Managing Wealth in 2023

Ivan Kennedy, Managing Director at OBI Wealth Management provides a round-up of content from this year’s Managing Wealth event.

The ‘Managing Wealth’ series has been up and running for well over a decade now and has garnered a large following during this time. While it is a joint endeavour between LIA, Irish Tax Institute and FPSB Ireland typically aimed at CFP® professionals, attendance is open to all members. This year’s event was held at the Iveagh Garden Hotel in Harcourt Street, Dublin, commencing at 8.30 am. It was a hybrid event, with many also attending online. Emer Kirk, ever capable Chief Executive of FPSB Ireland and fellow Editorial Committee member, opened the session and acted as MC for the morning.

Long-term Challenges for People Managing Pension Funds in Retirement  |  Brian Grimes

The first speaker was Brian Grimes, an actuary with over 35 years’ industry experience and a well-known lecturer in LIA circles, who presented on the long-term challenges for people in managing their pension funds in retirement. This is a synopsis of some ideas Brian shared with the audience. It’s been more than 20 years since the introduction of ARFs, a great contract for those who are in poor health. The prior way: a simple annuity. But the ARF breakthrough brought complexity to the retirement income funding challenge. Behavioural economics shows people tend to overestimate the benefits of large amounts of money – overspending in the early years of retirement or being overgenerous by gifting to help dependants. It may also leave them more open to scams and fraud. When one does not know how long these funds need to last or whether they will retain the level of cognitive capability they had at the outset and early years, it becomes a significant challenge.

UK research shows people underestimate their own longevity by 4-5 years. 25% of males will make it to age 90, rising to 40% for females. In the UK, currently 12% are taking annuities and a smaller amount are fully drawing down their funds. UK research also shows people are not drawing down income and as a result, funds are not bombing out. But people are showing a fear of spending in order not to run out of money. In Australia, new law changes oblige trustees to formulate an investment and spending plan in order to mitigate this.

So, what does good look like? It provides a core income for life and allows for increased spending in the early years, with a clear view on bequests once the above has been established. Focusing on income, how long do you provide for? This question is near impossible to answer as ‘averages’ often don’t cut it. The challenge seems to call for insuring this; annuities warrant much closer scrutiny than most currently give them. There is quite an aversion to annuities out there. Some are rational, such as the loss of liquidity, short life expectancy and expensive pricing. But also some less rational reasons: how it is framed, a ‘bet’ with the insurance company, underestimation of longevity.

Research also shows that how the adviser frames it can have a huge influence on how a client feels about an annuity. A calculation of the investment amount versus the income over time can frame the benefit or the risk of same. Say at age 78, ‘my asset is equal to my liability’ with an investment linked fund. Consider ‘should I now guarantee this income at this point?’ Females get even better value out of annuities. In conclusion, research suggests retirees in receipt of annuities have a higher level of satisfaction. Perhaps an ARF in the early years is appropriate and an annuity at age 70 or 75. A simplified ‘at retirement’ proposition? Define required income and make a plan to purchase an annuity at an appropriate time in a fixed period? Perhaps by buying a long-dated bond with an ARF pot for discretionary spending, with say a 10-15-year time horizon for the bond part.

During the Q&A, there were many questions such as why now for annuities? Interest rates make them more palatable as yields have risen lately, now 5% annuity rates and above are available. On loss aversion, try to create the feeling at age 75 of how you will feel with an income coming from a risk based fund versus the certainty from an annuity. Would likely go for a level rather than an increasing annuity, so bigger spending earlier on. Asked ‘are there hybrid products available in Ireland like there are in other markets?’, we are not there yet, while at present we may have many of the tools required to produce them. Also ‘what advice would you give to advisers now?’ Talk about now, how they will feel in their mid-70s, the feeling of being an ‘earner’ at that time rather than the scenario of being on a dwindling income.

Key Tax Issues for Individuals Close to Retirement  |  Finola O’Hanlon

The second speaker of the morning was tax practitioner and solicitor Finola O’Hanlon, of O’Hanlon Tax. Her topic was ‘Key Tax Issues for Individuals Close to Retirement’. Using case studies, Finola presented on the best ways for retiring people to extract value for exiting their businesses in the most tax efficient manner. Of course, tax relief on pension contributions features as part of the wealth extraction process. Tax relief on pension contributions: if old self-employed tables used, it is not as generous as employer contributions either via Master Trust or especially since the Finance Act 2022, with employer’s PRSA contributions no longer BIK-able and not related to salary or service either.

Tax on pension drawdown: limit of €200,000 on tax free lump sum with excess lump sum payments up to extent of 25% of fund taxed in two stages. Above €200,000, tax paid at 20%, on the next €300,000; at a rate of 40% over that. Note the SFT €2m ceiling on tax relieved pension contributions means marginal rate tax on the fund at 40%. In such cases, would be better to have had higher tax paid via salary pre-retirement. On exiting from a business, the longer consideration given to this before the planned exit date the better and ideal from age 55 onwards.

There are three main options to exit a business: pass on to family, sale to a third party or MBO of the business. Liquidation is the third and last resort. CGT retirement relief may apply but you don’t necessarily have to retire to benefit from it if there is no tax on chargeable business assets. If the tax payer is aged 55 or over at the time of disposal and the business assets owned for a period of at least 10 years. For shares in a company, it must have been a trading company and the individual must have been a working director for 10 years and full-time working director for five years. Tax relief from CGT has a ceiling of €750,000, reduced to €500,000 if age 66 years or over (higher if disposal is to a child).

There is a lifetime limit and clawback if exceeded on a later transaction. There is also CGT entrepreneurial relief at 10% tax on a €1m gain, 33% tax above this. Assets need to be owned by the individual for a continuous period of three years prior to disposal. CGT buy-back of shares can also be availed of, rather than income tax. For this, the vendor must be resident or ordinarily resident in the State and have owned the shares throughout the previous five years ending on the buy-back, while the transaction must be wholly or mainly for the benefit of the trade or business.

On a third-party sale, the key points are that there is an open market sale to a third party, shareholders realise the value of the company including goodwill (which is whatever someone is willing to pay to buy the shares!). With an MBO, the disposal is to the ‘newco’, but it is more complex with greater income tax risk. Shares may qualify for CGT treatment and retirement relief, or entrepreneurial relief may apply. On liquidation the key points are that it is a less attractive option as the goodwill value is lost. The shareholder realises the net asset value. There is also CGT for the company on disposal of capital assets and CGT for shareholders on disposal and probably at nil base cost.

Other points to consider are updating wills and consideration of enduring power of attorney. On pensions, passing DIS benefit to estate; may pass to beneficiaries subject to CAT at 33%. On pension fund passing after drawdown of ARF; passes to spouse who ‘steps into the shoes of pensioner’ who has income tax on drawdown.  Trends to consider are the growing retirement savings gap and the ageing workforce as per the recent census. More flexibility is needed to delay retirement and save via pensions.

In the Q&A, Finola pointed out that so many business owners run such a good business outfit that they often overlook their own exit plan from the business. There can be CGT retirement relief of up to €750,000 and one may then go on to receive 10% entrepreneurial relief for a new business later. However, the overall €1m allowed is reduced by the first €750,000 relief.

Investment in the Current Economic Environment  |  Kevin McConnell

The third and final speaker of the morning was Managing Wealth’s most frequent speaker, Kevin McConnell of Gem Consulting. Called ‘Investment in the Current Economic Environment’, as always, Kevin’s presentation was a rapid fire of interesting and useful Irish and global economic nuggets! Now near the end of a rate tightening cycle in the US and Europe later, the cost of living crisis is easing. But the banking crisis, caused by the bond market rout, is not yet over especially in the US, less so in Europe. Interest rates should start to fall over the next 18 months. The SVB bankruptcy and other bank problems are likely to lead to banks changing behaviour and offering longer term deposits to customers. Irish banks are in a very good position currently, likely also to offer higher deposit rates to protect their excellent funding position after the global bank turmoil. Watch out for the Fed cutting rates leading to a weakening US$ affecting US equity holdings’ value.

Inflation is falling in the US but not as fast in Europe, hence likely currency value differential. Oil and gas prices continue to fall; US and European unemployment levels are at record lows leading to wage increases which will keep central banks on their tightening bias until signs of higher unemployment emerge. History lesson No. 1 shows 1970s-type inflation returned in 2022, mainly oil price driven. Lesson No. 2 is that 4% interest rates and higher is the danger zone for the economy, so the central banks have a delicate job. Lesson No. 3 is long term investing means better outcomes – ‘time in the market v timing the market’. Bond market outcomes mean one should consider fixed income for retirees along with an investment linked option, to reduce risk.

On Ireland, we have moved from bailout to record real wealth; we now have more in deposits than pension funds! Our population expansion is accelerating, we need 70,000 houses built annually and are currently short 400,000. Irish house prices are up 4x since the 1970s. Housing needs to be addressed or it will lead to a political backlash; dilemma between using the great budgetary surplus to solve the pension crisis for us all, or the one million people who need housing. We have the third highest life expectancy at birth, now 82.6 years. Ireland’s average age is 38.5 currently and still the youngest in Europe which means there is still time to fix our pension timebomb! 1.3m workers have no pension. Of those that do, they are massively underfunded.

There are now 2.6m people at work, the most since the 1850s, resulting in strong growth in key financial planning cohorts to 2030. Irish private pension coverage is concentrated and weak; only €120bn or 30% of GDP and we need much more. The IMF sees Ireland growing by 34.3% over the next five years and the European Commission is not far behind in its estimate. Since 2013, household wealth has increased hugely; €162bn in deposits nationally, savings at 20% level contributes to this. It has been a remarkable recovery since the GFC. Strongest budgetary position ever; €83bn in taxes in 2022 rising to €105bn by 2026.

There were many questions on high tax on savings: 41% is insane, eight year deemed exit and ARF forced imputed distribution. We need an ISA type gateway to pension type savings plan. The removal on the cap for PRSA company funding is most welcome, a good chance to address the pension funding crisis. Retirees really need to own their own house in retirement; there’s a €1m deficit between one who owns their house and one who doesn’t. Australian auto enrolment 20 years ago radically changed their entire economy for the better as a result.

The back end of property construction i.e., the production side, needs funding but ECB ending restrictions means there is currently too little. State pensions means testing may need to come in, from say age 75, politically unpalatable, but… Kevin feels advisers are in a great position with the economy and its wealth position so strong at this time and for the foreseeable future. A nice note on which to end the morning.

The above article is re-produced from the LIA Advantage Magazine September 2023 edition with permission from the author. Views expressed in this article are those of the author and do not necessarily reflect the views or positions of FPSB Ireland DAC. This article is for information purposes only and should not be construed as financial advice. Formal advice is advised in advance of taking any action.