Rule of thumb?

jamesd

jackyann wrote: »

When I began rooting about in here, most people said (of saving into a pension pot) "you buy an annuity, which gives you about 3% of your pot".

If someone was to be foolish or wealth enough to buy an annuity linked to RPI inflation that is about what it would cost. But around 90% of annuity buyers are not so foolish and instead by level - not increasing - annuities. This is because the expected payback time for an RPI annuity to beat a level annuity tends to be close to or above the life expectancy at the time of purchase. So most buyers are going to be worse off with the RPI annuity than the level one.

Worse for annuity buyers, long term investment returns in the UK stock market have been around 5.2% plus inflation. So if you buy the RPI annuity instead of using income drawdown, at the time of purchase of the RPI annuity you're sacrificing around two fifths of your potential income. That extra income potential that you're giving up is a very large safety margin before buying an RPI could end up making you better off than using drawdown.

But annuities are in part an insurance product, providing a guaranteed result. So some annuity buying as part of diversification can make sense. but not too much, because if there are circumstances that cause a sustained loss of two fifths of income from investments, that's also likely to put insurance companies and governments under stress. When buying annuities you can reduce the risk in this sort of stress by buying from several different companies, so even if there's trouble with one, the others may be fine. The protection for annuities is also pretty good, even if a company was to get into trouble, assuming the FSCS remains solvent and able to raise funds, which depends on government finances in the case of major disruption.

jackyann wrote: »

As I am interested in what my children are contributing and how they will manage their pensions

For children the most important thing is to pay attention and adjust how much they are paying and and how it's invested as time goes on. If they have a goal they are working towards, know how to get there and are monitoring progress they will be able to adjust as needed.

Nothing we can say today can beat them doing that.

jackyann wrote: »

I would like to know how much annuities vary. I have seen posts saying that they are poor at the moment, but I don't know how variable they are.

Annuity payouts have been on a long term declining trend as life expectancies have increased. This has gradually changed them from being a prudent major purchase into moving towards being an imprudent choice. The issue is relative returns - how good or bad a deal the annuities represent compared to the alternative options. Giving up two fifths of income is very expensive. They used to be actually pay out more, not less.

This long term trend is why you might often see is mentioning "guaranteed annuity rates" to people considering moving pension pots around. Back before around the year two thousand there were pension companies that sold products that would guarantee to buy an annuity at rates that looked sensible then. Today those rates can easily be twice what you can buy on the open market. So switching out to buy an annuity would be a major mistake compared to staying in and getting an annuity at the older good rates. Those could enough to make them a better buy than staying invested to produce income. But no insurer is selling such products today. Nor are they likely to. Guarantees caused massive problems for one of the largest old UK insurers, Equitable Life, when the courts ruled that it had to honour its guarantees.

In the shorter term view, the payout rates from annuities may increase because of the potential ending of fiscal easing and rises in interest rates. But there's a competing factor, potential rises in life expectancies and regulation.

Nothing we can say today will tell your children whether annuities will be good or bad value when they want to retire. They just need to pay attention and adjust as required. If they look like good value then, they can buy them, or buy with some of their money for diversification. If not, they can buy none or less.

Similarly, nothing can tell them which investments will be good or bad value, nor which parts of the world. They just have to pay attention and adjust.

Getting started with a substantially bigger pot than required also helps, because that allows more time for compound growth and increases the safety margins. Doing things like overpaying on a mortgage instead of making pension contributions hurts because mortgage interest rates ore generally lower than investment returns, so you lose years of compounded higher growth. But no rule saying that will always be true, that is yet another of the things your children need to pay attention tom. Maybe there will come a time when paying off a mortgage early makes you richer instead of poorer than you could have been.

jackyann

Thank you for helpful replies.