I have an Approved Retirement Fund (ARF) from which I draw a monthly pension at the rate of 4 per cent. Assuming there is a balance in the account on my death, does that balance become part of my estate or does the ARF die with me?
Ms MK
ARFs, or Approved Retirement Funds to give them their full name, have become increasingly popular in recent years as the private sector in Ireland moved away from defined benefit, or final salary, pension schemes.
Under defined benefit, your pension was determined by the number of years you worked and your salary. It was paid by way of an annual annuity. Essentially, your employer bought an insurance policy that promised to pay you a set sum every year until you died. Some allowed for inflation and some for a reduced pension for survivors.
As companies found themselves unable to meet the “promise” of a guaranteed lifelong pension, most workplace schemes moved to a “defined contribution” model, where your final pension pot was determined by how much you and your employers put into it and the investment performance of those funds.
As part of this shift, people were eventually given an alternative to the annuity insurance policy option – not unrelated to the fact annuities had become ludicrously expensive, offering people very poor value in retirement. This was the ARF where your money remains invested after retirement rather than being used to buy an annuity.
ARF rules state that you must draw down at least 4 per cent of your fund each year – or at least, Revenue will tax you on the presumption you have drawn down 4 per cent, so it makes sense to do so. With the elegance of language that only legislation can deliver, it calls this an “imputed distribution”.
Once you hit 70, this figure rises to 5 per cent. And if you are fortunate enough to have an ARF fund that is worth more than €2 million, you will be taxed on the basis you are drawing down 6 per cent a year.
One of the big advantages of an ARF over an annuity is it does not die with you, so you can be reassured on that point. It is possible to have annuities that continue as a survivor’s pensions, as we mentioned above, but they are very expensive and you are constrained to providing only for a spouse or partner.
ARFs are more flexible. Essentially, the funds in your ARF become part of your estate when you die. Where those funds go depends on the wording of your will, assuming you have a will.
If you want to ringfence the funds for a specific person or persons, it is important your will states this for two reasons. First, without specific instruction, it will be allocated according to a general division of assets under a will or in the will’s residuary clause.
Second, it could have unintended tax implications.
If the ARF is transferred to become an ARF for your spouse or civil partner, there will be no tax on the transfer in line with the inheritance tax law provisions that exempt transfers to a spouse or civil partner. They will, of course, pay income tax on anything they subsequently draw down from the fund.
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However, if they just close the ARF and take the funds as cash, it will be taxed at whatever your most recent marginal income tax rate was. So, if you were paying 40 per cent income tax before you die, that is what they would be charged on the encashment of the fund. It would also be liable to universal social charge and, depending on age, PRSI.
If you leave the funds in your ARF to your children, their age becomes important. If they are under 21, they pay no income tax. However, the funds count toward the tax-free exemption from inheritance tax that they enjoy, which is currently €400,000.
If they are 21 or older, they will face a flat 30 per cent income-tax charge on the contents of the ARF but will be exempt from inheritance tax. That means the fund does not count towards their €400,000 tax-free limit on gifts and inheritances from either parent.
If you do not have a spouse/civil partner and/or children, the tax treatment changes again.
Any other beneficiary – a friend, a sibling, cousin or other relative – will face two tax issues. First, they will be charged income tax at whatever your most recent marginal tax rate was.
What is left after that will also be subject to inheritance tax. How much depends on the relationship of the recipient to you. If it is a sibling, niece, nephew, uncle or aunt, they can receive €40,000 free of tax – but that includes any other large gift or inheritance they might have received before from others in that group.
If the recipient is a cousin, a more remote relative, an in-law or a friend, the tax-free limit is €20,000 and the same rules apply.
Of course, if you have no will, the ARF funds will be allocated under the laws of intestacy.
Please send your queries to Dominic Coyle, Q&A, The Irish Times, 24-28 Tara Street Dublin 2, or by email to dominic.coyle@irishtimes.com with a contact phone number. This column is a reader service and is not intended to replace professional advice.