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Weekend reading: Live fast, buy an annuity

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What caught my eye this week.

There are many things I do because I am an investing maniac that you probably shouldn’t.

For starters, I invest actively. That’s why I coaxed in my passively-pure co-blogger to keep Monevator on the straight and narrow.

Here’s another crazy notion of mine – I want to be able to live off my capital.

I don’t mean reach some lump sum that I then dwindle down to nothingness while eating grapes and watching Loose Women.

I mean replace a notional salary with an investment income that exceeds it, generated from an otherwise unmolested portfolio.1

This is a pretty quixotic goal on multiple fronts, as some of you have pointed out over the years.

First, it means I need a lot more money amassed before I can declare I’m financially-free on my terms. Not planning to spend the wodge down to zero has a big impact.

Second, I don’t plan at this point to ever entirely stop working for money. So my notional salary will be topped up by some kind of continuing income for years to come, making it all an even weirder modus operandi.

Third, I don’t have kids, have never aspired to, and it’s now looking unlikely I ever will. So there will be no official heirs to leave a woefully under-taxed inheritance to – only friends, relations, and the metaphorical dog’s home.

Really I should plan to spend the lot on Wine, Women, and Whatever – feel free to re-jig for your own sexuality and alcoholic tastes – and go out with empty pockets. Perhaps I will, but it’s not a goal I have in mind.

But for me, investing isn’t really a means to an end, it’s a means to a means.

When I tell people I don’t care much about money, they raise their eyebrows, given my passion for markets – and this site. Obviously on some level I do care about money, but really even spending it is not what motivates me.

I seem to find it all a big game and a passport to self-purpose. In my head I am a bohemian and I lived like a graduate student for decades despite having increasingly chunky assets because I liked it that way. I rarely judge people for not being able to save as I have, because frankly I found it no hardship.

But most people – even most of you – aren’t like that. You’re investing because you have to. You want to be able to retire in comfort, sooner or later, and perhaps have more to spend along the way. You have kids you’d like to help out. You hate your job and want to be free.

Remix to suit.

Who’s weird, anyway?

What you might not realize is that people like you have puzzled economists for decades.

Indeed, even though some of what I’ve written about myself above probably seems a bit out there, lots of people – especially in the US but increasingly here too since the advent of the pension freedoms – are arguably just as irrational.

The reason – the puzzle – is why most people don’t buy annuities when given the choice?

Theoretically annuities maximize the amount of spending you’ll potentially be able to do in an average retirement. This is because annuities spread the risk of any particular retiree outliving their savings among many retirees.

The alternative – to self-insure against a telegram from the Queen – is an expensive option.

I suspect people don’t buy annuities because the thought of being hit by a bus the next year and leaving an annuity company hundreds of thousands of pounds up on the deal is eye-watering.

But that risk is the price you pay for not running out of money – and for probably spending more than you would have in that year until the bus comes. Your sadly early demise keeps somebody else having fun at 100.

Also, as you’d be dead, who cares?2

I won’t hash it all out here because Victor Haghani of Elm Funds has done a great job for us.

In a post succinctly entitled The Annuity Puzzle, he makes a few simplifying assumptions and then offers the following graph:

(Click to enlarge)

The blue bars shows a consistent and high spend from an annuity. The red bars show what happens if you have to make sure you don’t run out of money.

It’s a pretty compelling image, presuming the maths checks out. As I say, assumptions are made. Your mileage may vary.

One thing that probably isn’t a valid criticism of the pro-annuity argument though is that annuity rates are too low. If rates are low it’s probably because expected returns from other investments are (in theory) somewhat lower, too.

And low expected returns don’t have anything to do with longevity risk, anyway.

I’m no expert on annuities – they still seem far away so I’ve not crunched the numbers for myself. Friend of the site and IFA Mark Meldon wrote a great post on annuities back in May, so check that out.

And of course you can see all our articles on deaccumulation for the other side of the argument, such as this one from The Greybeard.

You should also read the full article at Elm Funds.

I’ve long thought I’d buy an inflation-linked annuity to cover my basic income floor. Beyond that I’d be the oldest Wolf of Wall Street on the block, and maybe die as one of those mystery millionaires you read about who hoards supermarket vouchers. (Albeit from Waitrose or Whole Foods!)

But what about you?

From Monevator

How to buy and sell ETFs – Monevator

From the archive-ator: Should you buy gilts directly or invest in a gilt fund? – Monevator

News

Note: Some links are Google search results – in PC/desktop view you can click to read the piece without being a paid subscriber. Try privacy/incognito mode to avoid cookies. Consider subscribing if you read them a lot!3

Speculation ahead of Monday’s UK Budget – ThisIsMoney / The Guardian / FT

Interactive Investor has bought Alliance Trust Savings – CityWire

Is the London property market slump here to stay? – The Week

Very few people are trading those much-hyped Bitcoin futures – Bloomberg

World’s billionaires became 20% richer in 2017 – Guardian

Anger spreads over squalid new homes built by Persimmon – ThisIsMoney

Can ‘co-living’ solve millennials’ housing woes? – Guardian

(Click to enlarge)

Hedge funds: Still fleecing investors with expensive mediocrity – SL Advisers

Products and services

NS&I changes index-linked savings certificates to track CPI rather than RPI – ThisIsMoney

Active funds fail to keep up with passive fee cost cuts – Money Observer

The pros and cons of the most popular app-only banks – ThisIsMoney

Should you be using Amazon Smile? – Yahoo

Ratesetter will pay you £100 [and me a bonus] if you invest £1,000 with them for a year – Ratesetter

Neil Woodford’s flagship fund halves in size [Search result]FT

Robinhood app gets almost half its revenues selling customer orders to high-speed traders – Bloomberg

The cost of buying and selling homes in different countries [Search result]FT

Comment and opinion

Larry Swedroe: Why international diversification works – ETF.com

How often does a 10% US stock market drop get worse? – A Wealth of Common Sense

Academics in defence of active managers – Morningstar

Where is the snowball? – 3652 Days

The case for drip-feeding investing is plausible, but it costs more [Search result]FT

Ignoring the signs? – The Humble Dollar

Indexing myths that need to be busted – The Evidence-based Investor

Patisserie Valerie: What happened? – Young FI Guy

John Bogle: No such thing as a stock-pickers’ market – Business Standard

Get rich with… lodgers – The Escape Artist

For naughty active types: Year-end rally ahead? – Top Down Charts

Brexit

Ken Fisher: As the Brexit fog clears, UK stocks will bounce back [Search result]FT

Millennials may lose up to £108,000 over 30 years with no-deal Brexit – Guardian

Why I remain a Remainer [Search result]FT

RBS plunges on warning Brexit hit to clients may cost it £100 million – Evening Standard

Kindle book bargains

A Million Years in a Day: A Curious History of Daily Life by Greg Jenner – £0.99 on Kindle

Magna Carta: The True Story Behind the Charter by David Starkey – £0.99 on Kindle

You Are a Badass: How to Stop Doubting Your Greatness by Jen Sincero – £0.99 on Kindle

Way of the Wolf: Straight line selling by Jordan Belfort – £0.99 on Kindle

Off our beat

Director Peter Jackson’s colourised World War 1 film looks incredible – The Guardian

Why the world’s recycling system stopped working [Search result]FT

The Wild West open-world game Red Dead Redemption 2 is a near-miracle – Guardian

Humble exits – Morgan Housel

Remember web bookmarks? [Bookmark Monevator if you do!]Digg

And finally…

“The intelligent investor is a realist who sells to optimists and buys from pessimists.”
– Ben Graham, The Intelligent Investor

Like these links? Subscribe to get them every Friday!

  1. In reality I’d probably continue to tinker until senility sets in. But this would be the high concept. []
  2. I know, I know, your heirs and spouse. []
  3. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”. []

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{ 84 comments… add one }
  • 51 Factor October 29, 2018, 7:28 pm

    @Naeclue

    Gosh, pass the paracetamol!

  • 52 RetiredinLondon October 29, 2018, 11:37 pm

    Interesting debate on annuities. I myself am mid-30s so am not gonna take one out. But i got my dad to take one out last year. His old company pension had a benefit whereby he could get a 10% fixed rate annuity. He has other assets including other pensions, stocks ISA, cash and eventual inheritance of share in a couple of properties plus will benefit from full state pension in a few years so thought why not grab the 10% rate now (he is now retired and so not a higher rate tax payer anymore).

    Given the calculation of the 5% rate annuity and the money the provider makes, i wonder how much they make (lose?) with my dad’s annuity? How do they actually fund a 10% annuity? Its not like my dad has any major health issues (the 10% rate doesnt factor individual life expectancy).

  • 53 dearieme October 30, 2018, 1:31 am

    “if DBs are such a bad deal, …”: they are a wonderful deal – as long as the scheme outlasts you and your widow.

    “why are companies throwing all this lovely cash around trying to buy people out?” I’m mildly surprised that I’ve not read about DB schemes offering, say, 50% buyouts. It might save them quite a bit of money if more people were inclined to risk it, even at lower multiples.

  • 54 Brod October 30, 2018, 9:43 am

    @Dearime – aren’t schemes guaranteed by the Govt? So the scheme has to fail. AND the Govt back stop (such a fashionable word!) fail too? That’s a reasonable risk.

    Isn’t Mike Rawson (apologize if I got the name or attribution wrong) saying 40x multies? Or am I not understanding you correctly?

  • 55 Mathmo October 30, 2018, 10:09 am

    Nice work, Naeclue spelling that list out. It’s left me with the residual idea that you do this magnus opus gradually over time — for example it’s possible to now buy a bond that pays my target income in my 75th year. When I have some more cash I could go and buy a bond that generates my target income (taking into account the income from the 75th year bond) in my 74th year. And so on and so forth. Then when I am the same age as the bond I’m buying I have — almost by definition — reached early retirement. Of course I need enough cash left over to buy the annuity in my 75th year at (presumably) favourable rates.

    And in the meantime these bonds throw off income from today (HMG doesn’t offer zeroes yet – shame as gilts CGT free: could be held naked and calculation a lot easier), so that can go in the pot which is building up.

    Strikes me that there are a number of downsides to this idea:-
    – I believe that the SWR from a mixed equity portfolio is higher than the annuity rate + capital recovery. This builds in bonds which presumably won’t be sold as counterweight to buy equities.
    – Inflation risk — perhaps buy linkers: the most expensive form of income ever?
    – Do I really know my target income — perhaps lay it down one layer at a time? Buy a full bond ladder this year for £1k income all the way to 75. Then when more cash appears top up each of the bonds in proportion.
    – It’s a dog to buy gilts in my broker, apparently.

    I think the first is the biggest problem, however, I’d just need a lot more money to have this kind of security. Although I wonder if my 40% bond holding could at least have some of it thrown into this structure for fun. I’m kinda curious.

    * * *

    In other news: where Monevator leads the entire financial press follows. Here’s an article – https://www.bloomberg.com/opinion/articles/2018-10-29/trading-on-news-before-it-s-published – [TI can you linkalise?] on Bloomberg about an article on WSJ (paywall) dealing with annuities being a product which is SOLD and not BOUGHT (think about that for a minute and tremble for the incentives it sets up), and the underlying commissions paid to agent being around 6%. I’m assuming that’s product gross margin and the insurers make money out of the risk arbitrage. Good work, zxspectrum48 — bullseye.

  • 56 dearieme October 30, 2018, 12:09 pm

    @Brod: “@Dearieme – aren’t schemes guaranteed by the Govt?” No; they are backed by an arrangement funded by the DB schemes themselves. If my principal DB scheme failed, and if it didn’t bring the protection scheme down with it, I’d get the same monthly pension – but stripped of almost all its inflation-protection. It would be much less valuable, in other words.

    My wife, however, would suffer huge losses on her widow’s pension as well as the removal of her inflation-protection. Since she is likely far to outlive me this would be disastrous. So much so that having a DC pension might actually be less risky.

  • 57 The Details Man October 30, 2018, 2:11 pm

    @Dearieme – Well it’s possible more schemes might regularly offer a partial transfer. Last week it was announced that the Ford Scheme will start offering a 50pc carve-out. Google: “Ford takes a new direction with company pension scheme” for the FT article. There’s no law stopping schemes from doing this now, but traditionally trustees have been reluctant due to lack of demand, administrative costs, hassle factors. That may be changing.

    @Mathmo – I saw Matt Levine’s article too and it gave me a chuckle. As a community, we can be quite down on IFA’s but I think we should count ourselves fortunate that we don’t live in the US where being ‘fiduciary’ is seen as optional/a burden!

    @Brod – the PPF is the ‘lifeboat scheme’ for DB schemes (for example, like what happened with the BHS scheme). It’s funded by a levy on other DB schemes and not by taxpayers. It guarantees a certain level of benefits for members whose schemes fall into the PPF (100% for those already retired, 90% for those not yet retired). However, there are caps on the total amount of benefits and on future increases. These caps particularly affect high earners and those who accrued most of their pension benefits pre-1997.

  • 58 Joe October 30, 2018, 4:08 pm

    I see quite a few problems with the assumptions here;
    -First, with a very high expectation that the pot will outlast me (via firecalc etc) I can withdraw more money from my pension pot than an annuity would pay me. I dont recognise that graph as reflecting reality at all.
    -Second, most annuities will pay a constant amount (disregarding inflation increases) but my spending will be substantially higher in the earlier years of retirement than the latter and drawdown gives me the flexibility to do that or indeed drawdown at any rate i want. Maybe i need a lifesaving operation that costs £100k aged 80. Cant do that if ive blown my pot on an annuity. I’m discounting need for care home fees in later life being part of higher spending then because for most people they are so high they are well beyond either an annuity or a large pension pot and they are still a minority anyway.
    -Third, buying an annuity means I cannot leave a potentially large sum of money to relatives, and an annuity that gets paid to a partner after my death would provide dismal income, down from perhaps 4% to about 2.5%.
    -Fourth, by waiting until i am older, when perhaps i wont have the inclination or ability to manage drawdown, i can purchase an annuity at a much better rate and perhaps i wont have to use all my pension pot.
    -Fourth part 2, buying an annuity is irrevocable. And the earlier you do it the lower the payout. So it makes sense to put it off, because its almost a one-way bet. If for example i got a medical condition that shortened my life I can take a view on will an annuity pay me out very well now, or is it pointless anyway eg if the doc says Ive got 3 months well no point buying one.
    -Fifth, living to age 100+. I’ll take my chances that wont happen but if it does, i dont think I’ll be capable of spending my monthly income from an annuity anyway.I wonder what the maths look like if Jane decides she wont last past 95 and shes willing to take her chances on not having much money age 96 because whats she going to spend it on anyway?
    Thats probably enough to be going on with
    Joe

  • 59 Brod October 30, 2018, 7:15 pm

    @Joe – although of course the biggest assumption of the lot is your #1.

    Don’t quite get the antipathy to a guaranteed income for life myself, but you chooses yer own poison.

  • 60 KayD October 31, 2018, 11:03 am

    My in-laws and parents have each done the experiment for real.
    20 years ago my in-laws took out an annuity with their private pension contributions but they also had some money invested in shares. My own parents had money invested in shares that they partially lived off, but they decided not to buy an annuity when my father retired, so they live off dividends and my fathers state pension. After 20 years my parents seem to be much richer as their income seems to be exceeding their outgoings. My in-laws however are now complaining about the cost of everything. The annuity payments do not seem to have kept up with inflation over time, but their dividend income has, although that is a fraction of their overall income.
    Living off your dividends may be a scarier prospect at retirement time but seems to pay off over time in my opinion. I think you are locked more directly into how the economy performs and the financial services do not take such a cut of your money.

  • 61 Hari Seldon October 31, 2018, 12:38 pm

    @`brod
    “Don’t quite get the antipathy to a guaranteed income for life myself, but you chooses yer own poison.”

    I think you have the crux of the matter there. A guaranteed income is very important and reassuring for many. Having been self employed for most of my working life, I never had guaranteed income and you formulate a way of living that it will work out, retirement followed and you take that mantra forward.

    It so happens that things have “worked out” better than expectations, a mixture of ability and luck. If it hadn’t, then I would have adapted but I can see where this way of living would be unappealing to many !!!!

    Thus your second point, we have a choice. Know thy self.

  • 62 Joe October 31, 2018, 1:25 pm

    @brod. “Don’t quite get the antipathy to a guaranteed income for life myself, but you chooses yer own poison.”

    Thought experiment Brod (and Hari*), lets say i guarantee you £50 a year for your one £million pot. No, not a typo, £50 a year for life for a £million
    I suspect you’d have a strong antipathy to that 🙂
    So your “dont get it” is perhaps predicated on the expectation of a reasonable payout substantially better than £50, all things factored in, for example inflation or not rises, bounded or not, joint or not, 100%, 75% or 50% payout to second life, etc etc.

    When i factor in all things, I find a reaction similar to the one I’m sure you experienced when i offered you £50 in return for your £million, eg its not enough in comparison to even a low ball reasonable return on what I could get for the million.

    Ive just looked again, to be sure I’m current, and the quote i got will return me less than my million, over 30 years, which is some time beyond my life expectancy as well (and I’m in good health fingers crossed).
    So i could just stash my million in cash and burn it down and it will last my lifetime and more unless I’m a real edge case into teh ;iving to 114 this graph misleadingly shows.
    Of course, there will be a loss to inflation, but them again this annuity quote wasn’t inflation linked either and neither was it joint life.

    So my antipathy is based *not* on rejecting “a guaranteed income”, which IMO is a strawman argument, its based on rejecting a *rubbish* income.

    * Hari, surely you can predict how your investments will work out and adjust appropriately 🙂

  • 63 The Investor October 31, 2018, 1:43 pm

    This has been a great discussion (and you’re all of course welcome to continue it!) but just wanted to say thanks to all contributors, especially those who’ve gone into some detail with numbers and theory.

    For my part, it’s firmed up my view that currently I’d go for an inflation-linked annuity for a minimum income floor and then try to live off capital beyond that. I feel it’s the best balance between the advantages of an annuity and the advantages (and risks) of avoiding them like the plague. 🙂

  • 64 Naeclue October 31, 2018, 3:22 pm

    We will continue to live off our investments for now and revisit annuities in a few years time, maybe when we are 65. I must revisit McClung’s Living Off Your Money book as well soon, previously recommended here. This is an excellent source of ideas and strategies. Possibly a combination of fixed length annuities plus bond drawdown, topped up by selling equities, as suggested by McClung, will work well.

  • 65 Brod October 31, 2018, 5:12 pm

    @TI – way to go! If you need any more thoughts on saving for retirement, I recommend a portfolio of low cost trackers, buy and hold, diversification and regular re-balancing 😉

    Note: none of this is investment advice. As always, DYOR.

    @KayD – maybe your in-laws are the complaining type? Or your parents are stoics? 20 years ago (well 1999) was possibly one of the worst times ever to retire. (So far, it’s only been 19 years) It’s US and S&P500, but check out:

    https://earlyretirementnow.com/2017/01/18/the-ultimate-guide-to-safe-withdrawal-rates-part-6-a-2000-2016-case-study/

    @Joe – you talk about thought experiments and offer me £50 p.a. for a £1m portfolio rather than £55,000 or so that a quick search (level rate, no guarantee, single life) says I can get? About 0.1% of current) How about another thought experiment that overnight your £1m portfolio collapses to £1,000? About the same ratio. Not very useful, is it?

    Sorry, I’ll stop banging on about this now, I don’t think that after the last decade I’ll change anyone’s mind and I’m just arguing for the sake of it*.

    Shall we talk about something else? How about Brexit?

    * and because I’m right.

  • 66 Vanguardfan October 31, 2018, 5:50 pm

    @brod, I think the thought experiment is useful in pointing out that most people will have a tipping point at which they say ‘no thanks’ to an annuity – so cost is a factor. Your rebuttal is also pertinent of course. I think many factors come into play, not least that nearly all of us in the UK will have a baseline guaranteed income from the state pension.
    @kay, without any hard numbers it’s hard to comment, but I note that both parents and in laws have a mix of guaranteed income and invested wealth – but perhaps in different amounts, both relative and absolute?

  • 67 Get Rich Brothers November 1, 2018, 2:47 am

    Annuities are a topic that remind me of home ownership vs. renting. Many people seem to have strong opinions one way or the other.
    The way I see it, it can make sense under the right set of circumstances.
    Anecdotally, I met a woman in her late 80s around ten years ago who told me she picked up her annuity in the late 1980s and which pays her 18% annually on the money she invested. Consequently, the company has lost a TON of money on her. She’s the poster-child for an “annuity gone right”.

    Thanks for the food for thought.

    Take care,
    Ryan

  • 68 James November 1, 2018, 11:40 am

    @Get rich bros
    I’m sure my grandad had something similar before he passed. Only had to draw for ten years to be in profit so must of been around 10%
    Think he had around 20 years on it. Was a smoker who worked in construction during asbestos times and took it out around retirement age (60) about 25 years ago. Probably all factors in the high payout rate?

  • 69 Factor November 1, 2018, 1:04 pm

    Retired now but during my working days I did a temporary stint for an iconic publicly-owned organisation, which took pension contributions from my salary; these were returned to me when I left because my stay was below the minimum for membership of the pension scheme. It wasn’t a king’s ransom but, “prudently”, I put this money into good old Equitable Life, and we all know what happened there!

    Writing it off to experience, I pretty much forgot about it but several years later, out of the blue, I received a cheque from the administrators of the wreckage for the greater part of what I had put in, which I then used to buy a Standard Life annuity (other providers etc.).

    Now, and it never ceases to pleasantly surprise me, I receive every quarter the princely sum of £42.95! “Every little helps …..”.

  • 70 Mark Meldon November 1, 2018, 1:08 pm

    It’s interesting that annuities are the subject of earnest discussion now that investment markets have become more volatile. Indeed, I’ve just received ‘MiFid II’ letters from Octopus regarding three IHT planning clients who each hold AIM stocks in their ISAs (if kept for 2+ years, these qualify for Business Property Relief and are thus exempt from IHT); these letters have to be issued when an investment falls by 10% or more, although quite what these clients are supposed to do with this information isn’t clear (answer = ‘nothing’).

    A few days ago, I was chatting to a fund manager (an ‘active’ fund manager, heaven forfend) about various things and my anonymous friend and I got round to the subject of pensions and risk. Pleasingly, like me, he ‘eats his own cooking’ and much of his SIPP is invested in the fund he manages (that’s so reassuring), but, the bulk of his SIPP is, in fact in lower-risk investments such as index-linked gilts and cash on deposit. He’s about 10 years or so out from the time when he thinks he might retire.

    When he does, he told me that he has absolutely no intention of doing anything other than buying an index-linked annuity with his pension fund, perhaps event using his Pension Commencement Lump Sum to do so, too, whether via a pension annuity or, more likely, a ‘purchased life annuity’. He is no hypocrite and, like many of those who understand risk, prefers not to take too much with his retirement income fund. My friend and I agreed that those who don’t really understand risk are the ones who, perhaps inadvertently, do!

    If you have a decent pension fund, I think you should concentrate of why its there; to provide an income in retirement. Forget all the nonsense about ‘inheritable pots’ – if you are really serious about handing the fund on to the next generation or two, cough up for an expensive whole of life assurance instead – and so-called ‘safe withdrawal rates’ – there aren’t any.

    Buying an annuity, and there are several options, of course, offers something that removes anxiety as you age and peace of mind is so valuable as the years roll by.

    Choosing an annuity properly is quite a task, in truth, and, although I would say this, dealing with an experienced IFA can easily pay for itself with much better rates as they will scour the market for the best deal.

    I have just sent off an annuity application to Legal & General – top dog at the moment – for a couple in their early 60s who, for various reasons, really couldn’t handle drawdown as they would lie in their beds at night staring at the ceiling worrying if markets took a tumble – and what on earth would be the point in that?

    So, remember my friend the fund manager when thinking about what to do with some, or all, of your pension fund when you are old(er) and give annuities very careful consideration!

  • 71 Factor November 1, 2018, 1:21 pm

    @MM

    Wise words indeed but they could put the cat among the Monevator-reader pigeons methinks!

  • 72 Mark Meldon November 1, 2018, 1:52 pm

    @Factor

    Thank you; you really can’t solve the ‘retirement income puzzle’ with a spreadsheet, you really can’t.

    For instance, I’m in the process of arranging a SIPP for a new client that will have a fund of about £500,000 – very nice – and the individual will take his ‘benefits’ in a month or two. He requires £2,000 a month net from the fund (so that’s £2,500 a month accounting for basic rate income tax at 20%). That £30,000 ‘required drawdown’ equates to a yield from the fund of about 6%. That’s very ambitious, in my view, but the individual concerned understands that.

    But, I always ‘park’ 2-3 years worth of the ‘required drawdown’ amount in the SIPP bank account as a kind of ‘buffer’ to try and help ride out market volatility. That might mean that £90,000 is left on deposit (earning about 0.85% gross interest), meaning that the long-term investment fund would be reduced to £410,000, thus pushing the yield requirement up to an eye-watering 7.31% or so. Yikes!

    That isn’t going to happen, period, but we might obtain a yield of, say, 3.75% on the invested fund. This would be received gross as its a pension fund. So, we might expect ‘natural income’ of, say, £15,375, assuming that the investment fund remains stable – which it won’t – if we achieve this for three years, we might expect income of about £46,125 over the period. That extends the ‘buffer’ period.

    However, if the fund fell to, say, £300,000 (I hope it doesn’t, but it might), we now need a yield of an astonishing 10% to achieve the individuals objective. Double yikes!

    Thankfully, this drawdown strategy is likely to be over a relatively short period, and the individual will very likely annuitize, in full or in part, in the not too distant future.

    We have looked carefully at the annuity market and, for various reasons, the individual has postponed that decision.

    Clearly, if the fund goes up in value, matters are rather easier but, I can tell you, ‘flexi-access drawdown’ is NOT an easy thing. In fact, it’s often described as ‘the nastiest, most difficult problem in all of personal finance’, and I completely agree with that!

  • 73 Mathmo November 1, 2018, 2:11 pm

    Wow — the Octopus AIM IHT ISA rears its head in the wild. That is some gold-plated money-doesn’t-matter, as-long-as-the-government-doesn’t-get-my-cash-I-don’t-care-who-does, product sales going on there:
    – 1% to put your money in.
    – 2.4% annual charge.
    – 1% dealing charge on every purchase or sale (estimated at 0.2% annually, plus 1% to get out).

    Estimated fees over 10 year investment — 25%. Just 19 years to get over 40% — the tax rate you’re probably trying to avoid. Cost of doing it yourself is about 4% over 10 years. You have to seriously hope you die fast if you’re buying that product. Probably of shame.

    Out of interest was that product bought or sold?

  • 74 Mark Meldon November 1, 2018, 2:35 pm

    @Mathmo

    Ouch! That was a bit harsh.

    In actual fact, the product has zero initial charge, 1.50% + VAT annual charge and 1% dealing fee, if Octopus AIM ISAs are ‘intermediated’. I don’t take fees from this kind of investment, but most IFAs do, I suppose. (Source: Key Facts document 07/2018).

  • 75 Mathmo November 1, 2018, 2:51 pm

    No harshness intended. Some people just need Lamborghinis.

    I do hope, though, that they know they are buying something that’s very very expensive when they buy it.

    With a Lambo it’s obvious. Oh but the howl of the engine. The head-turning of those you pass. You know what you’re paying for with a chunk of Italian engineering.
    Is it the same with this product? I expect they pay advisers to let them know they are getting the best of the best. After all, we all need a friend to hold our hand sometimes.

    With intermediated rates mentioned, 10 years sees 20% go in fees plus whatever the IFA charges. You get another 6 years before breakeven against HMRC.

  • 76 Mark Meldon November 1, 2018, 3:05 pm

    @Mathmo

    Sports cars are not relevant to these clients, the youngest of whom is now 92. This client’s attorney allocated £345,800 to the AIM ISA in 2016 and it now stands at £541,700. They have lived the two years and this cash is now outside their estate. There will still be an IHT liability of approximately £850,000 on death.

    Let’s draw a line under this.

  • 77 Grislybear November 1, 2018, 7:02 pm

    @ Mark Meldon, Thanks for sharing the senario about how you arranged a SIPP of £500k, interesting on the reasoning behind how you allocated the the money. Very adventurous I think.

  • 78 Mark Meldon November 2, 2018, 10:09 am

    @Grislybear

    That’s why its the ‘nastiest, most difficult, problem in personal finance’. I agree that it is adventurous, but drawdown is. The situation is made worse, much worse, by the fact that investors increasingly sense that a big correction is coming.

    Even if the ‘know’ that a crash is coming, there’s less than you might suppose that big institutional investors (like pension funds and insurance companies, for example) can do about it. They can’t just sell, because doing that in any serious size takes down the price of whatever you’re trying to offload. It may be physically impossible to ditch big holdings at any price at all, because there can’t be sales without matching purchases.

    A good analogy here might be the housing market; in the main you can only sell your house to someone who has already got one – with some 17% of the S&P 500 being owned, I read in the FT a few weeks ago, by three index funds run by Vanguard, Fidelity and Charles Schwab, just to whom, exactly can they sell?

    On a chart, a big fall might look like a line, with continuity, but there may be few, if any, trades between the top point and the bottom. The small investor can, it is true, offload a few thousand stock without pushing the price out of reach, but you can’t offload millions that way.

    As a fund manager, you are paid to be invested. If clients just want to hold cash, they don’t need a proxy to do it for them. The institutions which kept buying dotcoms back in 1999/2000 weren’t as daft as it appeared to outsiders – so long as retail investors kept buying dotcom funds, managers had to keep putting money into dotcoms, whatever their own reservations might have been.

    Even if you could pull big money out, where would you put it? Cash isn’t really an option, at todays, ‘financial repression’ rates. Remaining in equities seems the best bet, even if they fall, as I put my faith in the 4% yield from the likes of BP, BATS, et. al.

    So, I do worry about those entering into, and already in, drawdown because it won’t take much to ruin their plans. That’s why I like to see a clients ‘bottom line’ (bills, food, shelter) covered by a guaranteed income for life via (a hopefully index-linked) a conventional annuity, with drawdown being used to ‘top-up’ for one-off items or to add discretionary income into the picture.

    Everyone is different, but there are no free lunches when looking at structuring a decent retirement income profile.

  • 79 Larry November 2, 2018, 11:28 am

    @ Mark Meldon. Thanks you for a well argued and intelligent posting. I find myself agreeing with just about everything you say but surprisingly I take a very different conclusion from your arguments.
    You make a very well argued case ref your general comment: “Even if the ‘know’ that a crash is coming, there’s less than you might suppose that big institutional investors (like pension funds and insurance companies, for example) can do about it.”
    Also I can see the reason for concluding: “That’s why I like to see a clients ‘bottom line’ (bills, food, shelter) covered by a guaranteed income for life via (a hopefully index-linked) a conventional annuity, with drawdown being used to ‘top-up’ for one-off items or to add discretionary income into the picture.”

    My conclusions are almost 180 degrees opposite yours. Large financial institutions might see a disaster coming but cant do anything about it for the reasons you describe, as a small investor if I see the same disaster coming I might be able to jump out of the way. To me the one true advantage as a tiny individual investor I have over the financial industry is the ability to be agile. I CAN move into cash for 3 months if I want to, or I CAN move out of US equities into emerging market debt if it seems the right thing to do. If I buy an annuity I lose ALL this agility. Even if I see a disaster coming down the track all I can do is sit there until it hits me.
    I also strongly disagree with the concept of an annuity being a safe, no risk, investment. There is no such thing. Over my 50 year career in engineering I have come to realise that the “Zero risk option” is almost always the “hidden but significant risk you didnt see coming but it hits you anyway option” You could list a whole lot of “known” risks to annuities, even if inflation linked. A major financial disruption could destroy the industry and the supposed guarantees. High inflation, deflation, currency collapse, political change, wars, internet disruption, global hacking attacks, bank collapse etc etc etc could all sweep away your “safe” annuity overnight. “Unknown Unknowns” are also lurking!

    All these risks obviously apply equally to all financial products but if you accept these risks exist for all financial products you might as well put you money in a good investment trust because the total risk profile is probably the same if you invest in an annuity or if you decide to put your money in City Of London Investment Trust (Or PNL or RICA or CGT or whatever) . The investment trust route still leaves you with the agility to jump out of the way or change direction or take some other sort of action. The Annuity Route doesnt.

  • 80 Mark Meldon November 2, 2018, 12:00 pm

    @ Larry,

    Thank you and, perhaps oddly enough, I do agree with you when you say there are no riskless investments. I would say that annuities, despite their evident inflexibility, are about as riskless as they can be – 100% protected by the FSCS, for example. But if the FSCS ran out on money, what then? I believe its true to say that no annuity has ever failed for hundreds of years. I remember when I started out the UK Provident, a Salisbury-based life office, effectively ran out of money in, I think 1985. At the time they were substantial providers of annuities (amongst many other things). They were rescued by Friends Provident. Nowadays, that fine Quaker-founded mutual life office is part of Aviva having been sold to the latter by Sir Clive Cowdery’s Resolution Group some years back. No-one lost their annuity income.

    Annuity ‘books’ are often bought and sold (they have bond-like qualities) and firms like Rothesay Life, Canada Life and Phoenix are active in this market. No-one has lost their annuity income.

    Most of my clients who have SIPPs hold some or all of City of London, Capital Gearing, Personal Assets, Alliance Trust, Caledonia, Temple Bar, Brunner, Scottish, etc. amongst conventional closed-end funds. These are ‘dividend heroes’, according to published research from the AIC (www.theaic.co.uk). I also happen to believe that there is, perhaps, a ‘great rotation’ underway in the equity market from ‘growth stocks’ to ‘value stocks’ – though clearly I could be completely wrong about this – so many of my clients in the ‘accumulation’ stage of retirement planning hold funds like Aberforth Smaller Companies Trust, Keystone, VT Munro Smart-Beta UK ( an ‘active tracker’!) and Kennox Strategic Value to name just a few.

    I understand all of the arguments about index v active, costs, etc. but buying into a fund with decent revenue reserves, thus covering dividends for a year or two, especially where the manager(s) have ‘skin in the game’ is quite a comfort.

  • 81 Joe November 2, 2018, 5:03 pm

    @Joe – you talk about thought experiments and offer me £50 p.a. for a £1m portfolio rather than £55,000 or so that a quick search (level rate, no guarantee, single life) says I can get? About 0.1% of current) How about another thought experiment that overnight your £1m portfolio collapses to £1,000? About the same ratio. Not very useful, is it?
    =======

    Au Contraire, I’d say it is very useful. A collapse of that magnitude, assuming I didn’t put my whole SIPP into Carillion shares, would wipe out your annuity company as well (anyone remember Equitable?) plus teh worldwide financial markets.
    So we’d both be in the you know what 🙂
    Getting back to real life, I dont see how you can usefully comment on someones position regarding taking an annuity without knowing the terms they are offered and other factors such as other income, how much income they need, expected lifespan, and wish to leave money to the cats home etc. To blithely comment “why turn down an income for life” >>when you dont know what that income is, or the life will be<<, is dismissive and even mildly derogatory.
    For example your "level rate, no guarantee, single life" is no use to me whatsoever. So where you are seeing £55k as a deal , for what i want, a quick look shows joint life 50% 3% inflation linking about £28k. Half your number. And 50% joint life is rubbish, £14k is a miserable sum to live on for the survivor. Maybe this is the answer to the question posed at the start "why doesnt Jane aged 65 take an annuity" the answer is, "shes married and has dependents and survivors she'd like to live on something other than an income less than the national average wage".

  • 82 Brod November 2, 2018, 5:42 pm

    @Joe – that sort of collapse may well wipe out the Life Companies, but the annuitants with the pooled liability matched Gilts based annuities? Much less so if at all, I would think. According to Mark Meldon on the other/first annuities thread, the last time annuities didn’t pay out was when Henry VIII dissolved the monasteries. And I do remember Equitable Life. Do you remember how many annuitants got wiped out? To the nearest zero it was umm… zero. It was With-Profit Bondholders, I think, who got the haircut. (And I don’t know the legal position, but I expect annuitants be among the first creditors first in line.)

    And please, point me to where I stated £55k was a deal? It doesn’t work for you, fine. It’s your money and you can do with it as you choose. Those percentages don’t work for me either for more or less the same reasons, I was just responding to your thought experiment.

    If I have offended you, I apologize, I didn’t mean to , and certainly not to be dismissive or derogatory. Shall we agree to disagree?

    Damn – I swore of this thread!

  • 83 Richard November 4, 2018, 8:24 am

    @MM – maybe I am reading it wrong, but from your posts I take the following conclusion. Most people do not have enough money saved to get the income level they want. An annuity is not going to fix this, but it protects these clients from themselves (esp if there is a market drop).

    Drawdown does feel like a luxury. It makes sense if you can live off the interest alone, or if your pot is in excess of what you would ever need, including market drops. But then why not buy a basic living costs annuity for peace of mind…. If not, work longer, save more, cut the cloth accordingly and think about how to secure the basics.

  • 84 Mark Meldon November 5, 2018, 10:07 am

    @Richard,

    Yes, that’s along the lines of what I think, in a nutshell. Of course, it’s not just the pension fund that should be considered in isolation – the overall financial circumstances (other investments, cash to hand, debt, health/lifestyle, etc) need to be taken into account, too.

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