pension pot size?

jamesd

FatherAbraham wrote: »

Retire at 55 on a 10% pension-contribution rate?

You might find it useful to read my post again and consider the meanings of the phrases "what you really should be doing", "plan for" and "pension and ISA investing" in the context of your misreading of that post as a claim that 10% only going into a pension would be sufficient to retire at 55.

I wouldn't want to use the assumptions you used, though:

• Less than half of the real total returns average for equities over the last hundred plus years
• An index-linked annuity, notoriously bad value compared to level
• Buying an annuity at a very young age, well before they start to become more efficient, when purchased some 25+ years older
• A spouse...
• ...who doesn't provide for their own needs
• and a choice of inefficient way (annuity instead of drawdown) to provide for those spousal needs

The 2% annuity choice alone divides the achievable income by 2.5 compared to income drawdown at 5% of capital taken as income per year, though I'd want much more generous safety margins than that at 55.

FatherAbraham

jamesd wrote: »

I wouldn't want to use the assumptions you used, though:

• Less than half of the real total returns average for equities over the last hundred plus years

You'll need to take that point up with the FCA, not with me, but it's likely that the FSA deliberated long and hard before changing the mid-range projection rate from 4.5% (which is what the HL calculator uses by default) to 2.5%. http://www.guardian.co.uk/business/2012/nov/02/fsa-cut-pension-projection-rates

jamesd wrote: »

• An index-linked annuity, notoriously bad value compared to level

No, that's the cost of guaranteed, inflation-proof income. A level annuity is misleading, because one needs to start putting some of that large initial income aside as savings to help get through the lean times ahead, as well as one can predict those costs. Level annuities can be regarded as relatively toxic financial products, which lure pensioners in with a high "teaser" rate.

jamesd wrote: »

• Buying an annuity at a very young age, well before they start to become more efficient, when purchased some 25+ years older

That's the cost of guaranteed, inflation-proofed income.

jamesd wrote: »

• A spouse...

Not a bad assumption, in the absence of sufficient information. Most people retire with a spouse.

jamesd wrote: »

• ...who doesn't provide for their own needs

Okay, you've got me on this one. Certainly the proposed changes to the basic state pension are partly a reflection of the decrease in dependent women. Harder to generalize for the personal pension which sits on top of this, of course, since caring for children gives no "credit" into the personal-pension pot.

Let's adjust to a single-life index-linked annuity rate to make the OP independent -- up from joint at 2.0% to single at 2.24%. Pension income rises correspondingly by one eighth, to 10.42% of current salary.

jamesd wrote: »

• and a choice of inefficient way (annuity instead of drawdown) to provide for those spousal needs

No, an annuity is an extremely efficient way of getting risk-free income.

jamesd wrote: »

The 2% annuity choice alone divides the achievable income by 2.5 compared to income drawdown at 5% of capital taken as income per year, though I'd want much more generous safety margins than that at 55.

You really should be quantifying the risk of running out of money in the investment pot at your favoured income level for the original poster, shouldn't you?

Retirees are people who can't tolerate risk -- some of your choices (level annuity, income drawdown) are those which place them most at risk as they are older, when they have no capacity to unretire and return to the labour market to recharge their capital pot.

Warmest regards,
FA

tony4147

FatherAbraham wrote: »

You'll need to take that point up with the FCA, not with me, but it's likely that the FSA deliberated long and hard before changing the mid-range projection rate from 4.5% (which is what the HL calculator uses by default) to 2.5%. http://www.guardian.co.uk/business/2012/nov/02/fsa-cut-pension-projection-rates

just tried the HL calculator mid range projection defaults to 7% growth rate, not 4.5%

gadgetmind

tony4147 wrote: »

just tried the HL calculator mid range projection defaults to 7% growth rate, not 4.5%

Add on 2.5% inflation per year and that's your 4.5%. When people above talked about "real" 2.5% or 4.5% pa they meant after inflation.

As t happens, the 4.5% real is closer to historical figures, but 2.5% means that people are less likely to underestimate what they should be saving and therefore more likely to have a nice surprise later on.

My pension plans use a 5% absolute growth figure, and 3.25% for inflation, so only 1.75% real growth. Currently I'm somewhat ahead of projections!

jamesd

FatherAbraham wrote: »

You'll need to take that point up with the FCA

I'm content to take it up with you because you're the person using those rates. You can find the PwC report commissioned by the FSA here. I read it when it was published and it hasn't improved since.

The report uses a portfolio of "57% equity, 23% government bonds, 10% property and 10% corporate bonds". Is that the sort of thing you want to be buying with your investment money today?

23% government bonds at current rates? As PwC correctly notes "the yields on offer to government bond investors are now at historic lows" and "our analysis suggests that medium-term real returns on government bonds have reduced from 1¾%-2% in 2007 to ½%- 1%".

Just in case you missed it, they expect the real return from buying that investment to be between making only 0.5% a year to losing 1% a year.

They don't then go on to say that you'd be daft to spend 23% of your investment money buying them. Which is a shame. But it's really quite easy: standard investment advice is not to buy high. And that's what anyone buying government bonds at today's prices would be doing. So don't.

There are more dubious "joys" in the paper but that's a good start to be getting on with. If you haven't read it yet, please do, then you too might be less than inclined to just quote the FSA projection values as if they were what a sensible investor who pays attention might get. They aren't.

FatherAbraham wrote: »

No, that's the cost of guaranteed, inflation-proof income.

See that bit above about projected returns from government bonds? Which is much of what annuity providers are required to buy. That's part of why annuities bought today are offering such poor value, particularly the inflation-linked variety. See for example The inflation-linked pensions that don't pay off until you're 97, leaving retirees £20,000 out of pocket or if you'd like something more substantial, a report submitted when considering the income sources required for the £20,000 Flexible Drawdown minimum income that explained why it was foolish to require inflation-linked rather than level annuities, on the basis of the poor efficiency of the inflation-linked variety compared to level, an argument that was accepted.

But the person we're discussing is not buying in today's market. Their time horizon has since been refined from 35 years to go to "i am 31 ... I would like to retire at 60", some 29 years from now.

Is it your prediction that in 29 years quantitative easing and historically high government bond prices will still be around? Or might we have gone back to something closer to the long term trends over the last hundred plus years by the time those 29 years are up? Of course, if that doesn't happen, the person can adjust their planning regularly to allow for it.

FatherAbraham wrote: »

A level annuity is misleading, because one needs to start putting some of that large initial income aside as savings to help get through the lean times ahead, as well as one can predict those costs.

I agree that putting some of the higher income away is a good idea.

FatherAbraham wrote: »

Let's adjust to a single-life index-linked annuity rate to make the OP independent -- up from joint at 2.0% to single at 2.24%. Pension income rises correspondingly by one eighth, to 10.42% of current salary.

So lets consider the effect of that adjustment and your choices on investment returns:

1. You've chosen to use investment returns that are half of the long term history. What does that do? This:
£68,362 = Value of real £1000 invested at the start of the year for 29 years at 5.25% real return.
£42,902 = Value of the same at 2.5% return.
So your assumed rate of return increases the cost by 1.59 times.

2. You've chosen to use an annuity that multiplies the cost of getting the income by perhaps 5% / 2.24% = 2.23 times.

The combined effect of those choices is to increase the cost by 1.59 * 2.23 = 3.55 times.

I'm unsure of what safety margins you like in your investing but my own do not require me to invest 3.55 times as much money as appears to be required.

I'd be quite content with say a 100% safety margin and only twice as much as required, with regular monitoring and adjusting as required.

FatherAbraham wrote: »

No, an annuity is an extremely efficient way of getting risk-free income.

Hardly. See those numbers above.

FatherAbraham wrote: »

You really should be quantifying the risk of running out of money in the investment pot at your favoured income level for the original poster, shouldn't you?

Sure. How does putting away 3.55 times as much money as required based on long term historic results seem as a safety margin?

Perhaps you'd care to plug that into Firecalc and see how often starting with 3.55 times as much money as required for a given income level fails? Or maybe try it instead with only 2.23 times as much money?

FatherAbraham wrote: »

Retirees are people who can't tolerate risk

That is not a generally true claim.

Retirees - and all of us - have a certain level of fixed expenses that are minimally required to live. Above that is a discretionary level where it is entirely possible to accept variable levels of income. Retirees who use income drawdown normally do this.

Retirees who buy some 90% of all annuities purchased routinely accept inflation risk, judging that level annuities are preferable to the poor income returns of inflation-linked annuities compared to level, given the current state of those two markets. That choice also reflects their expected variation in income needs as they age.

For much more on this subject you might find it interesting to start reading from page 50 of the Annuity Markets: Welfare, Money’s Worth and Policy Implications paper if you haven't already done so.

Lets consider timescales. Start with the FSA's PwC paper, in which "we focused on an investment time horizon of around 10-15 years".

The accumulation phase here is 29 years followed by, using current life expectancies for convenience, some half of people expected to live another 26+ years, for a total investment timeframe of some 55 years.

With respect to both you and the FSA, I do not think that it is sound financial planning to use 10-15 year horizons starting at historically exceptional investment circumstances with a poor asset mix for a 55 year investment planning horizon. That's well into the sort of time range where long term trends are more applicable.

If we were discussing someone with perhaps 10-15 years to go who'd be using a default balanced managed fund and not capable of doing anything else, there would be considerably more merit to using the FSA's projections. But still not in assuming that the exceptional circumstances behind today's annuity market conditions will still be present 10-15 years from now, nor in assuming that 100% of the income of the retiree is completely inflexible and required at a constant level throughout retirement

Linton

FatherAbraham wrote: »

...
Retirees are people who can't tolerate risk -- some of your choices (level annuity, income drawdown) are those which place them most at risk as they are older, when they have no capacity to unretire and return to the labour market to recharge their capital pot.

Warmest regards,
FA

As a retiree I can assure you that this isnt true. It all depends on your means.

Sure, if you have lived a hand-to-mouth existence all your working life and continue to do so in retirement then I would agree. However those in a more fortunate situation (which would include all people interested in and able to consider serious investing) can afford to take a flexible view.

It is essential to my sanity that the very basics are risk free. This is provided by the State Pension, some guaranteed pensions and ultimately the option to downsize the house. Anything beyond that can accommodate some risk. At lower risk I would include solid dividend paying investments as one can afford to change the drawdown amount depending on wider economic circumstances. This normally provides a better income, broadly inflation linked, than would be possible with an annuity.

Finally one has to consider that some of the retirement pot wont be touched for perhaps 20 years. It is surely reasonable to use a strategy based on higher risk/higher return investments here.

jamesd

gadgetmind wrote: »

As it happens, the 4.5% real is closer to historical figures, but 2.5% means that people are less likely to underestimate what they should be saving and therefore more likely to have a nice surprise later on.

I think that using such low returns, and based on only a 10-15 year time horizon starting at an exceptional time, is more likely to discourage many people from using pension investing and have many switch to residential property or just give up instead. Add today's annuity rates and the use of inflation-linked annuities and the projections will be even more discouraging to many who may just be looking for an excuse to avoid pensions.

gadgetmind wrote: »

My pension plans use a 5% absolute growth figure, and 3.25% for inflation, so only 1.75% real growth. Currently I'm somewhat ahead of projections!

We're both doing rather better than that sort of projection level... hopefully it'll continue until retirement. At the moment my pots are some 91% of my net pay plus gross pension contributions for the last 87 months and I'm over my minimum financial independence target about as many years from minimum pension age as you are. No investment growth and just my current contribution levels needed to get to above median pensioner income level by then, though naturally I'd like to do better and have my income range from median at the low end result to higher rate tax at the higher.

tony4147

So when using the HL calculator what would be a reasonable growth rate figure? should people be using the standard figure of 7% for growth rate or should they be using the 5% figure?

Linton

tony4147 wrote: »

So when using the HL calculator what would be a reasonable growth rate figure? should people be using the standard figure of 7% for growth rate or should they be using the 5% figure?

I would say use both. Use the results to guide your investment strategy. If 5% easily gives you the final sum you need you can avoid high risk if you want. If 7% isnt enough you have a problem, possibly fixed by high risk investing or more likely by higher contributions.

tony4147

Linton wrote: »

I would say use both. Use the results to guide your investment strategy. If 5% easily gives you the final sum you need you can avoid high risk if you want. If 7% isnt enough you have a problem, possibly fixed by high risk investing or more likely by higher contributions.

Well 5% is short of what I would want and 7% would meet my needs, my pension is a standard portfolio with Scottish Widows (pens 2 & slowly moving funds into pens 3). I have 15 years to go before my planned retirement and I always find it difficult with these calculators as to what growth rate to assume.

I would hope for 7% - 2.5% (inflation) over the long term