What caught my eye this week.
You don’t need to commission a full-on report to know that we all have wildly different ideas about money – and about how much of it is, well, a lot.
And you don’t need to be a dedicated peruser of the personal finance Internet to know the rule is that the more money you have, the higher you set your number 11 on the That’s A Lot Of Money dial, either.
Just witness the regular handbags swinging on Reddit – quite possibly over the price of a handbag – or even the more respectful differences of opinion that follow some of our FIRE-side chats.
One person’s obliviously rich princeling is another’s squeezed middle striver.
But my job isn’t just to ponder the nature of these eternal tugs-of-war.
No, I’m here to introduce the latest one…
This time it comes courtesy of HSBC, whose new Wealth Report was covered this week by This Is Money:
Nine in 10 Britons earning £100,000 or more a year before deductions do not view themselves as wealthy, despite being in the top 4% of earners, new data claims.
On average, most Britons think an individual needs to rake in £213,000 a year before they can be considered wealthy, according to HSBC Premier’s new research.
At over £200,000, the sum most people view as the wealth threshold is over six times the national average annual salary.
Read the rest of the article to spot all your favourite features of the genre!
There’s the map of Great Britain showing how out of touch London is. The claim that Gen Z cares more about buzz than bonuses. And the must-have interview with an obviously rich person who splits her time between the UK and the US but who’s unfortunately benchmarking herself against peers earning millions, and so she feels a little brassic.
Tax twister
Okay, we all understand this.
Money is relative. Taxes eat very nearly half of seemingly vast salaries. A two-bed flat in Zone Two costs £1 million. And won’t anybody think of the school fees?
A more novel twist comes though when you pair this discussion with new research about high-earners’ attitude to taxes. Or how “we all deserve to be rich”, as Joachim Klement put it on his blog this week.
Again it’s no surprise to read how the research found that people who believe their good fortune is down to their skill or effort will then favour lower taxes on the proceeds.
I’ve thought that at times myself, and most of you will have too.
But as Klement explains, researchers at the University of Warwick also showed that even people who derive their winnings entirely from luck will call for lower taxes, compared to those who won nothing.
You can see this effect in the following chart, although it’ll possibly only make sense if you read the full article:
The bottom line is people who have a lot of money don’t want it taken off them, while those who don’t have the money think more of it should be.
Again, hardly rocket science. But I suppose there are only so many well-paid jobs for rocket scientists?
Keeping up with the Jones’ parents
Now I’m not sharing these thoughts because I think £100,000 a year is a vast fortune. Nor am I calling for another round of tax hikes.
If anything I believe that after many years of real terms wage stagnation, the UK has a poverty of ambition about what constitutes a very high salary – certainly versus our US peers.
And as for taxes, the national take approaching a post-war high seems like a pretty good place to say enough is enough, and that perhaps we need to draw a line in the sand and to try something different from here.
However it does all serve as yet another reminder as to how and why it’s so hard to talk to each other about all this. Let alone to reach a political consensus.
Entrenching wealth inequality will only make it worse.
I’ve been warning for years of the increasing risk of what I call ‘neo-feudalism’. It’s one reason why I favour high inheritance taxes.
Meanwhile an article in The Standard this week argues that London has become an ‘inheritocracy’.
The author concludes:
The major frustration in all this is that our 21st-century inheritocracy contradicts everything we were told: work hard, get good grades, land a solid job, and success will follow.
But that promise has crumbled.
Wages don’t keep up, work doesn’t pay, and in London, opportunity is inherited, not earned.
Leaving the city feels like failure, but the real failure is a system where talent loses out to wealth and good fortune.
Have a great weekend.
From Monevator
Which asset classes beat inflation after the pandemic? – Monevator
Infrastructure [A few weeks old, Moguls follow-up imminent!] – Monevator [Members]
From the archive-ator: Bring me sunshine [Covid hits in 2020] – Monevator
News
Note: Some links are Google search results – in PC/desktop view click through to read the article. Try privacy/incognito mode to avoid cookies. Consider subscribing to sites you visit a lot.
Complaints about leasehold homes rise by 67% – Which
The UK’s net zero push is driving growth, finds CBI report – Morningstar
LSE boss says UK needs to change ‘perverse’ view on retail investment – CityAM
UK house prices rise more than expected in February… – Reuters
…as price gap between houses and flats hits 30-year high – This Is Money
National Grid sells US renewables to Brookfield for $1.7bn – Bloomberg via F.P.
A billion Indians have no spending money – BBC
The true streaming battle is between YouTube and Netflix – Sherwood
Products and services
New TIPS ETF solves inflation hedging. Gilt version to follow? – FT
Energy price cap increases by 6.4% in April – Be Clever With Your Cash
How furniture flippers turn trash into treasure – Guardian
Get up to £1,500 cashback when you transfer your cash and/or investments through this link. Terms apply – Charles Stanley
Cash ISA providers fail to support new flexible rules – Guardian
How to get a free will in March – Which
VCTs have little reason to celebrate turning 30 [Search result] – FT
Get up to £4,000 when you transfer your ISA to InvestEngine our link. (Minimum deposit of £100, other T&Cs apply. Capital at risk) – InvestEngine
Few will qualify for HSBC’s new 3.98% fixed-rate mortgage – This Is Money
Brutalist and modernist homes for sale, in pictures – Guardian
Comment and opinion
Wow, have you seen the stock market lately? – Mr Money Mustache
Buy-to-let: RIP – Fire V London
How should your asset allocation change with age? – Of Dollars and Data
It’s five years since Covid came out of the left field – Humble Dollar
Swedroe: all risk assets experience long periods of poor performance – W.M.
“I’m 68 and I just spent £189,000 on an annuity” – This Is Money
Norway’s sovereign wealth fund should be open to everyone – FT
Trust in a black hat world [On U.S. deregulation but relevant] – Dave Nadig
A money psychologist on how rich people can feel wealthier – This Is Money
Micro-retirements: Gen Z’s brilliant fix for burnout – Guardian
Investing like an endowment mini-special
Can we all invest like Yale? [PDF] – Cambria
…maybe, but the high fees on alts mean we shouldn’t [Research] – SSRN
Naughty corner: Active antics
The inevitable capital cycle – Flyover Stocks
Probabilities and payoffs [Research, PDF] – Morgan Stanley
Warren Buffett’s annual letter to shareholders… – Berkshire Hathaway
…and how Berkshire might change after Buffett – Rational Walk
The 15 most value-destroying stocks of the past decade – Morningstar
Kindle book bargains
Poor Charlie’s Almanack by Charlie Munger – £0.99 on Kindle
How to Run Britain by Robert Peston and Kishan Koria – £0.99 on Kindle
Invisible Women by Caroline Criado Perez – £0.99 on Kindle
Chip War by Chris Miller – £1.99 on Kindle
Environmental factors
A climate solution on the half shell – Noema
One tiny island is redefining travel to Thailand – BBC
Battery storage: a quiet revolution in energy industry [Search result] – FT
The elegant math model that could help rescue coral reefs – Quanta
Total collapse of Atlantic currents unlikely this century, FWIW – Guardian
Robot overlord roundup
Y Combinator deletes posts after A.I. startup’s demo goes viral – TechCrunch
Amazon’s souped-up Alexa+ arrives next month – Wired
The new aesthetics of Slop – The Honest Broker
Not at the dinner table
This has never happened with an American president before – New York Times
Tories discover that Britain is located in Europe [Search result] – FT
The case for DOGE… – We’re Gonna Get Those Bastards
…and the case against – Culture Study
How to buy your way out of a Federal lawsuit – Popular Information
Consumers shun companies whose bosses kowtow to Trump – Guardian
Off our beat
Rare frescoes unearthed in Pompeii shed light on ancient rituals – Reuters
What we learned from ‘that dress’, ten years on – Slate
There’s a small chance asteroid YR4 might hit Earth in 2032 – The Conversation
Seeing foreign languages: how synaesthesia can help language learning – BBC
How many episodes should you watch before quitting a TV show? – Stat Significant
The Murdochs x Succession – SatPost
What’s it all about? – Humble Dollar
And finally…
“A capitalist economy cannot be maintained, however, if it oscillates between threats of an imminent collapse of asset values and employment and threats of accelerating inflation and rampant speculation, especially if the threats are sometimes realised.”
– Hyman Minksy, Stabilizing an Unstable Economy
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Annuities: I see the point of the level annuity and the RPI-linked annuity. I’m sceptical of the merits of the annuity that “escalates” at a fixed % per annum.
I can see some attraction, for some people, of a with-profits annuity but that could also be a with-losses annuity. Equitable Life!
@dearieme — Yes, the 3% escalator annuity seems a bit of a pointless in-the-middle product to me, too, given the whole point about future inflation is that it’s uncertain.
You’re basically just giving them more money upfront only for them to give it back to you over time at an escalating rate, and you’re not protected from the inflation spikes like we saw in 2022/2023 at all.
I don’t mind paying high taxes but it’s the sneaky ones that infuriate me. Mainly the 67.5% income cliff at 100 – 125k in Scotland if you’re ignorant or desperate enough not to be able to pay it into a SIPP. Also the loss of child benefit, free child care and loss of benefits if working more than 16 hours at the lower end. If you make it complicated, smart people will just play the game.
Great discussion points here
I don’t think inheritance tax will do the equality “thing” as much as is thought
The “rich” will always find their way round any human construct because they are as clever if not cleverer than those who construct the financial hurdles
What society should do is cut loose those fortunate few with superior drive ,egos,and genes etc while at the same time installing a sense of community and social responsibility in the well off for those less well endowed and less fortunate
I think by and large in Western societies our better off do indeed shoulder most of the tax burden without debate- very unlike in most societies in the rest of the world -any world traveler will notice this obvious factual difference between the West and the rest
However if you overly constrict your wealth creators/buisnessmen you run the risk of killing the growth engine -too few equities and too many bonds?
The rich may move because they can and that’s not a long term endurable scenario for our society
Perhaps we are now approaching an over taxing situation and sadly serious rearmament with all its costs seems a certainty
Something will have to give -probably we will all get poorer for a while -hopefully not
Free societies have a lot of resilience which often manifests itself at its best when under serious pressure
Tough times indeed
xxd09
There’s a hoot of an article in this morning’s paper copy of the Telegraph. Chap earns £178k as a contractor, wife also on high City income. Money, though, is tight. He virtue-signals that they don’t use private schools and then admits to using private tutors – a touch of the Toniblair’s there.
He contributes to JISAs while still carrying credit card debt – sounds loony to me. He spaffs £3 or more on coffee several times a day and – here I admit I nearly sobbed – the poor bugger eats chicken four times a week.
@TI (2) @dearieme (1)
I don’t think a 3% escalating annuity is quite as pointless as you both imply. Inflation protection via an RPI-linked annuity is very expensive. If you are not prepared to pay for this, and regard 3% as a reasonable long-term estimate of inflation, what other possibilities are there for a secure income that makes some attempt to keep up with inflation and also provides longevity protection?
We had an extensive discussion on this in the comments on TA’s article “How to buy index-linked gilts” of 8 Oct 2024. I mused that a possible alternative to an RPI or fixed-escalation annuity was phased annuitisation with level annuities. After presenting results of several other analyses in earlier comments, I provided results for phased annuitisation vs 3% fixed escalation in my comment #126. My conclusion was phased annuitisation provided slightly better value than fixed escalation, but introduced the added risk of future annuity rates deteriorating and the remaining fund growing insufficiently.
@dearieme & The Investor
A few years ago I opted for an annuity as part of my investment strategy. I would have lost too much initially by going for the RPI-linked, so went for a 4% escalation. As Mum is very much alive at 95 and Dad died aged 94 Im planning on making on the deal! Nature may have other ideas but it’s a plan.
I have S&S ISAs, a SIPP and another small annuity also so I can afford to “gamble” a bit also. it IS nice to have a guaranteed sum rocking up into the bank every month.
@DavidV @Barm — Thanks for the thoughts and I should stress I haven’t done the maths.
Also this isn’t about whether having an annuity is good or bad per se (I think there’s a lot of merit for using one for many people again at today’s rates for the ‘floor’ part of a retirement income, especially if you can’t be bothered with linker ladders etc).
However conceptually an annuity is basically your capital being returned to you with interest.
With a level annuity that interest is (from your point of view) calculated and rolled-up at the time you buy it, and then you get your fixed payout each month. And hope to live to 100… 😉
With a 3% escalating annuity, the same thing is happening, except the payout now needs to adjust for this 3% additional return each year.
This is of course why the upfront cost is higher for any given starting payment — or more probably that your initial payment is lower.
Money isn’t being magicked from anywhere here. 🙂 Although how exactly it works is a bit opaque from the purchaser’s point of view. (Most annuity buyers are not actuaries nor well-placed to judge the competitive dynamics of the annuity market!)
From your point of view going for the 3% annuity you’ve bought that extra 3% return on day one.
But what have you gained for it? Remember, you’ve already paid for it.
What you have I’d say is even more uncertainty about whether the annuity will pay off because of the lower payments (perhaps you now hope to live to 110!) to buy a return that may or may not do better than inflation, depending on how that turns out.
You haven’t protected/hedged yourself from inflation really (except in as much as you’ve captured market expectations at the time you buy the annuity).
In contrast, with an inflation-linked annuity you are further reducing uncertainty in exchange for the lower payout upfront. You don’t need to worry that inflation will be 10% for a couple of years in a row, say, because your inflation-adjusted payout will capture that.
In contrast, the 3% purchaser is 7% behind for each of those years and from then on forward. So they haven’t hedged inflation risk at all.
Another alternative (spitballing here) might be to buy a flat annuity for a higher initial payout, and to run the extra money this releases in shares or maybe even linkers to give a bit of annuity protection.
But personally if I was buying an annuity I think I’d be doing it to reduce uncertainty and increase safety, hence I think I’d go for an inflation-linked one (unless I was 90 or whatnot).
Obviously it’s a very individual choice and there’s no ‘correct’ answer.
(And if inflation is unexpectedly 1% for the next 30 years you’ll be laughing, but that’s basically because you made a bet about inflation upfront that came good, which again is not my definition of reducing uncertainty. It could have gone bad!)
I accept too that 3% is ahead of the BOE inflation target, so you it’s not like there’s no reason to believe it will provide de facto protection over most periods.
But we just lived through 2022/2023’s inflation surge and so we hardly need reminding that ‘most years’ isn’t ‘all years’! 😉
Just my thoughts, NOT advice for anyone reading, and I’m definitely not an annuity expert (yet… 😉 )
@TI (8)
Well, yes, I can’t argue about anything you say here in qualitative terms – it is obviously true that fixed escalation provides no protection against a run of high inflation. It does, however, provide the comfort blanket of seeing your income increase a little each year, as opposed to it being obviously eroded in real terms with a level annuity.
As with a level annuity, the payouts from a fixed-escalation annuity are predictable with the only risk to the insurance company being longevity. Insurance companies are expert at predicting this and have been doing so for over 200 years, so can still price keenly. My own analysis showed breakeven (3% escalating vs level) in cumulative terms was 86 (i.e. life expectancy at 65) in nominal terms and 89 in real terms. With RPI escalation the uncertainty is much increased and any hedging instruments are expensive, so you pay dearly for this protection. Breakeven is obviously a lot sooner with sustained high inflation, but much longer with more benign inflation. (Approximately 5% sustained inflation is required for breakeven around life expectancy.)
So, yes, if you want absolute safety an RPI-linked annuity is the way to go but be prepared to pay very dearly for it (a further 50% on the additional premium for 3% escalation).
I must admit I’d always assumed inflation-linked annuities had a cap (e.g. 5%), as is common (normal?) for defined benefit workplace pensions. But I gather from a quick search that this isn’t generally the case (except for LPI-linked ones). I can now better understand both their value and cost.
Regarding high rates of income tax/NI, my gut feel is that marginal rates should never be higher than 50%, so you at least get to keep half of any extra you earn. Effective rates of 62%+ just feel wrong to me. But then I don’t know how that would work with student debt, child allowances etc., so it’s probably not as simple as I make it sound.
I should make clear that the life expectancy figures I mention at #9 are for males. Female life expectancy is a few years higher.
@DavidV
I’m not so sure insurance companies are so expert at the maths, Equitable Life ticked along, well regarded for 238 years and then…..
Some people like annuities they are a certainty ( well you hope someone else picks up the tab if they fall into difficulties) but ultimately it’s an investment pot, largely government bonds and similar bonds. With an element of longevity insurance…
The cost of the insurance and the cost of running the investment is unknown, the management of the annuity is “opaque”, you just take it on faith.
It’s that blind trust that puts me off, my preference is enough government bonds in £ and $, a barbell of maturities and around half index linked to provide enough income for long enough, combined with a much larger equity pot to refill the bond pot in 15 years or so.
If you cannot afford the risk, or dislike uncertainty then annuities may make sense.
Personally I prefer to manage our own money but accept an inflation protected annuity would probably provide twice the income we are likely to spend in retirement, does that make me irrational !!!!
It’s likely that the bad stuff will come out of nowhere and the finer details we debate probably won’t matter…
@Hariseldon (12)
Equitable Life did not get into trouble on their conventional annuity book. They failed because they offered guaranteed annuity rates (GAR), set in a high-interest world, on an investment product (with-profits) and, unlike other life assurers, declared ‘discretionary’ final bonuses in advance. When they tried to reduce the ‘discretionary’ bonuses to GAR policyholders to compensate for the now-unsustainable annuity rates, the courts controversially ruled that they couldn’t. None of this reflects well on Equitable Life and its actuaries, but should not be used as a stick to beat conventional annuities. I have seen no evidence that they failed on the core life assurer competence of longevity prediction.
Conventional annuitants continued to be paid – I believe the policies were transferred to Prudential, on commercial terms as far as I understand.
@Dearime& TI.
Re escalating annuities I thought just the opposite, doesn’t mean I am right of course. My advice to my future widow was never buy an inflation linked annuity because the pricing is at the issuer’s discretion and they are bound to be conservative in their estimate of future inflation so chances are you’ll lose out. Fixed escaltion can be precisely priced. Views ?
There is an interesting article by David Stevenson I got today ( didn’t post the link in case it offends). Basically reporting on a financial conference of big shots and one point was to question the equity risk premium. Sometimes it’s there but often it not. Worth reading if you can find it.
Won’t comment on the inheritance tax barb except to say there is a saying ‘clogs to clogs in 3 generations’ so I think any worry about inheritance creating a persistent sub-class is misplaced. Now if they could come out with a scheme to reward meaningful downsizing then that would be a plus. Of course you need the right quality housing in the right place…..
In terms of feeling wealthy. We have about £1.5M in ISA’s etc excluding house, pensions, SIPPS. We don’t feel rich and I worry about it. Now if we had another £1M I would relax. No I wouldn’t, I would worry more about IHT. Can’t win.
About TA’s piece about direct holding of IL gilts rather than short duration funds. I am selling RLAAM too. Thanks for that article.
@Paul
Are you confusing workplace pension annuities and sipp purchased annuities?
If you buy an annuity then surely the terms are contractual and there can be no Adverse discretion (can’t see there being any positive discretion either!).
With DB pension annuities some employers did make discretionary uplifts in good times, and some people mistook discretionary betterment as being an entitlement. I recall some complaining that earlier generations retired before NRA without any actuarial adjustment – they thought it would last forever.
£1.5m in isa is awesome, double what we’ve got – i’m planning to take 6% pa once i hit 60. Whats your plan?
Wade Pfau has done some interesting work on annuities which is worth reading: he covers subjects like mortality credits, combining annuities with an investment portfolio and the impact of buying annuities at different ages.
I am thinking about buying an annuity to cover essential expenses partly
to help my wife if I pre-decease her and partly as dementia insurance. But I would be reluctant to use all my pension pot on an annuity as I would like to keep my options open.
@Boltt. I was thinking purchased annuities, really for my wife to buy when she gets to mid-70’s.
Re sipp etc. Was being nursemaided for iht reasons, now taking out max up to my 40% tax bracket, equates to just less than 4%. In terms of investments, we had a lot of help. Would have been more if I had been less conservative !
@David V. It’s fair to say that inflation-linked annuities are a fair bit more expensive than fixed ones, but to me that’s not necessarily the most useful comparison. I think the 4% rule is perhaps a better benchmark. For example, a 65 yr old can currently get a single-life, RPI-linked, 5-year guaranteed annuity paying 4.9% (and that’s assuming no health issues). This trounces the 4% typical drawdown, and with a guarantee that inflation can’t touch you and you can’t run out of money. This seems like a bargain to me. Even a 55 yr old can get 3.9%, which only marginally undercuts the 4% rule, but with a colossal amount of protection thrown in for that 0.1% lost.
As others have mentioned, a level (or fixed ratchet) annuity essentially offers no practical protection from inflation at all, which to me defeats the point of cashing in for an annuity in the first place. The protection offered by an RPI-linked one currently looks cheap to me, but that’s just my take.
My German friends weep when they hear about the taxes here.
From memory it was ~15% total tax rate on a six-figure salary. (Of course there is some deferred basic-rate tax from pensions.)
The UK has very generous allowances that disproportionately benefit the top earners. Which average worker can save 80k into pensions & ISA per year?
Then there are the trusts, offshore tax havens and such wheezes that the UK provides for multimillionaire tax evasion.
There is a huge amount of wealth in the UK, while the country has been crumbling. Now all of Europe is facing an existential threat from Russia, and the alliance with the US is dead. Security will cost vastly more than planned.
Unpopular take: The richest 10% can afford, and probably *need* to, pay more tax. I’d rather pay more and live in a free country with decent healthcare.
> Leaving the city feels like failure
Oh FFS, I was too poor to live in London in the late 1980s. I could rent there easily enough, but not buy. So guess what? I moved out. This is capitalism in action, no? JFDI. Contrary to what cossetted Londoners seem to think the rest of the UK is not a Hunter S Thompson-esque
, though it pays to keep your eyes open as to what part you choose. As a hint, avoid anywhere where Thatcher destroyed industry in the 1980s, the damage was never repaired.
The air quality is better outside the Smoke, too 😉
As for that paucity of ambition on wages re the US, I kind of worry that the newly minted Kingdom of America is held up as a shining city on the hill. Pro DOGE article notwithstanding, it will be interesting to see the results of small government executed at scale and at haste. Let’s just wait a year before we all decide that work-in-progress is what success looks like, eh?
Is it just me who thinks the whole premise of trying to determine what salary makes someone wealthy is non-sensical? To me, wealth is what you have, not what you earn. Consider someone with £10 million in the bank but no income to speak of. Clearly a wealthy person in my book. On the flip side, consider a playboy footballer earning a million a year, but nothing invested, no assets, and an over-extended lifestyle that’s all paid for with debt. The footballer may have a high income, and a lavish lifestyle, but has literally no wealth to speak of. Fair enough, anyone earning a high salary has much more potential to become wealthy; but that’s all it is, potential.
For my part, my partner and I have a combined income towards the higher end of the overall population. That doesn’t make us wealthy, at least not yet (we’ve not long been in this position and don’t yet have much accumulated in comparison to our mortgage). What our income does provide is a privileged opportunity to be somewhat wealthy in the future, which is not the same. All that said, there seems to be plenty of people earning far more than us who don’t realise they clearly have it good and only have themselves to blame if they can’t make the sums add up.
@AW (18)
I actually agree with everything you say in your first paragraph and the last sentence of your second. It was just that I considered the earlier suggestions that fixed-escalation annuities were not worthy of consideration to be unduly dismissive. Having compared the various types of annuity in some detail last October, I felt the need to reiterate the results of my comparison.
Incidentally, this is only of academic interest for me as I am fortunate to have a DB pension and a full New State Pension with additional Protected Payment. I do also have a very small level annuity, bought as the most expedient route for accessing the taxable part of a Section 32 policy that offered enhanced tax-free cash.
@DavidV (#22). That’s a fair point. Whilst inflation protection is a big appeal for me with an annuity, I can’t argue that forgoing the RPI link gives you an awful lot more payout, at least in the early years.
FWIW, all my planning assumes that the state pension will have been fiddled with by the time I (hopefully) get there. Any state pension, should it materialise, will be a nice bonus.
If I was an actuary for an annuity company offering rpi linked annuities I would lie awake at night worrying I might have underpriced the risk I have taken off my customers shoulders. To avoid that I make them pay such that the chance I am wrong is acceptably low.
Why pay the high price just so some actuary gets a good night’s sleep. Buy a fixed or escalating annuity and invest some of the early payments rather than spend all of it.
Well that’s my thinking anyway.
I worked in General Insurance for. 20 years and then moved to a Life company (Retail protection, Term, WoL, etc Not Annuities).
I was amazed to find out that almost 100% of the mortality risk was reinsured and that the real risk they bore was the Lapse risk. Some commissions were 2-3x annual premiums!
I’m pretty sure the only thing that keeps Actuaries awake at night is the exams.
@Sparschwein “top earners” can’t save £80k into pensions and ISA either, as anyone earning more than £260k will have their annual allowance tapered, and anyone earning more than £360k will be able to invest a maximum of £30k (10k pension plus 20k ISA). (That doesn’t include the more arcane investment options like VCTs, EISs etc.)
Of course you can say that people earning lower than £260k are “top earners”, but as @TI says in the article this is all very much in the eye of the beholder.
@Boltt (25)
At least the life companies don’t have to worry about lapse risk on their annuities (having got all the money up-front)!
@Paul
“If I was an actuary for an annuity company offering rpi linked annuities I would lie awake at night worrying I might have underpriced the risk I have taken off my customers shoulders. To avoid that I make them pay such that the chance I am wrong is acceptably low.”
I would have thought the insurers underwriting these products are offsetting this risk (ie, buying linkers or swaps) so they aren’t taking a large inflation bet onto their balance sheet. In fact, Apollo and the large PE shops have been buying insurers so they can invest the premiums into higher returning assets (ie, private credit) and pocket the spreads.
But that also means we can do the same with a mix of linkers/equities…
Different people have different appraisals of wealth and income. Our personal opinions are formed mostly from our own situations. The less we physically interact through common activities uncorrelated with wealth, and openly socially talk with different people from different walks of life, the more myopic our opinions become.
The roots of “wealth”…
The word comes from the Middle English wele or “well-being.” Before taking on connotations of financial riches, wealth meant the welfare of people; their general happiness and joy.
On annuities:
For those really interested in digging in to the details, I’ve done some modelling with annuities for UK retirees (search for
“Using Lifetime Annuities to Increase Retirement Portfolio Survivability”
“Supporting Retirement Expenditure Using a Combination of State Pension, Investment Portfolio, Bond Ladders, and Annuities”
“A ‘Semi-Historical’ Time Series of UK Annuity Rates for Retirement Income Backtesting”)
Generally, it is the income profile that changes with different escalations – assuming inflation is generally positive, then, in real terms, level annuities are strongly front loaded, escalation annuities are partially front loaded, and RPI annuities are flat. As longevity insurance, RPI are likely to be best and level the worst. The answer to which of these is best is ‘it depends’!
@Paul_a38 (#24). I’m not an actuary, but my understanding is that RPI annuities are at least partially liability matched with inflation linked gilts and can be thought of as a ladder with mortality effects included.
From the FT article, “New TIPS ETF solves inflation hedging. Gilt version to follow?”
The answer will almost certainly be ‘no’ because of the difference in the TIPS and ILG markets. A glance at yieldgimp shows there one (yes, one) ILG with a maturity date of less than 1 year (TR26) with the next not maturing until near the end of 2027, while looking at the WSJ TIPS pricing page there are currently five TIPS all maturing in the next year making a viable fund. I also note that the graph in the FT article is for a period a) where there was a large increase in yields, and b) where the yield curve was inverted and therefore a good period for an ultra short duration fund. Using the British Government Securities database, total returns (expressed as a ratio) for ILG indices from November 1998 to end of December 2024 were 2.52 (under 5 years), 2.75 (over 5 years), 2.94 (5 to 15 years), 2.60 (over 15 years), and 2.80 (‘All Stocks’). OK, for much of that period yields were steadily decreasing favouring long durations, but the last couple of years has evened that out somewhat. Intermediate durations (the 5 to 15 year index) have coped best with the varying conditions.
@Sparschwein #19 The Treasury Committee session on Lifetime ISAs was surprisingly interesting as it included the product architect Michael Johnson (who frequently clashed with Martin Lewis).
He talks about how the Lifetime ISA was intended as a tester on replacing tax relief on pensions with a 401(k) style product.
He points out that if we accept that taxation should be progressive then it must be true that tax relief is regressive (to your point about who benefits from large tax shelters).
@LondonYank. Yes, true enough they must hedge to a greater or lesser degree but current IL gilt prices reflect a market view of future inflation rates but what do they actually know about inflation in 15 years time? As I don’t know how the process works I wonder how residual risks are addressed and how that affects the price offered.
From what I recall from the last time I looked at this, the breakeven time in years to be lived before rpi linked annuities finally matched level ones was such that advisors recommend level annuities. That must be a function of inflation expectations, rates etc but buying rpi protection isn’t a no-brainer in my book.
That’s why I tended towards an escalating annuity, say 3%. If inflation is 3% your covered, above that you need to have saved some of the income.
I think a sound financial advisor is absolutely needed before contemplating buying an annuity.
@paul-a38 #24
If a conventional annuity pays around 7% based on gilts yielding a round 4% and RPI linked annuity pays around 4% based on index linked Gilts yielding round 1% then very crudely a return of capital of around averaging out at around 3% a year , looks consistent and I don’t think they have anything to worry about.
“Not at the dinner table” NYT piece: to add this link:
https://open.substack.com/pub/larryjdiamond/p/the-manchurian-president
“tax relief is regressive”: I keep pointing this out in the context of EVs, solar panels, heat pumps and so on. The bien pensants seem entirely uninterested in my point.
@Hariseldon…worry…the actuary or their companys customer’s ? 🙂
According to Moneyweek as of Dec 2024,
‘If you opted for the RPI-linked product and it rose at 5% per year, then it would take 10 years to make up lost ground and around 20 years before you would have caught up in drawing the same amount of income overall as you would have got from the level product.’
And that’s with inflation averaging 5% per year for 20 years.
In my eyes that’s because rpi linked annuities are overpriced so you get the protection you seek but at a price that makes it less probable you made the right choice.
A link that would fit in the “not at the dinner table” section that made me think a lot. An address to the E.U. Parliament by someone viewing the situation from his own watchtower… https://www.youtube.com/watch?v=ZUbBU0OqCgE
JimJim
@Paul_a38 (#37)
As far as I know, the insurance company makes about the same fee whether the annuity is level, escalation, or RPI. The differences in payout rates arise from the underlying securities.
The moneyweek calculations are correct as far as they go. For example, currently, with level rates of 7.6% and RPI rates of 4.9% at 65yo with 5 year guarantee (27 Feb, Hargreaves Lansdown) and using the average UK inflation since 1948 of 4.6%, the crossovers in income and cumulative income are still 10 and 20 years, respectively (I note that these are 12 years and 22 years for the 3% escalation annuity with a payout rate of 5.4%).
There are two points:
1) At 65yo, the median time to death is about 86yo for males and 89yo for females (i.e., 21 and 24 years, respectively). In other words, there is a slightly better than 50% chance that the typical UK person will live to see the RPI annuity pay off with average inflation. Given that mortality statistics are built in to the annuity, this is not surprising.
2) As we have seen in recent years, inflation is not nice and smooth and ‘sequence of inflation’ has a huge effect on the outcome. For example, if annual inflation for the first decade was 12.3% (the average for the 1970s) and 2% thereafter (the average from 2010 to 2020) then the crossover in income occurs after 4 years and cumulative income after 7 years. Conversely, for a sequence the other way round (i.e., a decade of 2% and then 12.3% thereafter), the crossovers occur after 13 and 19 years.
For me, given that predicting inflation is not possible (implied inflation, i.e. the difference in yields for nominal and inflation linker gilts reflects the price the market is willing to pay for inflation protection and is not a prediction), it is the certainty in real income (no market risk, no inflation risk, and no longevity risk) that makes the RPI annuity a better tool for providing an income floor with risk then being taken in the portfolio.
One alternative to an annuity, i.e., a linker ladder, currently has a payout rate of 3.6% for a 35 year ladder (i.e., taking a 65yo to 100yo and minimising longevity risk, market and inflation risks).
@AlanX. Thanks for that. I noticed that Kitces has an article out there about annuities being better than bond ladders for income protection ( mortality credits).
The 3.6% ladder pay out, is this nominal or real ?
Thanks for the links. Annuity article and discussion is interesting although a bit academic for me now as I have recently applied for an annuity to run alongside my SIPP and made the decisions. After reading and deliberation I decided on a level annuity, the main reason being I wanted the higher payout over the RPI quotes, especially at the start. Inflation will eat away at it but I have plenty in the SIPP to counter that and can still put some of the SIPP towards an RPI linked annuity later if I wanted to. I didn’t want to faff with gilt ladders etc. Also state pension is coming along in a little under 6 years with potential additional tax liability. I was going to leave annuitisation of some remaining pots until a bit later but rates are attractive right now and it seemed tax optimal to take it before the SP.
London prices – I lived as a student in Kensington in 1985 paying £12 a week for a shared room, an SW7 address close enough to Imperial College to dash out after gobbling down my cornflakes about 10 minutes before my Physics lectures started and arrive on time. That’s about £36 a week in today’s money I think. IC lists nearby hall rooms costing between £200 to £400 a week depending on what you can tolerate. You’d need to maybe have some BMOD cover or live further out and get a bike.
I feel wealthy enough, free of work with time and funds to do what I want. Never earned salary over £100k but still managed to save enough for a decent retirement, might not spend it all in the time remaining. No kids and avoiding massive lifestyle inflation helps. Everything is relative, no need to keep up with the Joneses!
@Paul_a38 (#40)
The 3.6% payout is for a ladder of linkers, so is real. The equivalent 35-year ladder of nominal gilts has a payout rate of just under 6%.
A search for ‘LateGenXer’s financial tools’ will find both a gilt ladder calculator and an actuarially fair annuity valuator (i.e., the payout rates assuming no fees).
Firstly, thanks for the article. Secondly, wealth/being rich for me isn’t how much you earn, it’s how much you have. And high earning. Workers as you mentioned already pay a serious amount of tax.
I’d be in favour of a small wealth tax on assets held in the UK, on say estates of over £10,000,000. The argument that these rich people would move sort of misses the point, they can move, but their UK based assets can’t. So tax the assets not the person. If they don’t like it they can sell and there will be more UK based assets for the rest of us.
@AlanS thanks again. Food for thought. The issue isn’t immediate as my pensions cover income needs but if I die before my wife (aka my future widow) the pensions half and my state pension is lost so her buying an annuity could help floor income.
To provide some protection until that unhappy date I bought £60k IL 32 yesterday so that should be there for her.
As an aside I don’t share the concerns about trying to match ladder dates with cash flow needs. Once you get to within a couple of years of the maturity date the duration is so limited I can’t see a material interest rate risk.