Flat rate or RPI???

cyclonebri1

So, it comes to choosing an annuity.

The pessimist would expect to die soon and go for flat rate, it's higher initially

The optimist will live forever and wants his money to keep pace with time. He goes for RPI linked. he settles for a lower initial weekly sum.

Forgetting that past performance is no...... etc, when does a flat rate equalise with RPI linked?, by which I mean when does the total monies paid level out, not when they become the same.

JoeCrystal

Simple enough.... I run it through my spreadsheet with forecast numbers from wildly optimistic HL pension calculator. Assuming that pension income increase by 3%.

In the first year, I can choose an index-linked income of £14,951.24 per year or level income of £21,568.12.

In cash value, by a twenty fifth year, you get to the point where total income paid out by an index-linked is more than level income.

However, while the index-linked pension income is £30,392.79, in real term, it is £14,951.24. The level income is still £21,568.12 but in real term, it is now worth £10,610.09.

My working is below. The first column is year, the second is index-linked income increased by 3%, third and fourth columns show nominal and real income of the level income.

Cheers,
Joe

Year 1 £14,951.24 £21,568.12 £21,568.12
Year 2 £15,399.78 £21,568.12 £20,939.92
Year 3 £15,861.77 £21,568.12 £20,330.02
Year 4 £16,337.62 £21,568.12 £19,737.89
Year 5 £16,827.75 £21,568.12 £19,163.00
Year 6 £17,332.58 £21,568.12 £18,604.85
Year 7 £17,852.56 £21,568.12 £18,062.96
Year 8 £18,388.14 £21,568.12 £17,536.86
Year 9 £18,939.78 £21,568.12 £17,026.07
Year 10 £19,507.98 £21,568.12 £16,530.17
Year 11 £20,093.22 £21,568.12 £16,048.71
Year 12 £20,696.01 £21,568.12 £15,581.27
Year 13 £21,316.89 £21,568.12 £15,127.45
Year 14 £21,956.40 £21,568.12 £14,686.84
Year 15 £22,615.09 £21,568.12 £14,259.07
Year 16 £23,293.54 £21,568.12 £13,843.76
Year 17 £23,992.35 £21,568.12 £13,440.54
Year 18 £24,712.12 £21,568.12 £13,049.07
Year 19 £25,453.49 £21,568.12 £12,669.00
Year 20 £26,217.09 £21,568.12 £12,300.00
Year 21 £27,003.60 £21,568.12 £11,941.75
Year 22 £27,813.71 £21,568.12 £11,593.93
Year 23 £28,648.12 £21,568.12 £11,256.24
Year 24 £29,507.57 £21,568.12 £10,928.39
Year 25 £30,392.79 £21,568.12 £10,610.09

hugheskevi

Forgetting that past performance is no...... etc, when does a flat rate equalise with RPI linked?, by which I mean when does the total monies paid level out, not when they become the same.

Assuming that you purchase an annuity at age 60, if RPI is 2.75% p/a, age 99. If RPI is 3.5% age 91 and if RPI is 5% age 82.

Remember that as both RPI and level annuities are offered, insurers will get adverse selection as those who think they will live a long time will be more attracted to RPI annuities.

Yields on index-linked gilts are negative (haven't looked recently though so may have changed) so backing index-linked annuities is expensive.

And obviously a consumer will always have to pay for insurance, and an RPI linked annuity is insurance against inflation.

Studies a few years ago showed the expected value of a flat-rate annuity was 90% (ie consumers would expect to on average get back 90% of the amount paid for an annuity taking into account gilt yields) whilst the amount was only 75% for index linked.

Inflation-risk is important, but I'd be covering it via other means (eg investing ISAs in real assets) than an annuity.

cyclonebri1

Thanks Joe, I get it I think.

In simple money terms it takes 25 years for the figures to level, but by this time inflation has knocked that back.

So what would you reckon the score would be at 15 years post annuity?

cyclonebri1

hugheskevi wrote: »

Assuming that you purchase an annuity at age 60, if RPI is 2.75% p/a, age 99. If RPI is 3.5% age 91 and if RPI is 5% age 82.

:T:T Great stuff, given all the circumstances I haven't mentioned, it's a no brainer now.:T:T

JoeCrystal

cyclonebri1 wrote: »

Thanks Joe, I get it I think.

In simple money terms it takes 25 years for the figures to level, but by this time inflation has knocked that back.

So what would you reckon the score would be at 15 years post annuity?

On sixteenth year, the amount is £301,370 from RPI and £345,089 from level.

Of course, it really depends on how high the inflation is... Who knows, we might suffer 10% inflation one day.

EDIT: Basically, if you find youself living by 25th year and on level income, you can only afford half of the stuffs you were able to afford in first year. Not nice.

Cheers,
Joe

kidmugsy

Gentlemen, this discussion is mad. You don't buy an index-linked annuity to defend yourself from a regular 3% p.a. inflation, you do it to defend yourself from a return to the seventies. Bung in a few years of 10%, 15%, 25% inflation.

jamesd

At 15 years the level will be the clear winner unless there is substantial inflation, not also capped by the inflation-linked annuity.

Investing some of the level annuity income within a S&S ISA is how you become a winner compared to either alone, subject to the usual caveats about investment volatility. Say half to two thirds of the difference in income. That invested money then becomes a useful reserve pot that you can draw on in times of later need nearer to the end of like, such as for care fees.

kidmugsy, if that's the worry, you don't buy an annuity at all. You stay invested because wages are likely to increase by more and that means you'll end up in relative poverty (defined as 60% of average income).

redbuzzard

kidmugsy wrote: »

Gentlemen, this discussion is mad. You don't buy an index-linked annuity to defend yourself from a regular 3% p.a. inflation, you do it to defend yourself from a return to the seventies. Bung in a few years of 10%, 15%, 25% inflation.

Even 10% looks scary to me - my 2 FS pensions are capped at 5% for the smaller one, and part 2.5% part 5% for the other. I may defer the state pension to increase the index linked income, but that's nearly 5 years off so time to think about that and see what the deal is.

cyclonebri1

kidmugsy wrote: »

Gentlemen, this discussion is mad. You don't buy an index-linked annuity to defend yourself from a regular 3% p.a. inflation, you do it to defend yourself from a return to the seventies. Bung in a few years of 10%, 15%, 25% inflation.

Not so mad chap when you factor in someone with a short live expectancy and a desperate cash shortage:eek:

kidmugsy

cyclonebri1 wrote: »

Not so mad chap when you factor in someone with a short live expectancy and a desperate cash shortage:eek:

No, still mad. If you've got a low life expectancy you should be discussing impaired life annuities versus income withdrawal - level versus inflation-linked is completely irrelevant.