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5th November 2024
How much income would a €1 million pension generate? Planning for retirement in Ireland involves making important decisions about how to generate reliable income from your pension savings (assuming you use pensions as part of your strategy!).
We’re going to take the case of our illustrative friend, Harry Houdini, who managed to escape from high-strain corporate role at the ripe young age of 55!
Harry (and his wife Hilda!) have accumulated pension pots of €1m through 25 years of careful accumulation to pensions (they simply saved €2k per month for the past 20 years, and achieved 7.15% average annual net return, simple as that!). In addition, they lived within their means; drove half decent cars, enjoyed decent holidays each year, but kept things sensible!
With a €1 million pension pot, there are multiple options and aspects to consider. A €1m pension pot may be below what some people are aiming to have when they retire, it above what others may be aiming for. Either way, it is a useful ’round’ number on which to do this analysis, and for you to map to your own planning. Today, I’ll cover;
If you decide to buy an annuity with your €1 million, the income will depend on the annuity rate offered by the provider, of course. As of recent Irish rates, a €1 million lump sum could provide a fixed, guaranteed income of between €35,000 – €45,000 per year.
This is often described as ‘guaranteed income for life’. And that’s usually true; it will pay that income for as long as you live! Once you die, the income will cease entirely and the annuity provider will keep the lump sum you handed over on Day 1, unless you opted for a ‘joint life’ annuity. if you opt for that, your spouse/partner, if they survive you, will usually receive half the income you were getting from the annuity.
If you choose Joint Life, or an Indexed annuity (one that rises with inflation), your initial income will be lower than if you opt for a single and level annuity.
Lets take the case of Harry Houdini who has escaped from corporate life at the age of 55. What are his options for annuity? These are live actual quotes from one provider.
How much income will €1m generate via an Annuity in Ireland?….
You can see from these that it is the inclusion of any sort of even modest inflation adjustment on the annual income (which lets face it is key!), really drives the initial annual income downwards.
Age and Health: Older retirees and those with certain health conditions may be offered higher annuity rates. And as we saw above for Harry and Hilda, younger annuity-buyers won’t be spoilt for choice.
Spousal Benefits: Opting for a joint-life annuity, which continues payments to a surviving spouse, will reduce the initial annual income a little, but not hugely.
Inflation Protection: An annuity that increases each year (even marginally) provides protection against rising living costs but reduces the initial payout to a large degree (c25% reduction). It is a great benefit to have, but comes at a great cost!
As with anything in this world, if you are considering an annuity, shop around!
Annuity, as we can see, is great for generating an income that you don’t need to think about or worry about, but it’s not perfect.
While annuities provide stability, they come with limitations:
Lack of Flexibility: Once purchased, annuities typically cannot be changed, or reversed, even if your needs or priorities change.
Inflation Risk: Fixed annuities lose purchasing power over time due to inflation. You’ll likely lose 50% of your purchasing power in the next 20 years if inflation is at long-term norms.
No Residual Value: With most annuities, if you pass away early, your remaining pension goes to the provider rather than your beneficiaries.
With a pension drawdown, also known as an Approved Retirement Fund (ARF) in Ireland, you control your investments and decide how much income to withdraw annually. If you withdraw the minimum 4% annually from a €1 million pot, you’d start with an income of €40,000 per year (rising to 5% of pot value at 71). These rates can be adjusted upwards by you and your advisor based on investment performance, needs and and life circumstances, provided you don’t drive it to hard and inadvertently blow up your financial security.
A 4% withdrawal rate is the ‘minimum distribution’ one must take from an ARF in Ireland. And interestingly, it is the norm here that when you do ‘turn on’ your ARF, you will get 4% of the current value each month. This will obviously swing wildly up and down as your investment value fluctuates. Who wants a wildly fluctuating income each month? Not me! It is therefore often of great value when we establish a base-line income to draw, around which we can navigate and adjust within guardrails. Read more about this approach here if of interest.
Let’s take a look at Harry Houdini’s case here. He is 55, has €1m to allocate to an ARF and start generating income for himself and Hilda to go and enjoy their post-corporate-hell lives! Harry is only 55, and recognises that he is considered fairly young to be starting to draw on his ARF, with the hope of it lasting them until they are into their 90’s. Bengen’s research was based on a withdrawal horizon of 30 years, not 45 Harry! But, they need the cash, and he’s flat refusing to go back to the day-job!
So, let’s be having you they say!
They need €40k Gross right now per year. After a small amount of tax, they’ll net c€36k per year. Subsidised with some cash deposits and a tax effective CGT stocks sale of his old company stock each year (using CGT allowance, and hoping the stock holds its own!), they’re aiming to have total income at their disposal of c€50k per year. The ARF income is pivotal here.
We know they can take as much as they like in theory from the ARF, but the 4% is a healthy balance. We know that they will need to increase the withdrawal to 5% of the future pot value at 71 also.
For this illustration we have set their income at 40k initial (same as single annuity!). We have then set that income to increase at 2% every single year (indexation!). We then increase the withdrawal to €50k from age 71, increasing at 2% every year!
But even this approach requires careful management to get an ARF to last a lifetime. The longevity of your €1 million pension depends on your investment returns (particularly in early years – more on this next time), and your withdrawal strategy.
Investment Risk: Drawdown income sustainability depends on market performance, meaning returns and therefore longevity of your ARF will fluctuate inwards and outwards. Also, the more fees you pay and/or the worse the performance of the fund, the more risk you face in your ARF pot dying before you do!
Potential for Growth: Unlike annuities, your pension pot remains yours. It remains invested for hopefully 20-30years or more as you draw an income from it. Provided it is well managed and draw-down strategy is balanced, your ARF pot should outlive you. This legacy to your spouse/partner/beneficiaries is a big consideration for many.
Flexibility: Drawdown allows adjustments to withdrawal rates and your income based on needs and market conditions, offering more control. You can also opt to take lump sums (taxable of course) over time as and when you may need them – which many do!
In Ireland, a €1 million pension can offer a comfortable retirement for most. As I keep saying, the biggest influence on one’s financial independence is their rate of expenditure – whether that’s what one wants to hear or not! But how you manage your pots is crucial.
Annuities offer stability but lack flexibility, while drawdown strategies provide growth and income potential, but greater uncertainty. Using strategies like withdrawal strategies, and scenario planning can maximise your retirement income, helping you enjoy a secure financial future.
With thoughtful planning and professional guidance, your €1 million pension can be managed effectively, supporting a fulfilling and financially secure retirement in Ireland. No doubt about it.
I hope it helps.
Paddy Delaney QFA RPA APA
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Informed Decisions are one of Ireland’s only remaining independent financial advice firms. We specialise in retirement & investment planning for successful individuals, so that our clients only have to retire once.
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