BY JOHN ELLIS, FINANCIAL ADVISOR
In years past retirement meant one thing – handing over your pension pot to an insurance company in exchange for an annuity which is a guaranteed income for the rest of your life. That changed in the 1990s with the arrival of Approved Retirement Funds (ARFs), and today retirees face a decision no previous generation ever had to make.
Most people now take their 25% tax-free lump sum first. For the remaining pot, the options are straightforward – buy an annuity or transfer the money into an ARF.
An annuity offers certainty. It is the only product that removes investment risk entirely. Once bought the provider pays a fixed or indexed income for life and if required the annuity will continue payments to a surviving spouse. The annuity arrives every month no matter how markets perform or how long you live. But the trade-off is zero flexibility. The capital is gone forever and unless a spouse’s pension or guarantee period was chosen, it dies with you.
An ARF is the opposite. The money stays invested. It grows tax free inside the fund, and the owner decides how much income to draw each year. You retain control and any money left at your death passes straight to your spouse or children. At what cost, you may ask. The cost is risk. The pot can fall in value and crucially it is possible to run out of money in later old age, something that cannot happen with an annuity.
Age plays a big part. Annuity rates are heavily age dependent. A 55-year-old will receive a far lower annual income than someone buying at 65 or 70 because the provider expects to pay out for longer. Early retirees who are still working often choose an ARF initially and postpone the annuity decision until later when rates become more attractive.
Attitude to risk is the other decisive factor. You could split the pot. You might set up an annuity to cover essential living costs, the mortgage if still there, utilities, groceries. The balance goes into an ARF for discretionary spending and growth. Even within ARFs choices range from high-risk equities to ultra-cautious deposit accounts.
No one size fits all. For example, a healthy pensioner with the State pension wishing to pass wealth to children will lean towards an ARF. Whereas someone in poorer health with little other income and no desire for the ups and downs of the Stock Market will certainly be better off with an annuity. There are so many varying choices or options that good independent financial advice at retirement is essential.
Thirty years after ARFs were introduced, retirees have more freedom than ever. But with freedom comes responsibility. Get the balance wrong and you either leave money on the table or risk poverty in later old age.
For the thousands approaching retirement in 2026 the old certainties are gone, and the decision has never been more personal.
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