It will mean taking an annual distribution rather than monthly.

 

[S class]

That's a good plan. Your idea of getting a possible amount of extra ARF growth is good.

 

[Redzer]

As a follow on from above management of ARF discussion:

If one has a number of DC pension pots (PRBs/PRSA) from previous employments (I have 4 plus current scheme), can these be let sit / parked indefinitely or do they have to be moved to an ARF at a certain stage e.g. Normal Retirement Age (65)? Could some of them be moved to a PRSA to vest up until aged 75?

I'm considering 'retiring' early from my current employment when aged 61 but I may work part time or temporary in other employments until aged 65 if I feel like it. Depending on circumstances I'd like to be able to move 2-3 of my pots into an ARF (to have some income) but park 2-3 of my pots (to avoid having to take a deemed distribution).

If I get additional work (or not) I'd envisage drawing down 10%-25% distribution of the smaller ARF as required and possibly avoiding the 40% Income tax bracket. The other non-ARF pots could continue to grow without the deemed distribution requirement?

 

[Flybytheseat]

As a follow on from above management of ARF discussion:

If one has a number of DC pension pots (PRBs/PRSA) from previous employments (I have 4 plus current scheme), can these be let sit / parked indefinitely or do they have to be moved to an ARF at a certain stage e.g. Normal Retirement Age (65)? Could some of them be moved to a PRSA to vest up until aged 75?

I'm considering 'retiring' early from my current employment when aged 61 but I may work part time or temporary in other employments until aged 65 if I feel like it. Depending on circumstances I'd like to be able to move 2-3 of my pots into an ARF (to have some income) but park 2-3 of my pots (to avoid having to take a deemed distribution).

If I get additional work (or not) I'd envisage drawing down 10%-25% distribution of the smaller ARF as required and possibly avoiding the 40% Income tax bracket. The other non-ARF pots could continue to grow without the deemed distribution requirement?

If they are PRSAs then you can leave them sit up to age 75. If they are DB AVCs then they retire at the same time as the DB scheme. Not sure about PRBs but would think it's likely you could put PRBs in a PRSA and also avail of waiting to 75 to retire them.

 

[Fortune]

I have never seen someone do that. And while I don't have an exhaustive list of who does and who doesn't, I know some life companies will only pay out the imputed distribution each year and do not allow the option of "just pay the tax".

I saw it once. Someone had a self directed property in their ARF and only had enough liquidity for the tax, not the withdrawal.

 

[cremeegg]

Hard to see why someone would do that.

Let’s say my ARF is worth 100.

I’d rather end up with 2 in my back pocket and 96 in the ARF by taking the distribution rather than ending up with 98 in the ARF by suffering the deemed distribution.

This is a subtle point and I think many subsequents posts have missed it.

 

[Deauville]

Another issue that needs consideration is the timing of initiating an ARF.
As someone here has shared before,

The deemed distribution of an ARF is in relation to the value of the ARF on the 30th.November of that year.

So, the deemed distribution applied to a current ARF this year 2024 is 4/5% of ARF value on 30th.Nov. 2024.
If you don’t have an ARF on 30th. Nov. then no distribution.

This could also have implications as to the rate of tax paid on distributions.

 

[theObserver]

I often wondered about that too.

I suppose that’s related to the holding of some low risk assets including money market funds.
You may not be making the same realised loss when taking the distribution from a fund not as significantly hit if at all.
Perhaps then investing that distribution outside the ARF into the assets that are significantly down ?

It’s one of the reasons I’d prefer to have flexibility with different asset funds rather than a multi asset fund.

Maybe this is a silly question but if 4% is withdrawn annually, where does the 4% come from? Does a fund manager or an algorthim decide the best portofilio assets to sell to make up the 4%? So if the equities are down, the bonds and possibly gold are sold and then rebalanced later?

 

[Deauville]

Maybe this is a silly question but if 4% is withdrawn annually, where does the 4% come from? Does a fund manager or an algorthim decide the best portofilio assets to sell to make up the 4%? So if the equities are down, the bonds and possibly gold are sold and then rebalanced later?

Not a silly question.
The default is that the percentage is normally from the overall portfolio unless stipulated otherwise by the customer.
I don’t know if all providers allow customer to choose from which fund the distribution comes but I know Zurich and Royal London do.

 

[Deauville]

Your proposed portfolio is way over-complicated, with significant overlapping holdings.

Again, what’s the plan for your lump sum? If you are keeping that on deposit, there’s no need to replicate a cash holding in your ARF.

You really just need to use two funds to achieve your desired asset allocation - one global equity index fund and one fixed-income fund.

And you need to take account of ALL your assets, rather than focusing on one account in isolation.

I can see your point.

But I’d prefer diversify geographically. Risk management.
Fixed income. Active Fixed Income is 100% European. Prisma 2 is to my knowledge is mainly fixed income and mainly North American.
Equities. Each of the considered equity funds has attributes which has led to different performance in different market conditions.
Money Market. To address Sequence of return risk if required and when required.

You make a very good point about considering all accounts but I was only addressing the OP.
I made the mistake on another recent thread by wandering off topic and have been trying to keep relevant to OP.
Your comment is worth having there.

Thanks again for your opinion.

 

[Deauville]

I agree. It’s overcomplicated nonsense. I have equities, cash, and property. That’s all I’ll never need, just the mix may change over time.

Gordon, I appreciate your opinion.
However I don’t think the word nonsense is fair or helpful.
If what you have is satisfactory and works for you then I’m happy to here that and will take it on board.

 

[Sarenco]

But I’d prefer diversify geographically.

A global equity index fund already holds positions in all major publicly traded companies, in all developed countries, in proportion to their market capitalisation.

Putting together a random selection of actively managed equity funds actually makes your portfolio less, not more, diversified.

Your fixed-income fund (or cash deposits) should be denominated in euro (or should be hedged to euro).

Again, a bucket approach to drawdowns does not meaningfully address sequence of return risk - it’s simply mental accounting (aka fooling yourself).

 

[Redzer]

Again, a bucket approach to drawdowns does not meaningfully address sequence of return risk - it’s simply mental accounting (aka fooling yourself).

Surely having a Cash position plus an Equity position gives one options to mitigate sequence of returns risk? That's a basic 2 bucket approach and seems more than simple mental accounting. Draw down from equities in a bullish period and draw down from cash in a bear period. The % allocation varies depending on one's risk appetite and you can also include a Bond element if desired.

 

[theObserver]

Not a silly question.
The default is that the percentage is normally from the overall portfolio unless stipulated otherwise by the customer.
I don’t know if all providers allow customer to choose from which fund the distribution comes but I know Zurich and Royal London do.

In that case I can see why the OP wants 20% asset allocation of bonds, gold, cash and commodities as a hedge against a eg tech crash driving down the equities. Personally I would just go with a straight 20% in bonds considering the OPs fairly high tolerance of risk and the fact they can count on 25k a year outside this ARF.

 

[theObserver]

I'll hopefully be in a position in 5 or less years to retire, take a lump sum and put a balance of circa €1M in an ARF. I'm hoping to go execution only on the ARF and would like to keep the overall AMC/TER on the fund in the region of 0.6% to 0.7%. I have a relatively high risk tolerance (ESMA 5.5). From various state and DB pensions I should have a guaranteed pension on top of the ARF of circa €23K pa.

From what I've read Zurich or Standard Life seem to offer the lowest Fund Manager charges of the Irish approved ARF providers. My current incling is to go with Zurich with the following asset allocation:

Portfolio Risk Rating 5
Portfolio Volatility 11.34%

Asset Split:
Cash
8.17%
Bonds
10.83%
Equity
75.00%
Commodity
6.00%

This is made up of the following Zurich funds:

View attachment 8983

I'm open to any feedback on my strategy or suggestions as to how to improve it.

Thanks in advance.

There's a lot of overlap between the Indexed Global Equity and the International Equity funds. Both contain over 70% US Equities. I would pick the fund with the lowest fees and just go with that one.

 

[Deauville]

A global equity index fund already holds positions in all major publicly traded companies, in all developed countries, in proportion to their market capitalisation.

Putting together a random selection of actively managed equity funds actually makes your portfolio less, not more, diversified.

Your fixed-income fund (or cash deposits) should be denominated in euro (or should be hedged to euro).

Again, a bucket approach to drawdowns does not meaningfully address sequence of return risk - it’s simply mental accounting (aka fooling yourse

I obviously failed to make my point clearly.

The geographical diversity I referred to was meant to be in relation to the fixed income (mostly bonds). I don’t just want European government bonds (active fixed income fund). I also want an element of North America Hence Prisma 2 fund.

The money market was with reference to the cash fund.

Again, the equity funds weren’t chosen at random. They were chosen for their attributes in different market conditions.

Dividend growth fund can have a smoothing effect in a bear market. Its use would for me also reduce to a degree holding bonds with the benefit of a better probable return than bonds.

The international equity fund is well diversified and at a cost has a more dynamic approach. This can have a benefit in volatile conditions as is evident in its recent 12 month performance. However, long term 5 to 10 years, its performance is similar to the third fund, the indexed global equity fund Blackrock which would hold the greater portion of equities.
If I were to drop a fund, it would be the international equity and assign its portion to the indexed global as it’s questionable as to whether the cost of management is justified.


I’d be delighted to hear any constructive criticism or arguments for or against those funds. Or others for that matter.

It’s seems to me that the OP was seeking a discussion that might help in portfolio building.

 

[Deauville]

There's a lot of overlap between the Indexed Global Equity and the International Equity funds. Both contain over 70% US Equities. I would pick the fund with the lowest fees and just go with that one.

Very good point. May very well do that. The fee in relation to the long term performance that will likely be the decider in my case. Cheers.

 

[Sarenco]

That's a basic 2 bucket approach and seems more than simple mental accounting.

No, “bucketing” is mental accounting pure and simple.

If you draw money from a portfolio that has fallen in value, it doesn’t matter a jot whether you are drawing from the cash element of the portfolio or the equity element of the portfolio - you are still drawing money from a portfolio that has fallen in value!

You can never eliminate sequence of return risk - the best you can do is hold sufficient levels of diversifying, low risk assets to hopefully cushion the inevitable market falls.