Retirement lump sum investing isn’t a one-off decision, just like getting a dog ‘isn’t just for Christmas’! As an owner of a very active Irish Terrier, I can attest to that – and as a financial planner to successful retirees, I can assure you that there are many aspects one should consider when taking or investing a retirement lump sum. It’s not to be sniffed at!

Too often, people take the pension lump sum with no plan. They then realise that they now have another major financial decision (albeit a positive one!) to make, and another account to manage or for some, to worry about. Don’t let your retirement lump sum turn into a regret. Be smart.

Key Takeaways

• It is worth considering leaving your 25% lump sum in your pension pot for investment
• Decide how much of the lump sum you will next in the first few years of retirement
• Consider investing your lump sum in diversified equity holdings
• Which exit tax investments make the most sense for your financial plan

The top 3 considerations for investing a retirement lump sum

• 1) Should I take a retirement lump sum, or not! Tax benefits or not in doing so
• 2) Should I invest it or not? Ensuring you have enough
• 3) How should I invest it? CGT vs Exit Tax

Let’s look at each of these in brief, and determine what we ought to know and what we should do…

1) Should I take a retirement lump sum, or not!

The consensus among the vast majority of us is that when we get to retirement, we take the max tax-free lump sum from our pension, and move on. In blog 171, ‘Take Your 25% Tax Free Lump Sum, Or Not‘, I questioned that (at the prompting of an avid reader). Typically, this is what we do when we take retirement benefits from our pension scheme;

• When we get to retirement, most pension holders take the 25% Tax Free Lump Sum and stick it in the bank or otherwise invest it in a taxable structure
• Having done that, provided we are over 60, and we invested the remaining 75% of the pension balance in an Approved Retirement Fund (ARF), we are then obliged to take 4% per year income from the remaining 75%, at a potentially lowish tax rate of 20-25% effective rate
• In so doing, we have just taken 25% out of a structure on which any gains are tax free, and stuck it on deposit account or into a personal investment on which any gains will be taxed at 33% (CGT) or Exit Tax (41%)
• Unless I have an actual need at the point of retirement for the 25% retirement Lump Sum, might it have been better to leave that 25% portion in the pension structure and draw down the pot at the 4% and 5% annual income (minimum distribution) rules?

Based on our analysis, in Blog 171, it can often make financial sense to leave it in the pension – provided you are not leaving yourself short of the income you want, or worse, sacrificing your own comfort in order to leave an even bigger legacy to the un-deserved next generation!!

2) Should I be investing my pension lump sum, or not?

Assuming you have or will take the pension lump sum, what now? Unless you need it in the coming few years, or you are totally averse to volatility, you’d be barking-mad to leave it on deposit at present!

So should you invest it instead? Should you expose this valuable retirement lump sum to volatility, where it will be subject to the vagaries of the ‘markets’? Well, ask yourself some questions first;

• How much of this retirement lump sum might I need to access in the coming 5-7 years? (If yes, consider parking those sums on deposit/state savings or other similar secure vehicle)
• Is it highly likely that I will never ever need to access significant portions of this money for myself? (If so, does it make sense to gift/donate some of it now or in the near term, and see others enjoy it?)
• Have I been living really frugally in order to reach retirement in a financially comfortable position? Am I panting at the chance to let-loose and to go and buy that Porsche or book that extravagant rugby world-cup trip (France ’23, Mais Oui!), or whatever tickles your belly?? (If so, prepare to spend a good chunk of it shortly)
• Do I financially or emotionally need to try and achieve a rate of return on the retirement lump sum that will exceed inflation? (If so, you’ll likely be investing the retirement lump sum!)

Again, worth sense-checking for yourself, particularly if you have no intention of accessing the retirement lump sum in the future – would it potentially lead to better outcomes if you leave it in the pension.

Again, it can grow tax-free there, which would amount to a huge saving over multiple decades. Also, it could pass tax-free to your spouse if left in a pension vehicle.

And another thing, if it is in an ARF, it passes to adult kids at ‘only’ 30% income tax rate, as opposed to 33% Capital Acquisitions Tax (CAT/Inheritance Tax)! Again, does it absolutely make sense for you to take it out of the pension scheme in the first instance – you are not obliged to take or invest a retirement lump sum!

3) How should I invest my retirement lump sum?

If you conclude that you do need/want to invest your pension lump sum – the decision is now about ‘How?’.

You will have the usual range of options, mainly;

• Buy property
• Buy forestry
• Invest in Start-Ups/Angel Investing
• Put it on the dogs, or horses!
• Take your chances in Crypto, Mongolian Cave Art or some other high-risk stuff
• Invest in diversified equity holdings

Most of us decide that the latter; investing our retirement lump sum in a diversified portfolio of high-quality companies (aka equities) is the most prudent long-term approach to take.

A major decision then arises, should I invest in a CGT or an Exit Tax option?

CGT vs Exit Tax Investments

You will (assuming you are informed of the facts) be confronted with the reality that ‘Exit Tax’ investments carry a 41% tax on any solidified profits, while CGT investments are ‘only’ taxed at 33%. It is at this point that the Tax-tail starts to wag the Investment-dog!

When confronted with 33% vs 41% tax on gains, many people will understandably prefer the CGT route for their retirement lump sum. It’s the right thing to do, right?! Well, not so fast! Some pros and cons:

Exit Tax investments – facts, pros and cons

• Gains are subject to Exit Tax at 41% every 8 years – even if not sold!
• You do the returns the year after 8th anniversary, or whenever you sell at a gain
• All Insurance based investments from the main insurance companies are Exit Tax (in this instance, your money sits on their company balance sheet :O – and what’s more, you’ll pay 1% Govt Levy for the privilege of investing in an insurance-based Exit Tax product :0
• Most all accessible ‘index funds’ from the top investment managers in the world and domiciled in Ireland are UCITS, subject to Exit Tax, (We often use these for my own, and for clients’ needs)
• Exit Tax investments in UCITS tend to be cheaper than CGT investment portfolios and easier to manage/over-see/decipher
• They tend to have fees of c1% less than CGT portfolios per year, often much more

CGT investments – facts, pros and cons

• Solidified gains are subject to Capital Gains Tax (CGT) at only 33% – and only when sold
• There is no ‘deemed distribution’ every 8 years – you buy and hold until death if you wish
• Can be potentially advantageous if holding until death – no tax-hit until CAT is payable if passing to estate/next-generation
• They tend to be more complex, expensive and less diversified than Exit Tax/UCITS
• In theory, you have a ‘CGT allowance’ of €1,270 per person (meaning you can write-off the first €1,270 of gains from a CGT investment each year, with no tax). Doing so is easier said than done however
• They can be beneficial if you are drawing an income from the investment, potentially maximising the CGT allowance, and being more tax efficient than Exit Tax/UCITs route

If you want to see the numbers and how they could potentially stack-up, get your teeth into the detailed analysis I did of CGT versus Exit Tax and their financial outcomes here in Blog 160, Investment Trusts and UCITs Taxation, available for your pleasure.

There is no magic-wand to investing your retirement lump sum, and there isn’t a dead-cert winner as to which route will be the most successful for you. All I ask is that you are aware of the options, and make sure you get proper help in figuring-out which one gives you the best chance of success into the future.

I hope it helps,

Paddy Delaney QFA RPA APA

Here are a few more details about lump sums payable benefits on retirement.