7 Differences of Annuity and ARF

7 Differences of Annuity and ARF [Guide for Retirement Pension]

There are many different types of pension retirement options in Ireland, and it can be difficult to know which one is right for you. In this blog post, we will discuss the difference between an annuity and an Approved Retirement Fund (ARF) . We will also provide some tips on how to choose the right option for your needs.

What Is an Approved Retirement Fund (ARF) and How Does It Work?

An Approved Retirement Fund (ARF) is a post-retirement agreement. When you retire from a pension contract, and after you have taken the lump sum of your retirement, the remaining balance of your pension fund may be put into an ARF.

You can choose where you wish to invest and can take a regular income or one-time cash lump sum from your ARF at any time you’d like. The income you draw down from the ARF is subject to taxation at your marginal rate, plus the universal social charge, in addition to PRSI when you are younger than the age of 66. You can also opt to use the funds in your ARF for the purchase of an annuity (an income that lasts for the rest of your life) in the future.

What Is an Annuity and How Does It Work?

An annuity is a life insurance policy that pays out a fixed sum of money over a set period. Annuities are typically used as an income replacement during retirement. When you purchase an annuity, you will pay a lump sum of money to the insurance company. In return, the insurance company will agree to pay you a fixed sum of money every month for the rest of your life.

There are several options to choose from when buying an annuity. A Single Life Annuity is payable for the remainder of your life. If you have the Joint Life Annuity, the pension portion will be paid to your spouse when you die . If you opt to add a Guaranteed Period, the pension will be due for a specified time regardless of whether you die within that period. A Level Annuity is when the amount of the Annuity is constant throughout your lifetime, and an Escalating Annuity is when your Annuity payment grows at a predetermined annual rate.

It is essential to pick an annuity that is in line with your personal needs and those of your spouse when you retire. With this, seeking financial advice before deciding to get an annuity is essential.

What Are the Differences Between ARF and Annuity?

1. Flexibility to withdraw your money.

With an ARF, you have the flexibility to make withdrawals from your account at any time. You can withdraw money from your approved retirement fund (ARF) whenever you want to, but you must pay taxes on withdrawals. There is a compulsory withdrawal rate of 4% annually that increases to 5% per year when you reach 70. Regular withdrawals decrease the value of the ARF, and it could bomb-out while you’re alive ie you outlive it.

If you choose an annuity, you are locked into the contract and will only receive the income that was decided at outset.

2. Ability to invest your money

With an ARF, you can continue to invest your money and grow your account balance. The NRFM Self-Invested ARF offers the holder the opportunity to manage their retirement funds without the investment restrictions usually found with traditional ARFs with insurance companies.

The self-invested ARF is designed for individuals comfortable with making their own investment decisions and who have a clear understanding of investment risk.

With an annuity, there are no investment decisions to be made, as you have simply bought a guaranteed income from the insurance company, irrespective of how markets perform. ..  

3. Risk adversity

Annuities are a better option for those who want to be protected from risk factors like the volatility of the stock market and want a secure income during their retirement. 

Economic and stock market volatility cycles won’t impact your earnings. You have the peace of mind that your money is intact. 

With the approved retirement fund (ARF) , you are taking on the investment risks as you, with your financial advisor are making an active investment decision to invest in a particular asset class.  Investment returns will vary and can fall as well as rise.  Future investment returns are not guaranteed. A strategy for investing must be carefully managed to ensure that the income is sustainable since returns cannot be assured.

4. Income tax payment

For an ARF, you will pay income taxes on money that you withdraw from your account. The withdrawals you make from your approved retirement fund (ARF) are subject to income tax, the Universal Social Charge (USC), and the PRSI (where applicable). In the meantime, the ARF will remain invested in the funds that you choose. Taxes will be deducted at the source by the ARF provider.

Similarly, with an annuity, the income is subject to income tax, PRSI, and USC and will be deducted by the annuity provider at the source.

6. Long-term financial support

Another advantage of Annuity is you will receive a guaranteed income for the rest of your life. Your earnings will continue to be paid no matter the time you live.

On the other hand, if you did not invest your approved retirement fund (ARF) wisely, there’s the possibility that part or all of the funds could be exhausted before it is fully utilized.

7. Outcome after policyholder’s death

With an annuity, when the policyholder dies, the payments stop, and there is no death benefit. 

When the ARF policyholder dies, the ARF may pass to their next of kin,  If the next of kin is their spouse then they have the option to “step in” to the shoes of their deceased spouse and become the ARF holder or alternatively, they can decide to withdraw all monies from the ARF, but this will be treated as income and taxed as such.  The approved retirement fund (ARF) can be used to purchase an annuity for the beneficiary 

The preservation of assets is the primary benefit of an ARF since it can survive the death of the owner. 

The main difference between these two is that annuity payments die with the holder, while the ARF will pass to the next of kin of the deceased.  

How Do You Decide Which Option Is Best for You?

The type of post retirement plan  that is right for you will depend on your individual needs and circumstances. If you are looking for a policy that will provide you with a steady income stream during retirement and don’t want to take any investment risk then an annuity may be the better option. 

If you are looking for a policy that offers more flexibility and allows you to continue to grow your account balance, ARF may be the better choice. Ultimately, the decision between an approved retirement fund (ARF) and an annuity is a personal one and should be made with the help of a financial advisor.

When deciding whether an approved retirement fund (ARF) or annuity is right for you, it is important to seek professional financial advice from a Qualified Financial Advisor  to ensure that you are making the best decision for your individual needs.