Key Post Does an ARF negate the need to lifestyle your pension plan?

[LDFerguson]

Thanks for that LD, Just so I make sure I have this correct if I set up my pension with an active managed fund like the Prisma series or a passive global index (both zurich products as i have their website open currently) then I would have to cash in those shares when moving to an ARF but if I set up a self managed fund where I choose any stocks or bonds etc personally then I could transfer those assets to an ARF once I retire?

That's correct, but as Steven has pointed out above, there's no cost involved in cashing in your units in a modern managed fund and there's no cost involved in buying units in the same fund in an ARF. There will be a cost involved in setting up your ARF, but that will exist whether or not you're cashing in units and buying back units in the same fund.

 

[Gordon Gekko]

Hi Liam,

Are there not Bid/Offer spreads?

Thanks,

Gordon

 

[elacsaplau]

Hi Steven,

Can you elaborate on this please?

Say, I have a €1m and am aged 60 want to maximise the chances of withdrawing, say, €40,000 p.a. (increasing with CPI) for the rest of my life and that of my wife (say, age 57)......

1. What initial asset allocation is recommended?
2. Is re-balancing a feature and if so, on what basis?
3. What return assumptions are used?
4. What is the probability of success i.e. not running out of mullah in later years?

Finally, what would change if I wanted €30k p.a. (still better than an inflation proofed annuity) or €50k p.a.

Does Timelineapp help with this stuff?

 

[Eireog007]

That's correct, but as Steven has pointed out above, there's no cost involved in cashing in your units in a modern managed fund and there's no cost involved in buying units in the same fund in an ARF. There will be a cost involved in setting up your ARF, but that will exist whether or not you're cashing in units and buying back units in the same fund.

Yes but it would still necessitate lifestyling of some degree as most people would want to ensure the 25% of their policy that they withdraw at that time remained at the level it was at leading in to their planned retirement date.

If you have a cash reserve that will last you through the first 3 or 4 years then this is less of a concern but obviously not everybody will be in that position.

 

[Eireog007]

The original lifestyling options came under criticism because they shifted a policyholders funds to bonds automatically, no matter what the bond market was like.

With the introduction of the ARF, companies came up the the ARF lifestyle option where 75% of it would stay in a balance fund and the other 25% would go to cash to project the tax free lump sum. I always thought this was nonsense as the lump sum is a percentage of the entire fund, so if the Balanced element fell by 30%, the lump sum payable would decrease too.

Personally, I believe that clients should have an investment strategy they are comfortable with and stick with it all the way through and not to bother with a lifestyling strategy. But this is where emotions come into play. The tax free lump sum is sacrosanct and people want to protect it as much as they can. People are perfectly willing to forgo potential growth to ensure that the lump sum doesn't fall in value. They are happy to transfer to cash, even if it means they buy back into the market at a higher price when they start investing again in their ARF.

On a point Liam made about having to sell out of the pension and buy again in the ARF, it's not a cost to the client anymore. In the past, there was a 5% bid/offer spread where you sold less 5% of the value of the unit. That's gone in almost all cases. If you matured a pension, you will buy the same day you sell and at the same price.

And while I agree with Sarenco about Euro cost averaging, again, emotions have to be managed. If someone has a large fund, they may be willing to forgo some growth in order to feel more secure. While it is my job as an advisor to explain to someone that they are better to get their money working for them immediately, there's no point in having a client who is staying awake at night with worry.

I mentioned before, I use a piece of software called Timelineapp , which shows how successful a withdrawal strategy would have been going back to 1900. I can pick the asset allocation, number of years and withdrawal rate. Over a lenghty period of time (which an ARF is), most situations are successful. A key aspect to making your money last is to adjust your withdrawal with the market. As most ARF holders make withdrawals as a % of the fund, this is automatically done.


Steven
www.bluewaterfp.ie

But surely lifestyling is an investment strategy that people a comfortable with based on the assumption that they require the 25% portion to fund either a shortfall in state pension due to early retirement or simply as a cash amount to live off in the event of a market downturn?

My current ideal option would be a passive MSCI Index as I’m about 30 years out from retirement based on my current plans and then continue with an equity portfolio designed to pay out the 4% required removal once in the ARF, but I would still need to ensure a stable fund at that retirement age to remove the 25% in order to fund those early years or as a cash fund to remove the need to interfere with my equitity portfolio in the event of a market downturn.

Or am I missing an alternative approach?

 

[Duke of Marmalade]

SBarret has already made this point but I will make it in a slightly different way.

The transition to lump sum/ARF has no implications (other than emotional) for investment strategy.
Of course, the act of retirement may impact your financial plans. You might be planning the holiday of a lifetime and that has an impact on your investment strategy. But if you simply see retirement as a non event in the continuum of your plans then if you are x% in equities the day before retirement you should be x% in equities the day after, which may imply reinvesting some of your lump sum in equities.

 

[Eireog007]

SBarret has already made this point but I will make it in a slightly different way.

The transition to lump sum/ARF has no implications (other than emotional) for investment strategy.
Of course, the act of retirement may impact your financial plans. You might be planning the holiday of a lifetime and that has an impact on your investment strategy. But if you simply see retirement as a non event in the continuum of your plans then if you are x% in equities the day before retirement you should be x% in equities the day after, which may imply reinvesting some of your lump sum in equities.

Hi Duke, I understand your point and would generally agree that if you plan to move into an ARF your long term investment strategy pre retirement should be your investment strategy post retirement.
However if you have one opportunity to remove 25% of your fund tax free at that point wouldn’t it be best practice to reduce the potential volatility of your fund in those last years prior to your retirement, otherwise you would be forced to either consolidate the losses your equity portfolio would suffer during a potential downturn or postpone your retirement until the shares had returned to their previous level?
Again if I’m missing something I’m happy to be corrected.

 

[Eireog007]

I should probably elaborate the I’m assuming no other source of income at retirement other than your pension plan and a 100% equity portfolio in general other than that number of years leading into your planned retirement date.

 

[Gordon Gekko]

I’m not convinced that the investment strategy can remain consistent when pre-retirement there could be circa €50,000 a year dropping in and post-retirement there could be the same going out.

 

[Eireog007]

I’m not convinced that the investment strategy can remain consistent when pre-retirement there could be circa €50,000 a year dropping in and post-retirement there could be the same going out.

Well I guess it depends on the level of pension you have saved doesn’t it? €1,250,000 @ 4% is €50,000.

 

[Gordon Gekko]

Well I guess it depends on the level of pension you have saved doesn’t it? €1,250,000 @ 4% is €50,000.

My point is that the accumulation phase and the drawdown phase do create different dynamics.

 

[Duke of Marmalade]

Ahh Gordon! My turn to make a mistake and not even the cocktail hour. Yes by definition, retirement brings a substantial change to your financial position and so it is a pivotal element of your financial planning, not just a negligible part of a continuum.

However if you have one opportunity to remove 25% of your fund tax free at that point wouldn’t it be best practice to reduce the potential volatility of your fund in those last years prior to your retirement, otherwise you would be forced to either consolidate the losses your equity portfolio would suffer during a potential downturn or postpone your retirement until the shares had returned to their previous level?

It is an illusion that you have to move 25% into cash. You can reinvest immediately. There is the issue of transaction fees but this is small beer in this context.

 

[Sarenco]

Didn't you already make that point in your previous post Duke?

Of course, the act of retirement may impact your financial plans.

 

[Eireog007]

Ahh Gordon! My turn to make a mistake. Yes by definition, retirement brings a substantial change to your financial position and so it is a pivotal element of your financial planning, not just a negligible part of a continuum.
It is an illusion that you have to move 25% into cash. You can reinvest immediately. There is the issue of transaction fees but this is small beer in this context.

I was aware of that part but surely if you have an option to remove the tax element of €200,000 of your pension then it’s a no brainer to do so?

 

[Duke of Marmalade]

I was aware of that part but surely if you have an option to remove the tax element of €200,000 of your pension then it’s a no brainer to do so?

Absolutely but there is no reason it should stay in cash for more than a second. I presume that some providers facilitate seamless transition of the lump sum into fund investments.

Didn't you already make that point in your previous post Duke?

Well to be fair I was thinking more of that world cruise.

 

[Steven Barrett]

Hi Steven,

Can you elaborate on this please?

Say, I have a €1m and am aged 60 want to maximise the chances of withdrawing, say, €40,000 p.a. (increasing with CPI) for the rest of my life and that of my wife (say, age 57)......

1. What initial asset allocation is recommended?
2. Is re-balancing a feature and if so, on what basis?
3. What return assumptions are used?
4. What is the probability of success i.e. not running out of mullah in later years?

Finally, what would change if I wanted €30k p.a. (still better than an inflation proofed annuity) or €50k p.a.

Does Timelineapp help with this stuff?

It doesn't suggest an asset allocation, I input that myself, along with the length of time for the income to be paid, fees. I can adjust the inflation. It will look at historical returns for that asset allocation as well as the inflation during that period. So it would look at if you were retiring in 1900, how successful would you have been in withdrawing €40k from a €1m pot for 35 years. Given the 2 World Wars and a depression, not very hopeful. It will also show how much you could have withdrawn successfully.

There is another screen showing how you would be in in best/ worst 5% of performance figures as well as median return.

It's a pretty good piece of kit.


Steven
www.bluewaterfp.ie

 

[Sarenco]

Hi Steven

Does your app allow you to select a retirement date?

I would be very curious to know the following if you have the time:-

Say I retired on 1 Januray 2000 with €1m in my ARF, 100% invested in global equities (perhaps take MSCI World as a good proxy in this regard) and I've never altered that allocation. I've drawn down €40k per annum, adjusted for inflation, on 1 January every year since retiring to fund my living expenses. What would my balance look like today? Perhaps assume 1% per annum in fees and expenses.

As a follow-up question, does your app tell you anything about the likelihood that my remaining portfolio will continue to support that level of draw-downs for the next, say, 12 years (based on historical returns)? Should I be worried?

 

[Steven Barrett]

Example of what the software produces is attached. When I have the software open, I can hover over any bar chart or graph and it will show me the exact figures. I can adjust the asset allocation between different regional equities and bonds as well as Gold. The Irish version doesn't have property as the Irish records on property returns don't go back far enough.


Steven
www.bluewaterfp.ie

 

[Cervelo]

I should probably elaborate the I’m assuming no other source of income at retirement other than your pension plan and a 100% equity portfolio in general other than that number of years leading into your planned retirement date.

Eireog007, am I correct in thinking that you are going to invest your accumulated pension pot at retirement in a ARF and for the first 3/4 years live off your cash reserves and then use your ARF as your only source of income ??

 

[elacsaplau]

Hi Steven,

Thanks for taking the time to explain and share this - on first glance, it looks like a pretty cool tool.

If you get the chance........

1. How is currency treated in relation to the MSCI?

2. How would the example look with say 30% bonds (and what bonds are used - issuer, duration, etc.)

Thanks again