Insights
Market Update July 2016
ARF Options: The Rules Have Changed
Pat RyanHead of Retirement Solutions
FOR INVESTMENT PROFESSIONALS ONLY
Good news
On 22nd June 2016, Minister Noonan announced that he was extending ARF options to all Buy Out Bond holders with immediate effect. The change has been widely welcomed by pension investors and practitioners alike. The ARF is a popular alternative to an annuity purchase which gives investment control over post retirement assets and income to individuals who generally have borne the investment risk on their funds during the pension accumulation stage.
Problem solved
Prior to the announcement, members of Defined Benefit (DB) schemes who had transferred their DB entitlements to Buy Out Bonds were not permitted to exercise ARF options on retirement. This was despite the fact that from the time the initial transfer took place their pension fund had effectively converted to Defined Contribution (DC) status.
Members of DC schemes have long held automatic rights to select ARF options regardless of the DC product(s) in place at time of exercising the option. As such, the denial of the same options has been a significant problem for former DB holders looking to achieve the best outcome for their funds at retirement. The restriction meant that affected clients (often those whose DB entitlements had been forfeited on scheme wind up) who wished to access their retirement lump sum were forced to use their remaining funds to purchase low rate annuities during a period of record low interest rates.
Who benefits?
Now that the problem has been resolved, it is worth reviewing the main client types affected and some of the considerations for discussion.
Current Buy Out Bond holders (benefits originally transferred from a Defined Benefit scheme)
Clients over the age of 50 will be most interested in this change. In general, these clients have left service with their previous employers and early access options are now available to them. Annuity purchase is now no longer a requirement and as a result immediate or early benefit access, particularly lump sums, may be worth a meaningful discussion.
Current holders of preserved benefits remaining in Defined Benefit Scheme
Most clients in this category will no longer be employed by the company that provided the benefits, but they have chosen to leave their deferred benefit entitlement preserved until retirement age in the original scheme. When the decision was originally made, the ARF option was not available for consideration. The expectation was probably that the DB scheme would be in place at normal retirement age (NRA) or on earlier retirement. As a result of the extension of the ARF option to Buy Out Bonds and the continuing closure rate of DB schemes, a re-evaluation of the potential transfer choices may be timely.
Current active members of funded Defined Benefit schemes
The main group of clients in this category will be executives approaching retirement in well-funded DB schemes. These clients may not need a guaranteed lifelong pension and may prefer the concept of taking control of their retirement funds as assets on the family balance sheet. A lump sum conversion of 25% is often appealing when transfer values are attractive, especial in a low yielding bond environment. The important point for these clients is that a transfer to Buy Out Bonds as part of exit strategy will now create ARF planning options not readily available before the recent announcement.
Defined Benefit transfer review checklist
The checklist below combined with the recent benefit and transfer value statement may prove useful in helping clients formulate the most suitable plan for their retirement funds:
- What is the likelihood of Defined Benefit scheme being in place when client reaches normal retirement age?
- Are the Defined Benefit trustees currently paying increases in pension payments?
- Does the scheme currently meet the Minimum Funding Standard (MFS)? If not, what reduction factor currently applies to transfers?
- Have preserved pensions been reduced due to negative CPI revaluation?
- What percentage of funds may be taken as tax free cash?
- Are AVCs included in transfer value or in addition?
- Are trustees allowing early retirement benefit drawdown before normal retirement age?
- When does it suit the client to access cash/benefits?
- Now that there is no need to purchase an annuity, is a 25% cash and ARF strategy more suitable?
- What is the clients plan for his/her retirement funds?
Planning Opportunity
Until now, most pension clients who were not entitled to consider ARF options had little scope to formulate a plan for their retirement funds. The only real options were to hope to live for a long time in receipt of defined benefit pensions or to live frugally on annuity income. Now the rules have changed, advisers have the opportunity to revisit the affected clients and highlight new opportunities. The change has created the opportunity to explore the new dimensions of retirement planning provided by the availability of the extended ARF options.
Warning: There are risks associated with any pension. There is no guarantee that a pension scheme will meet its objectives. Tax laws and regulations are constantly changing, and they may be changed with retrospective effect which may have a negative impact on pension schemes. Various investment structures, vehicles and options are available to pension investors; each has its own benefits and risks, which cannot be fully outlined in this summary document. Davy Asset Management does not provide tax or legal advice. It is important to seek independent professional advice prior to making any decisions which have tax, legal or other financial implications.
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