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!
- In reality I’d probably continue to tinker until senility sets in. But this would be the high concept. [↩]
- I know, I know, your heirs and spouse. [↩]
- 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”. [↩]
I don’t think I’ve seen your goals spelt out this clearly before. Thanks for sharing.
As it happens my goals are almost identical to yours. With the added constraint that I want to continue to live in London, making the most of its opportunities (including its airports).
In my case, I think I already have sufficient funds for most scenarios. But I’m relatively young, a lot of stuff can happen over a 30+ year timescale, and ‘being ok 19 times out of 20’ is not good enough for me. Hence I obsess.
I’d never thought of using an annuity until the excellent piece on your site by Mark Meldon. He changed my thinking and I will now actively consider one as I near conventional retirement age, God willing.
When next someone says that in retirement he’ll hold (in addition to a lump of cash) a 60:40 equities:bonds portfolio I suppose I should ask him why he doesn’t just plunk the “40” into an annuity. It would even save him from bothering with rebalancing.
Separately, a re-read of the Marvellous Mr Meldon led me to his comment #103; it turns out that a specialist annuity that might suit us very well is commercially available.
Perhaps for the first time in my life I should engage an IFA: that is the best route to buying an unusual annuity, is it?
Thanks for the links, TI. Interesting week. Loved Harford’s piece on drip feeding: challenged a few assumptions. The annuity calculation is interesting as well — the difference in the graph is the expected value of the remaining assets, and it undervalues the utility of a large wodge of cash: that can give you a bit of security in your older years: credit is not so easy and you might suddenly want to trade off future expenditure of some cash right now. Annuities aren’t really reversible, so the optionality of cash is valuable. the simple do / don’t analysis misses this.
Will you look to preserve your capital sum in real terms, TI?
@Mathmo — Glad you liked the links, the time it takes to put this together has expanded again, so good it still appeals! There’s no getting around the remaining assets argument, but regarding the cash wodge, this could to some extent be countered by only annuitizing, say, 70% of one’s portfolio, and keeping the rest in a cash/bond buffer earning 1-2%. You’d still get most of the longevity insurance and income certainty, and you have a good chunk of cash for most eventualities, albeit not all. (But who is really going to roll their retirement portfolio into say buying a winery in Australia as a retirement project five years in? Granted they might buy their kid a house.)
@dearieme — Well, you *can’t* rebalance an annuity, so you have no ability to automatically buy stocks when they’re down and your bonds are up. But again, can have a bit of both, and I agree the fixed income chunk is where to draw the allocation from.
@Fire V London — I feel you, as the modern jazz hands say. I think we both know the obsessing potentially has no limit though — only the really wealthy people I know talk in multiple currencies (or some in US dollars, but that’s because it’s still considered fungible) because they have assets all over in case this or that jurisdiction goes down. Or see Silicon Valley gazillionaires buying end of the world holdouts in New Zealand! But at some point, enough must be enough. 🙂
I’ve mixed thoughts about the RPI->CPI change for the index linked certificates.
I bought some in my youth when I was much more risk averse, and it’s been vaguely niggling that they’re a stupid thing to hold, but I’ve held on to them because you can’t get them any more, and it seemed an easy place to hold risk free cash pending an opportunity to invest it.
They at least had a degree of return above CPI so I just considered them another asset, albeit low on the risk and reward scale. I’m now wondering if the reward will be too low, even for zero risk.
Very interesting that you all nudging towards annuities. I’m heading in the opposite direction, cashing in my DB pensions. Buy low, sell high and all that.
I’ll only be interested in annuities when the (index-linked) yield exceeds my fail-safe SWR, which I calculate to be around 3.25% pa. Same goes for bonds, largely.
I think I’ll be in my seventies before that happens.
I recommend this further reading from Wade Pfau
https://www.advisorperspectives.com/articles/2015/08/04/why-bond-funds-don-t-belong-in-retirement-portfolios
..and bear in mind that a defined benefit pension is also annuity.
I don’t think I’d ever go down the annuity route. I’d like to live off dividend income alone, at some point in the distant future. Initially from individual stocks but if my brain shrinks as I get older then perhaps from a passive global 50:50 stocks/bonds portfolio.
The income from that sort of portfolio should grow faster than inflation (assuming UK inflation stays somewhere close to the 2% target), so it shouldn’t matter how long I live. If the income covers my living costs on day one then it probably will do 50 years later.
And on the topic of web bookmarks vs feeds (from your Digg link above), I still mostly use bookmarks and rss feeds so that I can control what ends up on my attention plate. The only social media I use on a regular basis is YouTube, but even that drives me crazy because of the endless junk that it ‘recommends’ to me.
I much prefer the old approach of ‘search google for something, find some useful sources of info, bookmark them and get updates from those sites only’.
Here’s an excellent Radio 4 program about the negative impact of this ‘attention economy’:
https://www.bbc.co.uk/sounds/play/b0bjp0mn
And the opening quote:
“If a time traveller from two or three decades ago were to arrive on a street corner in any modern city, what they see would surprise them utterly. Everywhere, people, in bars, in restaurants, in cars, in shops and walking around on the street, all intently starring at little glass screens in their hands”.
I feel exactly like that time traveller.
TI — I think the observation that you don’t need to go “all or nothing” on annuities is an interesting one. I intend to spend the first £0 of my pension pot on my state pension for starters. I wonder whether trickling into an annuity then provides some insurance as life goes on. I haven’t done the maths (see Bobby Seagull article in FT! — https://www.ft.com/content/f039c3ca-d762-11e8-aa22-36538487e3d0 ) — but I wonder about the “portfolio effect” of paying 10% of expenditure into an annuity each year as an investment vehicle. Intuitively, I think that the “no lump sum at the end of life” always triggers a greater income per the chart, but this site has taught me to always ask “what about fees?”, and they seem terribly opaque on annuities. I am reminded of the Octopus AIM product which promises IHT protection (save 40%! and then goes ahead and charges most of that amount). Similarly buy-to-let mortgages — mysteriously 40% more expensive than residential ones until tax relief went away. The ability of financial institutions to capture most of the reward while passing through the risk is well-established: I see the difference in the heights of the red and blue bars, but I wonder how much of that goes to the insurer. I don’t see the lack of wealth at the end.
What is the spread between an annuity and the underlying bond + insurance product? Hard to see how much the insurer is syphoning out of the pooled risk. I am reminded of Ryan Gosling in The Big Short being asked the refreshingly direct ” How are you f-ing us?” question. I know they might be — I’d just like to know how much. And in a market that’s dark, it’s hard for me to price and decide to purchase a grand of annuity every now and again. Feels painful, frictionful, irreversible and possibly expensive.
But if you know what you want to spend, and you can’t afford to do it on swr, or (better) return or (best) distributed yield, then annuities offer a way to spend capital to get the right answer.
Sorry bit of an out-loud ramble.
Like seeing the Smile link — have used for some time and signed my charity up for it. I actively try to buy on ebay (cheaper, less evil) instead of Amazon, but some residual purchases go that way, and it’s good to do some good. Oddly another charity I support and advised to do this would have nothing to do with Amazon because of their tax structure…
It also echoes an almost throw-away line in TEA’s article. Saving 1% is considerably easier than saving the capital to generate the 1% — charities can act like they have a large portfolio if they can generate reliable income streams this way, and asking supporters to click a link is easier than asking them to part with wealth.
Good to see Annuities appearing again
I did not want one in early retirement because I wanted to control my income levels so as to avoid 40% tax rates
Would Insurance company go bust?
I could do better my self even if Iwas a conservative investor with a large chunk of bonds
I think I was right-fortuitous because the stock market has been booming?
Now I am older and with a wife that has no interest in running money,tax becoming less relevant-getting slower,doing less -Annuties coming into their own as a exit investment
In fact I have told my Executors to annuitize remaining assets in Portfolio as my wife will manage quite adequately with a fixed income
If she has more than enough she can give some monies away as she sees fit
xxd09
“Here’s another crazy notion of mine – I want to be able to live off my capital.” Like you TI that’s my plan. The original plan was to go into FIRE spending 85% of my dividends, having 3 years of spending in cash and also having a healthy amount of discretionary spending in my budget for when the rough times arrive. It looks like I’ll be close to that plan as my FIRE budget would currently spend 87% of my dividends, I’ll have about 4.5 years of spending in cash post home purchase (note to self: once the home is purchased and if the market has tanked maybe put a bit more cash into the market to get a bit closer to the plan) and about 48% of my FIRE budget is discretionary spending.
To Mathmo’s point that strategy gives 0.22% of total wealth to the financial services industry annually. While not being an annuity expert I suspect that’s a lot more favourable than what the annuity industry siphons off for their yachts today. Of course I freely admit both strategies also have vastly different risk profiles as well.
Yes, I think we can be pretty confident the annuity providers are taking their toll and then some. It’s a shame none of the Fintechs have attacked this end of the market yet, from memory? Or that somebody who trades on super low-cost (Tesco or Vanguard or Stelios or whoever) hasn’t come in with a clear product that explicitly shows how the annuity is funded and discloses the fees.
If you, dear reader, know they have, let us know! (If nobody has, perhaps that’s a sign the fees aren’t too outrageous?)
Another option for uber-nerds might be to try to create your own annuity with laddered gilts tied to some kind of insurance product, maybe by laddering terms and payouts?! (Similar in spirit to my guaranteed equity bond idea back when they were still popular: http://monevator.com/guaranteed-equity-bond/)
You’d presumably just reinvent an annuity, however, and spend more time with actuaries than is healthy. (No offense to actuaries.) But at least you’d know the cost! 😉
I tried to google for the profit margins of annuity companies, but its hard to find the right terms, all I found was a Telegraph article from 2013 where Standard Life said they took 15% Which is a lot better than the 1% p/a an active fund would take.
I think 10 years civil service pension and full State pension should give me nearly all my *essential* spending, mortgage free, so for the rest I’ll stay in the markets and skip annuities
The annuity article says that it’s a puzzle that only 8% of Americans take out annuities. Accounts on whether they would prefer ‘socialized medicine’ over their current system seem mixed, but it doesn’t seem to be overwhelmingly popular like we might think it would be. Perhaps two sides of the same coin. Admittedly, upon seeing the size of incomes and expected SWR on US FIRE sites, I at least console myself with the different healthcare regimes.
It never occurred to me before: I should ask my resident life actuary if he intends to convert his DC pension to an annuity (although as mentioned earlier, a small DB pension effectively provides the same function).
Was it you, TI, who applied the first law of thermodynamics to investment risk? I.e. total market risk is constant; it can be transformed from one form to another, but can be neither created nor destroyed.
I think an annuity transforms interest rate risk, exchange rate risk, and credit risk of multiple bond issuers into credit risk of the annuity provider.
“The ability of financial institutions to capture most of the reward while passing through the risk is well-established: I see the difference in the heights of the red and blue bars, but I wonder how much of that goes to the insurer.” Because insurer after insurer has given up the annuity market I’d think there’s a fair chance that it’s not particularly profitable.
If you read MSE you see that Derek Dimwit asserts that all the money he won’t get if he dies early will go to the vile company. Whereas Ronald Reflective sees that it must mainly go to the annuitants who outlive their life expectancies.
Until a Budget changes things (this Monday?) a natural age to buy an annuity with a pension fund might be 75, because your ability to leave your unused DC pension money on preposterously wonderful terms ends at 75.
I believe it was, despite someone else touting it as theirs in the last couple of years… 🙂
http://monevator.com/the-first-law-of-thermodynamics-and-investing-risk/
The idea that annuites are a cash cow for the financial services simply isn’t supported by the numbers. For a 55-year old, a single life, RPI-linked, the annuity yield is 2.05% with joint-life around 25bp lower. Now please tell me how you are going to outperform that using the replicating hedges: fixed-rate and inflation-linked gilts. The 10-year, 30-year and 50-year Gilt yields are at 1.35%, 1.85% and 1.79%, respectively; all lower than the annuity yield. You are getting a higher yield on the annuity due to the mortality pooling impact. You can see that impact from the fact that between 55 and 65, the annuity yield jumps 120bp and between 65 and 75, another 180bp.
2.05% — to use up all my wealth over my residual life — guaranteed.
x% — safe withdrawal rate to leave a non-zero and quite probably large amount of my wealth at end of life. 55 yo.
Is x more or less that 2.05%? Intuitively I think more. Not fair because one is guaranteed and the other is gilts? Why would an insurer build this product purely out of gilts? Are they required to do so by law and hold no equities? And in any case, with a gilt, I get the (inflation-eroded) capital back at the end, with an annuity I do not. That’s presumably worth 1/(years remaining) on the yield — call it 250bp: if your 55yo makes it to 90 he’s doing well.
I like the back of the envelope as much as anyone, but it does seem there’s quite a bit of spread between guessing one way and the other. I’ll ask a few actuaries friends when I next meet up but I can’t guarantee that I’ll stay awake for the full answer…
I suspect the reason fintech finds this hard to do is that it is a contract that requires considerable trust on the buyer’s part: I need to believe that the insurer will exist and pay out of that the government will step in and cover the payments. Fintech startups will find it hard to make those guarantees. I also suspect it’s got a lot less fun since it was a compulsory use of funds on retirement so the customers didn’t have any choice about buying. That would have made even the most saintly insurer wonder about taking a little more cheese out of the sandwich.
Insurers need to make money. I do not begrudge them their profits. Insurance gives peace of mind and that is valuable. However with a complicated irreversible trade I’d like more clarity going in. If I’m going to be a pensioner “buying a Lambo”, I’d like it to be the most expensive car money can buy rather than the most expensive peace of mind that money can buy.
Did anyone actually read the assumptions in the Elm Funds article ?
It’s assuming zero returns on using the cash pot ……ie spread a $1,000,000 over 50 years, by reducing the income taken each year, as the self insurance, ie the fear of living a bit longer.
Given the US article , then using a self managed level annuity, over 40 years (to age 105) would give $46,000 P.A. as against the quoted annuity rate of $50,000 P.A.
I’m assuming that the self investor invests in 20 year US treasuries. Add a small stock allocation, then the self invested investor would be highly likely to do better.
My own experience since retirement (49 years old) 11 years ago , was that a flat annuity offered an adequate income, about the same as my then Equity Income portfolio.
Now clearly late 2007 was a sub optimal time to retire with a 95% equity portfolio….. sequence of returns risk ….
The annuity income had I gone down that route would have been adequate but not generous now.
The equity approach is providing twice as high an income in real terms, unlike a flat annuity and is is based on a 3.3% yield. ( room to lift income if need be)
The freedom of having the capital has allowed me to buy a few houses for a modest turn, assist family etc
Take off for 3 months to South America earlier this year. Etc
Having the capital is good, it’s liberating.
I always thought having some money in index linked annuities is a good idea however I think the older you are the more they make sense. For a 75 year old male the payout is 5% linked to RPI , in my opinion for a part of your portfolio its a very good option.
@mathmo, under the FSCS payments under a lifetime annuity are 100% guaranteed by the govnt – so there is no credit risk. Unless the rules change of course, but I’d think that unlikely.
There is always the unmentionable government paid annuity available to those in their 60’s. I like RIT don’t count on it but for a married couple at full whack the state pension pays well and it’s something to remember as a UK investor – other countries have their own schemes of course.
I do wonder if there’s an inverse correlation between approach to annuities and distance from retirement. With six months to go, having a guaranteed income floor seems eminently sensible to me!
@2019er – I also suspect there’s an inverse relationship between 10 year bull markets and annuities.
Personally, I’m annuitized via the Civil Service pension route. An £8k state pension and another £5k CS Pension should cover the basics nicely with some (all!) inflation proofing.
My wife’s 15 years younger than me so I think I need to be invested as long as possible.
@brod, 2019er – I’m seven years into retirement and still moving away from annuities.
The inverse relationship is with interest rates, not bull markets or distance to retirement.
There’s also an inverse relationship with risk tolerance. Annuities make most people poorer, but offer certainty. Some people prefer optionality over certainty, especially when (as now) the price is right.
Conscious this isn’t a book club, but thought I’d add the below book to the weekly Kindle Bargains. A fascinating account of WW2 leadership and bravery, especially insightful if you enjoyed the Band Of Brothers TV program. Bargain at £0.99
https://www.amazon.co.uk/Band-Brothers-Stephen-Ambrose-ebook/dp/B00AHEKXBK
When I crystallized my SIPP, shortly after my 55th birthday, I asked Hargreaves Lansdown for a joint life indexed linked annuity quote. I then built a 45 year indexed linked gilt ladder in a spreadsheet designed to roughly match an index linked annuity using issued index linked gilts. A very tedious trial and error process for which I am sure there must be tools to do automatically, but could not find any. Anyway, the result was that the 45 year gilt ladder in my SIPP would deliver a slightly better return than my joint life annuity quote, albeit in a more lumpy way due to there only being at most one maturity per year.
The sole advantage I can think of with the annuity is that it would extend beyond the age of 100 should my wife or I survive that long. The disadvantages have already been mentioned, essentially your capital and flexibility is gone. Also, should I die before I am 75, my wife’s subsequent withdrawals from my SIPP would be tax free.
On the whole, the annuity seemed very poor value for money and leaves me with the impression that annuity providers’ costs were unreasonably high. Maybe annuities are better value in the USA than they are in the UK.
I am not opposed to annuities and will obtain quotes again at some point. Maybe after 75 they might be worthwhile. Meanwhile I would be interested if anyone can point me in the direction of some software that would automatically calculate the required weights of a gilt ladder to provide a level(ish) income.
I understand that purchased life annuities are even worse value that pension annuities, although there is less income tax to pay on them as part of the return is considered to come from return of capital.
I havent posted here before but this idea about annuities made me think. I had been wondering about getting an annuity (Im 65). Having looked into it I had the same problem as others in trying to figure out if it was good value and how much was the insurance company taking in fees.
I just ran a set of figures through my old trusty HP 12C financial calculator using the time value of money function. If you assume £100,000 as the initial amount and look up the current annuity tables for a 65 year old single standard rate level basis no guarantee you get £5,520 per year. I put this in the 12 c as follows: Present value £100,000, Future Value £0 ( as the annuity is zero value when you die!) Payment -£5520. And the number of payments as 19 ( average approx life expectancy for a 65 year), I then asked the calc to determine the annual interest rate and it came out with 0.48%! I then changed the life expectancy to 30 years and the annual interest rate came out at 3.62%. At 40 years the annual interest rate came out at 4.61%
What I take from this is the the insurance company is taking a huge wack. If the average life expectancy of a 65 year old is 19 years (which it appears to be) then the insurance company only has to earn about 0.5% interest on its annuity deposits take from a large number of people to break even. As the 20 year UK gilt yield is about 1.8% the average annuity will leave a residue of over £16,000 for the insurance company after the death of the average client 19 years after taking out the annuity (assuming they invest everything in Gilts, which I bet they don’t!).
My conclusion is that its terrible value for money, your much better off with a sipp invested in something relatively safe and conservative like Personal Assets Trust which might give you 4 to 5 % PA annual growth over 19 years. By my calculations you run out of money after 33 years at 4% annual growth if you withdraw £5520 per year from an initial deposit of £100000 (same basis as the annuity calculation) and run out of money after 46 years if you get 5% growth PA. At 6% growth you never run out of money!
I would be interested in anyones thoughts on my calculations.
I have some of your characteristics. I have tended to live in an outwardly modest way, with faded clothes, little interest in renewing kitchens and none in keeping up with peers. My only small observable signs of wealth are my sportscar and my boat, both of which are genuine sources of enjoyment, not status symbols. This approach goes back to university where I became an admirer of the Stoics and developed a dislike for flashy behaviour as ungentlemanly and a sign of inner worthlessness.
And so, my portfolio is unlikely to be seriously leant upon for day-to-day living. I get pleasure from managing it and seeing how it goes. And I like the idea that when I fade away, it will pass as a benefit to my nearest and dearest (I disapprove of the concept of redistributive taxation and as structured little if anything will go to the State).
@Hospitaller — Afternoon!
Hah, if you’re going to break from the pattern, why not do so in style eh? Puts my indulgent supermarket shopping into perspective for me. 😉
I should note perhaps that I’m currently playing against type myself, in that I bought this
follyflat and am still furnishing it — at task that seems to me both expensive and repeatedly disappointing.As someone who didn’t spend a lot of money, I had this fanciful notion that when one did things would work, stuff wouldn’t come broken, life might be less hassle. As my 30-something self would have warned me, if anything the opposite is true!
Still, it all looks pretty and is jolly comfy, so that’s something.
@Larry. The problem with your calculation is that you have not constructed a replicating cashflow hedge. If we take your example of someone who has £100k to invest in a level annuity at 5.52% (for £5520/annum). We’ll ignore the issues around Bayesian statistics and imagine everyone dies exactly 20 years later. The problem is the life assurance company cannot simply buy 20-year gilts at 1.77% to hedge that. In year one they would need to pay out £5520 but the gilt interest would be only £1770, leaving them needing to sell £3750 of the 20-year gilt to fund the cashflow difference. Those Gilts carry price (and yield risk) so they might be forced to sell those gilts at a poor price, locking in a loss.
Instead, to hedge the annuity cashflow and replicate the position without any price risk, the life assurer will need to buy a bond ladder with maturities from 1 to 20 years (with yields from 0.72% to 1.77%). They can calculate the required amounts using a ‘reverse bootstrap’. In year 20 they need to generate £5520, so given the yield on the 20-year gilt is 1.77%, they need to buy £5424 of that gilt (so that the redemption + interest is £5520). For year 19, they need to generate £5520 again, but the 20-year Gilt will give them £96 of interest so that leaves £5432 of cashflow to be generated from a 19-year Gilt with yield 1.72%. So they buy £5332 of that Gilt. This continues until year 1 where they find they need to buy £4265 of a 1-year Gilt with yield 0.72%. At this point they are cashflow hedged for each year.
Now based on the current par Gilt curve, the total amount of Gilts needed to be bought to hedge a £100k annuity at 5.52% is around £94,878. So that leaves them a profit of £5122 upfront. Amortize that over 20-years and it’s around 26bp running.
@ The Investor
Good afternoon to you, also. I see your comment and smile – but in truth I am, I suspect, more towards the end of days than you. And so, perhaps you too in your time will one day hurtle along with a howling engine, imagining you are Ascari, Farina, Fangio etc., up on the Monza banking. And I hope you do – for it is really great fun.
I find the annuity debate fascinating. I agree that costs are opaque, and more transparency to aid comparison would I think help enormously. I suspect however that the margin is not huge, given the number of providers who have exited the market since the pensions freedoms came in. Will it be a case of ‘you don’t know what you’ve got till it’s gone’?
I also find myself wondering whether these two statements can simultaneously be true:
1. There is such a large profit margin on annuities that it is easy for a retail investor to replicate similarly (ie self insure against longevity risk)
2. Defined benefit pensions are so expensive that huge blue chip companies can’t afford to pay out the promises they have made.
For myself, it’s hard to say what my attitude to annuities is because I have a large DB pension in hand. I can’t really imagine how I would feel without it – but probably a lot more stressed about retirement. That said, I am not sure whether I would pay over that amount of capital to buy the pension if I didn’t already have it. It would be a painful and agonising decision that’s for sure, so I’m relieved the choice is out of my hands.
I think there is a lot to be said for having a secured income covering your essentials. I also feel many of us underestimate the need for simplicity in later life – having steered one parent through declining cognitive function, I know how hard it can be to track down complex arrangements with multiple accounts, and what a blessing it is just to have a pension coming in that covers everything that is needed.
Sorry, just not able to hand over hundreds of thousands of pounds to a company in return for a future promise, no matter what the maths say, even at the risk of drinking my own urine in my dotage, or worse yet, staying at home and having to eat the wife’s cooking. Psychology eh?
@ZXSpectrum48k. Thanks for your response. I hadnt considered the cash flow requirements of an annuity from the insurance companies perspective. I will have to revisit my analysis based on your comments. Your comment “the issues around Bayesian statistics” intrigued me so I looked it up on Google. I did statistics and probablility theory in Uni in the early 70s but Beyesian theory wasnt even mentioned ( an engineering course, we were concerned with 100 year flood probabilities for Dam design and hydrodynamics ). It seems worthy of further study as it looks interesting!
Its amazing how complex pensions are becoming these days.
I can see the attraction of annuities as a simple guaranteed income for life. On the other hand Annuity income seems at risk from a surge in inflation over the next 20 years and I do wonder if the insurance companies and Government guarantees are as safe as claimed.
On the whole I think Ill stick with my SIPP for the moment but might consider using part of it to fund an annuity in the future, especially if interest rates rise.
One final thought…lots of talk about wealth taxes these days, if some such was introduced would annuities be included in our “wealth”? You might end up in a situation where annuities were not included (because its essentially an insurance product with no realisable capital value) but SIPPs were (because its clearly defined assets in a tax wrapper). That would change things I think!
@Mike Rawson – really? Oh shi*t, markets are down 20% (and I’ve taken 3% income of my starting capital, so that’s 23%), buying opportunity! Oh God, another 15% this year (and still withdrew my 3% of starting capital so I’m about 42% down!!!!) Phew, only 5% down this year, tightened the belt a lot and withdrew just 2% of the original starting capital so down 50%. Only need 110% return over the next few years (while taking my 2 or 3%) too see me through…
At the risk of repeating myself, (I made a similar comment back in May 18 after Mark Meldon’s excellent article on annuities).
IMHO the great disadvantage of purchasing an annuity is that although it turns ready cash into a future, secure cash flow, that ready cash has now irrevocably gone; in the event that either you or your partner are diagnosed with a terminal or totally life debilitating illness, then there is no opportunity to use that cash to, in some way, ameliorate the affects of that condition.
Perhaps private nursing, a world cruise or, well, whatever.
What is the value of a steady income cheque if there is no way of spending it, and it will finish when the inevitable happens?
Anybody who has experienced a major medical event in their lives might understand where I am coming from.
@Brod
My experience was retiring in late 2007 was a near 50% drawdown in less than 18 months.
Good thing I stayed invested , subsequent returns have been excellent. Heavy falls bring outstanding opportunities.
The game isn’t over until it ends but it looks very promising.
Clearly there are many ways to fund retirement and I think my approach would be totally wrong for most people, it just so happens to suit me.
The majority of the population has no interest in personal finance and an annuity is ideal for them, if they had an adequately funded pension in the first place.
A relative has a great traditional, full rpi index linked pension, which suits his temperament perfectly. 10 years ago his income was 25% higher than mine and now mine is 100% higher than his, but he has certainly and I do not.
The cost of his RPI pension now at his retirement age then, is well over £2,000,000
Not many people at 52 will have saved over £2m and retiring early with such a pension is rare.
I hope that it might be possible in future for companies (or even government) to offer a group annuity structure, with perhaps less certainty and able to use a wider range of assets, pooling risks by adding more pensioners over time. An updated version of the With Profits concept.
I can’t see the present system of pensioners with maturing Defined Contribution pensions lasting the test of time.
@zxspectrum — thanks for doing that calculation on the gilt ladder equivalent. I guess we should think of that as the alternative for the investor to buying the annuity (and losing out on the pooled risk), rather than the cost base for the insurer who presumably entertains more risk in his portfolio than a gilt ladder.
Indeed we can take this as several steps:-
1. Investor sets-up gilt ladder (gets 20 year product)
2. Investor sets up a mutual society with other gilt ladder owners to pool their risk.
3. Society buys cashflow from the insurer instead of setting up own gilt ladders.
4. Insurer finances the cashflow requirement with equity / bond mix.
You’ve identified the cost of 1. We can assume 2 is costless as the risk balances across the pool (not sure we need Rev Bayes to get involved anywhere). The gross profit of the transaction in 3 is 5.52%. Some profit is available in 4, subject to insurer accepting some risk and the regulator allowing them to accept it.
I’m not sure you get to divide the gross margin over the life of the product for an annual charge. The work is done in creating the ladder on day one. The rest of the work is done by HMG. But it certainly goes some way towards explaining the cost of the product, and also provides a reliable, independent way of assessing the insurer mark-up on the alternative. To be honest, I’d much prefer they presented it as a 5.5% cost on top of the gilt ladder equivalent, rather than a blackbox cost.
In this I notice everyone is looking up annuity rates. Where do I see a reliable source of those? Why doesn’t it compare that to the gilt ladder equivalent if that is a well-known and established benchmark?
“Why doesn’t it compare that to the gilt ladder equivalent …?” But the gilt ladder isn’t an equivalent to a life annuity – it’s an equivalent to a temporary annuity. A life annuity will run on and on until you die (or in Japan, apparently, until your children confess that you died some years earlier), not stop when you reach whatever “should” have been your life expectancy when you bought the annuity.
Moreover, there’s a selection effect: the average 65 year old annuity buyer will outlive the average 65 year old citizen because it’s people who are confident in their own health who have the greatest incentive to buy annuities. (That probably applies even within subgroups such as those who have had heart attacks and therefore qualify for larger annuities per £ spent.)
@brod – I think you may have misunderstood – the price of selling annuities / DB pensions is right (low interest rates = high cash values).
It’s always a good time to buy stocks.
@Mike Rawson – no Mike, I understand perfectly. I also understand that we’re talking about different things. I’m talking about people’s over-confidence in a bull market that’s very long in the tooth. I’m talking about Jack Bogle making a case that market returns might be 2% p.a. real over the next decade. I’m talking about diversifying risk away from stock market returns.
And Mike Rawson, “the price of selling annuities / DB pensions is right” – no, it’s not. That’s just your opinion. (And by the by, share prices are rather rich too. IMHO, of course.)
@ Hari Seldon – yes, I think many of us did well out of 2018 as we stayed invested. I also did very well out of Brexit. Am I patting myself on the back about my great judgement? No, I was lucky as I was out of the market in 2008 changing SIPP providers and couldn’t do it in specie. I can’t imagine what it must have felt like to those, like you, who had just retired.
But (in retrospect!!!) 2008 was a short, sharp crisis that was mitigated by concerted action by central banks pumping gazzillions of dollars into the market. Those gazzillions are still in there, so I’m not sure we’ve worked off our hangover yet. I’m more talking about a scenario of a decade plus of low growth, slowly deflating asset values WHILE withdrawing 3% or 4% per annum as a pension and potentially seeing your pot shrinking much quicker than you had envisioned. Think 1970s slow grind. We know 2008 turned out OK (to date!) because it’s in the past. For me, the killer is you can’t predict the future, so you can never know how it will turn out when you’re in the middle of it.
@Brod – Of course, everything expressed as a blog comment is in a sense an opinion.
I look forward to your case for keeping a DB pension when you are offered 40 times its annual value as cash.
Thanks ZX for the math and excellent concise explanation. I’d thought about wading in, but am very pleased you did so (in a far superior way to what I could hope to have done).
I’d like to add that I personally feel annuities should be less seen as an investment product and more so as an insurance product. The key being they insure you against unknowable longevity risk. As dearieme says, a life annuity doesn’t stop when you read your ‘life expectancy’, it keeps running to death. In a way, it’s an also an insurance for compos mentis. The idea of a gilt ladder is seductive today. Would it still be so when you are 85?
@Mathmo – Not to be flippant, but isn’t the process you describe literally how friendly societies started?
To answer your question, there are various places one can find some annuity rates. HL post some rates. There’s also Sharing Pensions and Moneyfacts. The Money Advice Service also has an easy to use online annuity quoter.
Good chat. I liked hospitaler’s references to his stoic outlook and boat/sports car ownership in adjacent sentences!
Inflation linked annuities don’t make me feel safe against hyper inflation because (even if there’s no RPI cap) the insurance company/ currency would likely go under in an uncontrolled manner.
@TI, could we please have an article about your house purchase? I guess it’s hard to write but many of us are thinking about it and It’s the biggest investment we’ll ever make (like it or not).
@Mike Rawson- simples, I already have 60 times my likely terminal DB in cash. Well, mainly equities and a little short-term gilts and gold. As I said earlier, I’m diversifying away from market returns.
Between my state pension and my small CS pension (I’ve only been in the CS for 4 years) I’ll have enough to cover my basics – food, heating, housing maintenance, Crystal Palace season ticket and wine. I’ll be able to sleep at night knowing my wife and I won’t be huddled round a candle for warmth.
My SIPP, the bulk, will provide the extras when appropriate – which I imagine will basically be travel – and can be allowed to grow without serious withdrawals so my to-be-widow can receive maximum benefit.
Like The Details Man says above – I’m insuring against longevity risk. And in my case multi-decade market stagnation, which is important to me as my wife is 15 years younger than me (though she has her own job, savings and pension.) In my case, not sure how realistic longevity risk is, but you never know.
This strategy allows me to be 88% in equities and not stressed about the “imminent equity crash” despite planning on starting my path into stay-at-home Dad next summer and completing in eighteen months when I’m 55 and can buy my Lamborghini.
There, the world according to Brod.
Oh, and by the way, if DBs are such a bad deal, why are companies throwing all this lovely cash around trying to buy people out?
@Larry, I have been through the tedious process of building a gilt ladder to provide a £100/month level annuity for the next 19 years using the following gilts
1¾% Treasury Gilt 2037
4¼% Treasury Stock 2036
4½% Treasury Gilt 2034
4¼% Treasury Stock 2032
4¾% Treasury Gilt 2030
6% Treasury Stock 2028
4¼% Treasury Gilt 2027
1½% Treasury Gilt 2026
2% Treasury Gilt 2025
2¾% Treasury Gilt 2024
2¼% Treasury Gilt 2023
1¾% Treasury Gilt 2022
3¾% Treasury Gilt 2021
3¾% Treasury Gilt 2020
3¾% Treasury Gilt 2019
You also need cash of £542.70 to help cover the period up until the first gilt maturity, in Sep 2019. Using dirty prices as of 25 October, the ladder would cost £19,340 + £542.70 upfront cash. I have assumed zero interest on the cash buffer held to provide the monthly income stream. Scaling that to £5,520 per year implies a cost of £91,460. In other words if the insurance company built that ladder with £100,000 they would have a profit of £8,540, or 8.5%.
In reality annuity providers would not build a gilt ladder to match cashflows like that. Instead they use a process called duration matching on their entire annuity portfolio, which is cheaper but probably not a whole lot cheaper, so the profit per annuity is likely a bit higher than 8.5%.
8.5% to cover all the running costs and risks actually seems fairly reasonable to me. When I did this before for a joint life index linked annuity from age 55, I did not calculate a profit but I matched the annuity with a 45 year index linked gilt ladder. In that case the gilt ladder seemed a better way to go to me, if I wanted it. It clearly would not be for this level annuity as a DIY gilt ladder would probably only get you to about 21 years.
@Naeclue
Gosh, pass the paracetamol!
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).
“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.
@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?
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.
@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.
@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.
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
@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.
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.
@`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.
@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 🙂
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. 🙂
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.
@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.
@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?
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
@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?
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 …..”.
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!
@MM
Wise words indeed but they could put the cat among the Monevator-reader pigeons methinks!
@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!
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?
@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).
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.
@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.
@ 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.
@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.
@ 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.
@ 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.
@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".
@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!
@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.
@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.