At Acuvest, we are lucky to be in the position of providing investment advice to a wide range of clients with different circumstances and needs. However, one of the questions that many of them have in common is how they should think about investing their pension funds and indeed their other assets, to meet their needs and objectives as they approach and begin to enjoy their later years.
A scenario that we often come across is when a business owner comes to us seeking our investment advice. They often will have built up a substantial pension fund of €500,000 – €1,500,000, often in addition to other financial assets that they have accumulated. Usually, we find that the question that is foremost in their minds is (quite understandably) around the growth of their assets between now and when they think they will retire –at around age 65, so they are in the best financial position at that point – often considered a key staging point. Our starting point in these cases is to ask the client to take a temporary step back, so that we can discuss some important considerations.
What will retirement look like to you?
We think it important for you to consider how you will live your life and fill your days when you retire, as this will ultimately impact your financial needs for the rest of your life. But alongside this, it is critically important to consider how you will stop working. Will you wake up on your 65th birthday having worked five (or more) days a week, never to work again in the future? This traditional approach is becoming far less common and is often not in keeping with how business owners or high-level executives would ideally like things to pan out.
Instead, many of our clients gradually reduce their workload over several years, with their income reducing over this period. Indeed, others continue to add value and maintain a smaller income potentially through providing consulting services or taking up directorship roles.
Even if you don’t have a clear plan on how your departure from the world of work will happen for you, it is worth thinking about it early, as there are strategic financial decisions associated with each, that are touched on below.
What really is your investment horizon?
A key area we ask clients to consider is their investment horizon. When a person retired 20-30 years ago, they were usually either in a defined benefit pension scheme that paid them a set income for the rest of their lives or exchanged their pension fund for an annuity from a life insurance company, that replicated this arrangement. This meant that people’s investment decisions effectively ceased on the day that they retired.
That’s often no longer the case.
As many clients today opt for the Approved Retirement Fund (ARF) route with their pension fund, they retain investment control of their pension assets throughout their retirement. The most fundamental change that ensues is the need to reconsider the investment timeframe.
If you are in good health and plan to retire at age 65, you can expect to still have assets invested for a further 30 years, or potentially longer if your expectation is to pass some or all of these assets on as part of your estate. Retirees are often advised to shift to a more conservative asset allocation on approach to or at retirement, or, in the case of pension plans/products, part of the fund maybe automatically switched to safer investment 5-10 years out from retirement age. This can provide important protection for someone who is focused on maximising their wealth at a specific retirement point in their mid-60’s. However, it is also important to remember that if you are in good health, your retirement could last for 2-3 decades or longer, so a considerable proportion of your retirement savings will remain invested well past that point. If your investment portfolio is too conservative, loss of purchasing power is your greatest risk when returns struggle to keep pace with inflation. Of course, your investment plan should also take into account your need for cash on hand and how much of your wealth should be allocated to deposits.
Your drawdown strategy is key
When you take your pension benefits, you can take a cash lump sum of up to 25% of the value of your funds – the first €200k is tax free, the balance of up to €300k is taxable at 20%. However, if you are over age 60 and take/or have taken your lump sum, Revenue rules effectively require you to drawdown a minimum of 4% of the balance of your fund per annum (minimum / imputed distribution) thereafter, even if you don’t need the funds. Also, income tax, USC and PRSI (if applicable) are chargeable on the amount drawdown each year, which should be considered when planning when to start taking your pension benefits.
Careful consideration needs to be given to which assets and sources of wealth in your portfolio can deliver your income needs during your retirement years, and the tax implications associated with each option. For example, you may have an investment property and cash on deposit which can support your lifestyle for a period at the start of your retirement, deferring the need to take your pension benefits and triggering the imputed distribution.
Or as mentioned earlier, if you continue to work on a part-time basis as part of your phased retirement strategy, you may be able to earn sufficient income to delay having to begin drawing down your pension funds. This has the effect of extending your investment time horizon and deferring your tax liabilities. Overall, a gradual reduction in earned income allows you to minimise the pressure on your portfolio of assets which you may look to pass onto your family as part of your inheritance planning.
Careful planning is key
People have been underestimating their retirement needs for years. If your phased retirement plans include some form of early access to retirement benefits, there is a very real risk that your retirement savings will dwindle faster than you might expect. Periods of poor market returns can also impact your planned drawdowns by reducing the overall size of your fund, and potentially requiring you to sell investments at low valuations to fund your living expenses.
For this reason, an investment plan and strategy that incorporates cashflow needs and investment returns scenarios is an important first step towards planning a phased retirement. It is important to consider your retirement / pension savings in the context of your overall financial position, and to think outside the box when planning how to invest and use all of your assets in a way that will best meet your life financial goals. The investment planning process will help you identify the optimal allocation of your investable asset(s), how much you need to be investing right now, and how your investments can be best managed to achieve your income objectives, while remaining aware of tax implications and avoiding forced asset sales. It will also help you establish a realistic timeline for your phased retirement.
So, circling back to our scenario client… We find that these considerations often cause some further reflection and indeed ultimately a different investment approach taken to the one the client had previously anticipated.
Have you considered your drawdown plan? If you would like to discuss this or any other aspect of your investment strategy, please feel free to reach out to me at damianc@acuvest.ie .
