13.0 Introduction
13.1 What are ARFs and AMRFs?
13.2 Re-definition of Proprietary Directors
13.3 AVCs
13.4 Tax Treatment on Death
13.5 Qualifying Fund Managers
13.6 Changes to the Rules on Distributions
13.7 A Health Warning on ARFs
The Finance Act 1999 introduced new pension options. Originally, they were directed at the Self-Employed and Proprietary Directors. At that time, proprietary directors were defined as those who held more than 20% of the voting rights in a company or in its parent. Shares held by the director's spouse or minor children were taken into account also, as were those held by trustees of any settlement to which the director or his/her spouse had transferred shares.
From the 6th April 1999 a proprietary director in a pensionable employment had the option of taking his benefits in the traditional format, or adopting a new format which was also available to the self-employed.
Normally, proprietary directors' benefits would be treated the same as those of other employees - a cash option based on final remuneration and years of service, with the balance of benefits emerging as a compulsory pension. The new system gave him/her the option of taking 25% of the accumulated fund in cash. With the other three-quarters an annuity could be bought in the same way as before. Alternatively, the money could be drawn down in cash, subject to conditions and also subject to tax, or invested in one of two new investment vehicles, the Approved Retirement Fund (ARF) or the Approved Minimum Retirement Fund (AMRF).
These are funds which are managed by 'Qualifying Fund Managers'. This term is explained below. An ARF is a fund which pays no tax on its investment income or capital gains while the money is invested in it. However, if the money is withdrawn, it is subject to income tax at the individual's marginal rate. An AMRF is similar, but has the effect of locking away the individual's capital until he/she reaches age 75 years. Income can be drawn from an AMRF, but the original investment cannot.
An ARF is open to a qualified person who is either over 75 years, or has a guaranteed pension income for life of €12,700 per year at least. You may include in this figure any pension payable under the Social Welfare system to you personally (but not allowances paid for dependants). The pension must actually be in payment - you cannot anticipate pensions that have yet to be paid.
If you do not pass this test, you may have to choose an AMRF. This means that the first €63,500 of your remaining fund, or the whole fund if it is less, would have to be invested in such a way that the capital is not available to you until you reach 75 years, though income generated by the fund can be drawn down. Alternatively, you can buy an annuity with €63,500, and any balance of the fund can then be invested in an ARF, or taken in cash subject to tax.
These options applied automatically to anyone who invested in a new Retirement Annuity Contract on or after 6th April 1999. For existing contributors, the agreement of the provider had to be secured before the new options would apply. In the case of proprietary directors in Occupational Pension Schemes, the rules of the scheme needed to be amended before the new options could be taken if the schemes were approved by Revenue before 6 April 1999.
The one complication about the operation of ARFs and AMRFs from April 1999 onwards was their treatment for tax. Under the system as it was introduced, a distinction was made between capital gains and income generated by the fund that was invested. If capital gains were made, they would be taxed on the basis of capital gains tax. However, if the funds generated were regarded as 'income' such as dividends, then they would be subjected to income tax. These taxes were payable even if the profits in question were not drawn down.
This was changed in the Finance Act 2000 and the position was greatly simplified so that anything drawn from an ARF or an AMRF is now subject to income tax as it is drawn down - the fund pays no tax while it remains invested. In that way, its treatment is similar to that of pension schemes. However, further changes made so that the income tax is now deductible at source under PAYE by the 'Qualifying Fund Manager' who operates the ARFs/AMRF on behalf of the individual. This applies even to self-employed people who may account for the rest of their taxes in arrear.
In April 2000, the term 'Proprietary Director' as used in this legislation was re-defined. Instead of needing to control more then 20% of the voting shares in a company or its parent, a person who controlled more then 5% of these shares was regarded as a proprietary director for the future, and thus eligible to invest in ARFs/AMRFs. However, for the purpose of calculating overall maximum benefits, or the traditional salary-related lump sums at retirement, the old definition - 20% shareholders - still applies. "5%" Directors have their final remuneration calculated in the same way as ordinary members.
However, the biggest change made in April 2000 was the extension of ARFs/AMRFs to everyone making Additional Voluntary Contributions (AVCs) to enhance their pensions. This meant that the new investments were available to a very large number of people. The rules for calculating the tax free lump sums payable to ordinary employees with AVCs have not changed. There is no option to take 25% of the fund in cash, the tax free lump sum must be calculated in the old way, related to salary and service. The big difference for AVC contributors now is that any part of their AVC fund that cannot be taken in tax-free lump sum form can now be invested in an ARF/AMRF at the holder's option, rather than being directed to a compulsory annuity, as before.
Special rules apply to distributions made from an ARF/AMRF on the death of the person who holds it.
In general, any amount distributed is treated as if it was income of the deceased person for the year in which his death occurs.
However, whether distribution is made to the spouse of the holder of an ARF/AMRF or to a child who is under 21 years at the date of the holder's death, no income tax is charged. In the case of a child there is, of course, the possibility that Inheritance Tax (C.A.T.) could apply. If a distribution is made on the later death of the surviving spouse, or to a child of the original holder who is 21 years or over on the death of the holder, tax is deducted at the standard rate for the year when the distribution is made. This charge to tax does not affect the child's personal tax rate and is not affected by it. Inheritance Tax would not apply in this case.
If a distribution is made to a person who is neither a spouse nor a child of the holder of the ARF, then full income tax and inheritance tax liabilities arise.
The role of the Qualifying Fund Manager (QFM) is mainly to account for any tax that may be due on distributions from ARFs/AMRFs.
Those eligible to apply for Qualifying Fund Manager status include:
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Banks (this includes banks licensed in another EU Member States);
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Building Societies
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Credit Unions
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The Post Office Savings Bank
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Life Assurance Companies (again including those licensed in other European countries)
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Certain bodies authorised to raise funds for collective investments, such as Unit Trusts, UCITS, authorised investment companies, etc.
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Authorised members of the Irish Stock Exchange or member firms, which carry on business outside the State, or in the Stock Exchange of another EU Member State, who have notified the Revenue Commissioners of their intention to act as Qualifying Fund Managers.
With effect from the year 2000, when banks and insurance companies from other EU Member States where included, the list was also expanded to include investment intermediaries authorised either in Ireland or in another EU state to hold client money - but not Restricted Activity Investment Product Intermediaries. If a Qualifying Fund Manager is not resident in Ireland, they must appoint a resident agent who is responsible for all the duties and obligations surrounding the management of ARFs/AMRFs - most particularly, the collection of the tax that may be due.
The 2003 Finance Act made some changes to the rules relating to ARFs. These changes were designed to make it more difficult for ARF holders to enjoy the proceeds of their investments without first paying the necessary tax. Rather than forbidding certain practices altogether, the Finance Act simply treated certain activities as 'Distributions'. In other words, if certain things were done with the money that was invested in an ARF, it would be regarded as if it had been paid out to the holder and therefore would be immediately subject to tax - which the QFM is obliged to deduct and account for.
From 6th February 2003, the Revenue Commissioners regard it as a distribution if the ARF (AMRFs are included) is used:
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To make a loan to the holder or to a 'Connected Person', or to use it to secure a loan for such a person;
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To acquire property from the holder or a 'Connected Person';
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To acquire property to be used as holiday property, or as a place of residence for the ARF holder or a 'Connected Person'.
1
If the property is acquired for some other reason (for example, to be let to third parties) and is subsequently used as a holiday property or residence by the holder or a 'Connected Person', the change of use immediately makes this a taxable transaction. Any money used to repair or improve the property will also become taxable at that stage;
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To acquire shares or other interests in a closely held company in which the holder or 'Connected Person' participates;
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To acquire any tangible moveable property - this is aimed at discouraging the use of ARFs to buy works of art, vintage cars and other collectable items.
Where assets held in an ARF or AMRF are sold to the holder or a 'Connected Person', this is also regarded as a distribution and therefore taxable.
2
Qualifying Fund Managers are in future required
to notify the Revenue Commissioners within one month of the date when they begin to act as a QFM. Managers already acting in that capacity had three months in which to notify the Revenue, after the passing of the Finance Act.
For those whose pension savings, or a substantial part of them, may be destined for ARF treatment at retirement, it is worth making a few observations arising from the peculiar nature of the products:
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ARFs and AMRFs are not pension schemes - except for the purposes of the Family Law Acts. They are investment products, and should be approached with the same care and attention as any other investment. Advice is desirable, not just at the time the original investment is made, but all during the periods when they are held.
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ARFs and AMRFs are personal property. They cannot be secured as a joint account, so they do not pass automatically to a spouse or other dependant when you die. Therefore, you must deal with them in your will, or risk them being dealt with under the rules of intestacy if you don't make a will. Failure to deal with them specifically in your will could mean that they would go into the 'residue' of your estate, perhaps with unforeseen consequences.
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Because the ARF/AMRF is not a pension, but personal property, there is no option to make payments from it to someone else (e.g., family or carers) if the holder becomes unable to act for him/herself. Professional advice should be taken on how best to deal with this problem.
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Because they will pass into your estate on your death, it may be difficult to deal with them for some time, until your estate can be administered, which could be awkward if they represented a substantial source of income to your family.
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Under the law as it stands, if the person entitled to invest in an ARF dies before it can be set up, their spouse or other dependant does not inherit the right to invest. Therefore, the only option open to a surviving spouse, for example, may be the purchase of an annuity.
1
In this context, a 'connected' person is a member of any of the classes named in Section 10 of the Taxes Consolidation Act, 1997, and includes spouses or near relatives, partners in a business partnership, related companies, trustees of certain settlements and their settlors, and so on.
2
By S. 14, Finance Act, 2003