As we approach our retirement date an important consideration looms large which is how will we best draw down our retirement income. It is a consideration that causes worry for many reasons. Some of which are:

  1. Will we have enough income to live the life we had planned for?

  2. Will our pension pot survive over the long term sufficient to maintain a sufficient level of income or will the fund run out?

  3. How should I invest my fund to ensure adequate growth each year?

Retirement causes a big shift in our mentality. We go from an earning and accumulating phase to a spending phase. We have a lot more free time in retirement and our spending habits will likely change and become less predictable.

It is important to have a strategy on how best to spend and invest your retirement fund to ensure meeting your needs over the long term. As we are all mainly living longer and healthier lives our retirement fund also has to last longer. This is a key consideration on how we invest our funds.

After you have taken 25% of your overall fund in a lump sum which, depending on the size of your pot, the majority will be tax free. The remaining 75% of the pot can be accessed using two main vehicles.

The two main vehicles for drawing down our retirement income are as follows:

  1. Approved Retirement Fund (ARF)
  2. Annuity

We can use either one or a combination of both. Your choice will depend on individual preferences and circumstances.

Annuities can offer a potential solution for many who are afraid of looking after the investment of their pension fund. You can hand over your pension pot to an annuity provider and they will pay you an income for life. The annual income will depend on the size of the pot but will be circa 3% to 5% each year. If you were satisfied to accept a set return each year from your pension pot, and have it guaranteed for life then an annuity might be the way to go.

There are, however, some downsides. If you don’t live long in retirement your pot will effectively die with you. You can opt to have a minimum guaranteed payment period of 5 or 10 years. You may have to live 20+ years to ensure you get the full value of the pot back.

The majority of individuals will go for an ARF on the basis that historically at least it offers a higher level of income, albeit with a level of danger that their fund will expire before they do. You also have more flexibility in how you draw down your income.

A possible strategy is utilising both an Annuity and an ARF to manage your income in retirement. The intent here being to use a portion of your pension pot to buy an annuity, generating a base level of income each month to cover your essential items. This can take some of the uncertainty away around the longevity of the pot.

The balance of the pension pot would be invested in an ARF. You can then take income from this for your more discretionary spending.

Spending Strategy in Retirement

The best way to approach your pension draw down strategy is from an outgoings point of view. You should work out what your essential spending is each month like your house, car, heat, food etc. You then look at what your discretionary spending would be. This would cover socialising, hobbies, travel etc. You can work out how much you need for the basics each month and then what is left over for the discretionary spending. In order to take that retirement at a time you wish, you may have to make cuts to your spending habits. It would be unusual to have the same level of disposable income in retirement as when you are working so it is an exercise worth carrying out regardless.

Investment and Draw Down Strategy

It is vital to have a plan around how your ARF is invested. Most people forget that your investment horizon is until you die when you are dealing with your pension or at least until it runs out. Most of your discretionary spending will be in the earlier years and you also need to take account of receiving the state pension when it kicks in. This will give an additional €14k per annum or double that if a couple both qualify for the payment. It is important to make sure you have sufficient contributions to get the full state pension.
In conjunction with your advisor pick an investment strategy that you are comfortable with and that stands a fair chance of getting enough growth each year to cover your drawings each year. Because markets are volatile you will have good and bad years.

The amount you draw each year is usually a percentage of the value of the fund. For some you can pick a set amount each year but it’s better if you can keep some flexibility. In Ireland you have to draw a minimum of 4% of the value of the fund up until age 70 and 5% minimum from age 71.

If your fund does well in one year then your 4% will give you a higher drawdown amount. If your fund performs poorly the next year then the equivalent 4% will mean a lower income. It helps to know this and have the flexibility to be able to cope with this if it happens. This however helps protect the overall level of the fund over the longer term.

An important point to remember is that the fund is there to be used for your retirement. Some people make the mistake of thinking they need to keep it intact as much as possible and will cut back on discretionary spending, in particular. You can miss out on a lot of life by being too frugal.

The main thing to do is review your strategy each year and adjust as needed. Keep an eye on how your returns are and make sure you are getting an adequate level of growth while bearing in mind there will be good and bad years. Don’t panic in the bad years and keep in touch with your advisor who will make adjustments as needed.

Conor Harte QFA CFP® is Senior Financial Advisor at Wealthwise Financial Planning, Hartley Business Park, Carrick on Shannon, www.wealthwise.ie. Wealthwise Financial Ltd T/A Wealthwise Financial Planning is Regulated by the central Bank of Ireland. All details and views contained within this article are for informational purposes only and does not constitute advice. Wealthwise Financial Planning makes no representations as to the accuracy, completeness or suitability of any information and will not be liable for any errors, omissions or any losses arising from its use.