Avoiding the annuity trap

onthewayout

I'd like to save something towards my old age, but it seems like a traditional pension is a wild goose chase. When I get to retirement, I'd be forced to choose between buying an annuity at a stupidly low rate (as in I'd actually lose money after inflation), or drawing it down so slowly (capped drawdown) that I'd not only be poor, I might never get to spend some of my money.

All designed by the powers that be to stop me ending up on benefits, of course. Which makes me very tempted to blow everything now on wine, women and song, and land cheerful and penniless on the NHS's doorstep when I'm old - as well as claiming all those benefits. /sarcasm

Anyone got a better suggestion? If it helps, I'm 32 and I'd start saving or investing in a year's time, after I clear the last of my old debts. I could put away £500 a month from that point. No existing savings; it wasn't so long ago I had no career and was facing bankruptcy.

bigadaj

Pensions are important but needs to be in the context of your whole finances.

Congratulations on being nearly debt free, following which you need to save up a cash fund of a few months salary or expenses, in cash isas, regular savers or now seemingly current accounts as they offer the best rates.

If you have employer comtribtuimsnor pay tax at a. Higher rate or can salary sacrifice then do a pension, if none of the above then investments in shares isas are generally no worse, you can hold the same investments and have access if needs be.

The benefits situation is probably going to get worse as a country we are less willing to pay more in tax to pay for others, you're still pretty young so I'd definitely be looking at pensions saving given the caveats above.

onthewayout

You're right about an emergency fund. I do have £400 in a savings account now, which I was thinking of more as insurance than savings. I will be adding to it when I can.

I'm not going to get any extras from my current employer. They pay a basic wage and decent commission, and that's it. Which maybe means I should be looking for another job... or maybe not.

Are you saying I'm wrong to believe I would lose money on a traditional pension, or do you accept that but think I have no good options so should do it anyway? What about trying to cut my costs in old age by paying for things in advance; the most obvious one being a mortgage-free home? I could get by on quite a bit less if I had no housing costs.

Or I could learn a foreign language, pack my bags and run for it....

bigadaj wrote: »

you're still pretty young so I'd definitely be looking at pensions saving given the caveats above.

atush

Ok, no1- you need more then 400 worth of 'insurance' although as you are recently come out if debt not bad.

No2, your employer HAS to pay into a pension for you soon, as it is law. How soon depends on the number of employees.

No3 "or drawing it down so slowly (capped drawdown) that I'd not only be poor, I might never get to spend some of my money"

This is kinda nonsense. First of all, you can save elsewhere, but money into a pension (even w/o employers contribs) means every 80 you put in become 100 immediately then grow from there. You'd be hard pressed to do better investing on your own. You may or may not be poor in retirement, but it won't have anything to do with DD, it has to do with how much you save in the end. DD rates wont make you poor, not having enough in your pot will. And DD rates change depending on your age, and gilts (ie the gad rate is set at a certain amt but this is not all the same and will vary getting larger the older you are. Any money left over is not lost (like annuity) but can be inherited 100% into a spouse's pension.

grey_gym_sock

i don't agree that you lose on a traditional pension. perhaps you lose if all your savings for retirement are in pensions, as then you may not be able get at enough of your money to go on those long cruises you planned in early retirement (or whatever you want to do). but so long as you have a sensible balance of pensions and more accessible investments, there's no insurmountable problem.

annuities are indeed a poor option at the start of retirement. and may well remain so. (though this is down to 2 factors: longer life expectancies, and very low yields on gilts. the first factor is likely to continue. the second may not, eventually.)

capped drawdown is the obvious approach in early retirement. currently that allows you to take out almost 6% at age 55 (rising with age). which is probably enough that the real value of your pension pot will fall gradually if you draw the maximum.

in later retirement, it's likely to make sense to switch from capped drawdown to buying an annuity. since the annuity rates get better as you get older. and this does allow you to make sure you spend nearly all your capital.

however, while i think pensions are OK, S&S ISAs tend to be better unless the pensions have any of the extra advantages which bigadaj mentioned (employer contributions, higher-rate tax relief, salary sacrifice scheme). all employers will have to offer employer contributions eventually.

nothing wrong with trying different countries. though there will be similar issues with retirement planning in any country!

jamesd

onthewayout wrote: »

When I get to retirement... or drawing it down so slowly (capped drawdown) that I'd not only be poor, I might never get to spend some of my money.

Assuming you die at 79 or older you'd get all of your own money back with capped drawdown if paying basic rate tax on the way in and out. At the 88 life expectancy you're ahead by 7.5% of what you put in. With an employer match of your gross contribution - the mandatory auto-enrolment level at the moment - you'd be ahead at 55 and would almost double your money by 88.

Lets pretend that you're a basic rate tax payer with no employer contribution or salary sacrifice arrangement so you only get basic rate tax relief. Pay in £800, get £1000 in the pension pot. At 55 take out £250 as a tax free lump sum and go into capped drawdown. You now have £750 left in the pot and I'll assume a more normal 4.5% gilt yield than the current one and use the Prudential GAD calculator from this table of capped drawdown limits:

in		1000	tax rate	0.2	net in	800	after lump sum		550
Initial input		550	initial pot	750					

age	years	GAD%	start	income	caprem	initrem
55-57	3	6.96	750.00	156.60	593.40	424.72
58-60	3	7.32	593.40	130.31	463.09	320.47
61-63	3	7.68	463.09	106.70	356.39	235.11
64-66	3	8.16	356.39	87.25	269.15	165.32
67-69	3	8.76	269.15	70.73	198.42	108.73
70-72	3	9.48	198.42	56.43	141.99	63.59
73-74	2	10.44	141.99	29.65	112.34	39.87
75	1	11.16	112.34	12.54	99.80	29.84
76	1	11.64	99.80	11.62	88.19	20.55
77	1	12.24	88.19	10.79	77.39	11.91
78	1	12.84	77.39	9.94	67.45	3.96
79	1	13.44	67.45	9.07	58.39	-3.29
80	1	14.16	58.39	8.27	50.12	-9.90
81	1	15.00	50.12	7.52	42.60	-15.92
82	1	15.84	42.60	6.75	35.85	-21.32
83	1	16.80	35.85	6.02	29.83	-26.14
84	1	17.76	29.83	5.30	24.53	-30.37
85	1	18.96	24.53	4.65	19.88	-34.09
86	1	18.96	19.88	3.77	16.11	-37.11
87	1	18.96	16.11	3.05	13.06	-39.55
88	1	18.96	13.06	2.48	10.58	-41.53

start = starting pension pot for the ages, income = income taken for the whole period, caprem = pension pot capital remaining, initrem = £ of your initial input remaining, after allowing for basic rate tax on the way out, negative means you're ahead.

What about with 100% employer matching of your gross contribution?

in		1000	tax rate	0.2	net in	800	after lump sum		550
Initial input		550	initial pot	750	employer matching amount:			500	

ages	years	GAD limit	start	income	caprem	initrem	
55-57	3	6.96	750.00	156.60	593.40	-75.28	
58-60	3	7.32	593.40	130.31	463.09	-179.53	
61-63	3	7.68	463.09	106.70	356.39	-264.89	
64-66	3	8.16	356.39	87.25	269.15	-334.68	
67-69	3	8.76	269.15	70.73	198.42	-391.27	
70-72	3	9.48	198.42	56.43	141.99	-436.41	
73-74	2	10.44	141.99	29.65	112.34	-460.13	
75	1	11.16	112.34	12.54	99.80	-470.16	
76	1	11.64	99.80	11.62	88.19	-479.45	
77	1	12.24	88.19	10.79	77.39	-488.09	
78	1	12.84	77.39	9.94	67.45	-496.04	
79	1	13.44	67.45	9.07	58.39	-503.29	
80	1	14.16	58.39	8.27	50.12	-509.90	
81	1	15.00	50.12	7.52	42.60	-515.92	
82	1	15.84	42.60	6.75	35.85	-521.32	
83	1	16.80	35.85	6.02	29.83	-526.14	
84	1	17.76	29.83	5.30	24.53	-530.37	
85	1	18.96	24.53	4.65	19.88	-534.09	
86	1	18.96	19.88	3.77	16.11	-537.11	
87	1	18.96	16.11	3.05	13.06	-539.55	
88	1	18.96	13.06	2.48	10.58	-541.53	-0.98

Ahead as soon as you take the lump sum and almost doubling your money by 88.


Now lets try that with higher rate income tax on the way in, basic on the way out but no employer contribution:

in		1000	tax rate	0.4	net in	600	after lump sum		350
Initial input		350	initial pot	750					

age	years	GAD%	start	income	caprem	initrem
55-57	3	6.96	750.00	156.60	593.40	224.72	
58-60	3	7.32	593.40	130.31	463.09	120.47	
61-63	3	7.68	463.09	106.70	356.39	35.11	
64-66	3	8.16	356.39	87.25	269.15	-34.68	
67-69	3	8.76	269.15	70.73	198.42	-91.27	
70-72	3	9.48	198.42	56.43	141.99	-136.41	
73-74	2	10.44	141.99	29.65	112.34	-160.13	
75	1	11.16	112.34	12.54	99.80	-170.16	
76	1	11.64	99.80	11.62	88.19	-179.45	
77	1	12.24	88.19	10.79	77.39	-188.09	
78	1	12.84	77.39	9.94	67.45	-196.04	
79	1	13.44	67.45	9.07	58.39	-203.29	
80	1	14.16	58.39	8.27	50.12	-209.90	
81	1	15.00	50.12	7.52	42.60	-215.92	
82	1	15.84	42.60	6.75	35.85	-221.32	
83	1	16.80	35.85	6.02	29.83	-226.14	
84	1	17.76	29.83	5.30	24.53	-230.37	
85	1	18.96	24.53	4.65	19.88	-234.09	
86	1	18.96	19.88	3.77	16.11	-237.11	
87	1	18.96	16.11	3.05	13.06	-239.55	
88	1	18.96	13.06	2.48	10.58	-241.53	-0.69

Now you're breaking even by age 65 and ahead by 69% of what you put in at 88.

How about basic rate with salary sacrifice and 0% of employer NI added?

in		1000	tax rate	0.32	net in	680	after lump sum		430
Initial input		430	initial pot	750					

age	years	GAD%	start	income	caprem	initrem55-57	3	6.96	750.00	156.60	593.40	304.72	
58-60	3	7.32	593.40	130.31	463.09	200.47	
61-63	3	7.68	463.09	106.70	356.39	115.11	
64-66	3	8.16	356.39	87.25	269.15	45.32	
67-69	3	8.76	269.15	70.73	198.42	-11.27	
70-72	3	9.48	198.42	56.43	141.99	-56.41	
73-74	2	10.44	141.99	29.65	112.34	-80.13	
75	1	11.16	112.34	12.54	99.80	-90.16	
76	1	11.64	99.80	11.62	88.19	-99.45	
77	1	12.24	88.19	10.79	77.39	-108.09	
78	1	12.84	77.39	9.94	67.45	-116.04	
79	1	13.44	67.45	9.07	58.39	-123.29	
80	1	14.16	58.39	8.27	50.12	-129.90	
81	1	15.00	50.12	7.52	42.60	-135.92	
82	1	15.84	42.60	6.75	35.85	-141.32	
83	1	16.80	35.85	6.02	29.83	-146.14	
84	1	17.76	29.83	5.30	24.53	-150.37	
85	1	18.96	24.53	4.65	19.88	-154.09	
86	1	18.96	19.88	3.77	16.11	-157.11	
87	1	18.96	16.11	3.05	13.06	-159.55	
88	1	18.96	13.06	2.48	10.58	-161.53	-0.38

Breaking even by 67 and ahead by 38% at 88.

How about higher rate income tax, basic rate salary sacrifice and half of the employer NI shared (you can get this if you have basic rate pay and higher rate other income, perhaps from investments or two jobs):

in		1000	tax rate	0.589	net in	411	after lump sum		161
	Initial input		161	initial pot	750					

ages	years	GAD limit	start	income	caprem	initrem	
55-57	3	6.96	750.00	156.60	593.40	35.72	
58-60	3	7.32	593.40	130.31	463.09	-68.53	
61-63	3	7.68	463.09	106.70	356.39	-153.89	
64-66	3	8.16	356.39	87.25	269.15	-223.68	
67-69	3	8.76	269.15	70.73	198.42	-280.27	
70-72	3	9.48	198.42	56.43	141.99	-325.41	
73-74	2	10.44	141.99	29.65	112.34	-349.13	
75	1	11.16	112.34	12.54	99.80	-359.16	
76	1	11.64	99.80	11.62	88.19	-368.45	
77	1	12.24	88.19	10.79	77.39	-377.09	
78	1	12.84	77.39	9.94	67.45	-385.04	
79	1	13.44	67.45	9.07	58.39	-392.29	
80	1	14.16	58.39	8.27	50.12	-398.90	
81	1	15.00	50.12	7.52	42.60	-404.92	
82	1	15.84	42.60	6.75	35.85	-410.32	
83	1	16.80	35.85	6.02	29.83	-415.14	
84	1	17.76	29.83	5.30	24.53	-419.37	
85	1	18.96	24.53	4.65	19.88	-423.09	
86	1	18.96	19.88	3.77	16.11	-426.11	
87	1	18.96	16.11	3.05	13.06	-428.55	
88	1	18.96	13.06	2.48	10.58	-430.53	-2.67

Break even by 59, up by 2.67 times what you put in at 88.

Pensions can be a really good deal. And that's without any employer matching except the NI sharing in the last one.

Lots of approximations here, like assuming investment growth is no more than inflation and grouping into sets of three years at the start.

AlTcher

Hello all. I'm a journalist looking for people to take part in a group study about annuities for a current affairs TV programme.

Participants need to be over the age of 55 and have an untouched pension. Filming will take place in Central London over the next week.

This isn't spam, I'm a real person, I'll be here following the thread all day so drop me a line if you're interested to find out more.

Best, Alex

atush

I don't live in London, nor will I touch an annuity under age 70.

So sorry can't take part.

FatherAbraham

onthewayout wrote: »

When I get to retirement, I'd be forced to choose between buying an annuity at a stupidly low rate (as in I'd actually lose money after inflation)

Bah. Annuity rates aren't "stupidly low", or even "low". They represent the cost of taking on your risk of outliving your capital. Retirement is more expensive than many people seem to think.

If you start out with bad preconceptions, you will end up with bad outcomes.

Warmest regards,
FA

gadgetmind

onthewayout wrote: »

When I get to retirement, I'd be forced to choose between buying an annuity at a stupidly low rate

Who says the rate will be low?

or drawing it down so slowly (capped drawdown) that I'd not only be poor, I might never get to spend some of my money.

The money is there to provide an income for the rest of your life. Yes, some might not get spent but this is better than running out.

All designed by the powers that be to stop me ending up on benefits, of course.

Yes, and I thank them for that.

jamesd

FatherAbraham wrote: »

Annuity rates aren't "stupidly low", or even "low". They represent the cost of taking on your risk of outliving your capital.

That cost is almost 50% of the possible after inflation income. It's a huge price to pay for greater certainty.

The most obvious alternative in a pension is drawdown. 5-6% income perhaps, plus inflation-related, though not formally linked, growth. That compares to perhaps 3.2% for an RPI annuity, depending on age.

For drawdown I'd want a generous safety margin, perhaps 50-100% if planning on taking 5 or 6% income. That's still much higher income than the annuity with lots of protection and an inheritance at the end if the really bad cases don't happen.

Using drawdown you also get more choice of when to take the money, able to do things like a barbell with higher income at the start, and if care is needed at the end, with a lower middle.

It's still appropriate at times to pay the price for increased certainty. Particularly for inexperienced investors and the most critical core income. Perhaps later when the annuity rates start to improve with age and the subsidy from those who die to those who live becomes more significant than it is at the relatively young ages below 75-80 or so.

Looking longer term it's worth wondering whether the annuity market is going to end up regulated out of existence by safety constraints placed on insurers. It's already pretty tough, with gilts being considered to be 100% efficient (a bad joke), but bonds also used by the companies, while investors can use much more balanced longer term investment mixtures to beat them. Even moderate amounts of flexibility on income levels, instead of forcing 100% at high certainty, might make it possible to put together more competitive annuity products. Most people can take say a 10% or 20% income drop in exchange for more income if the really bad market outcomes don't happen.

Meanwhile it looks to me as though non-annuity competition is gradually doing its job and progressively eliminating the odd annuity-dominated part of the UK retirement income market. Not quickly, but still seems to be heading towards the more internationally normal methods than the annuities quirk.