Flat Rate v Escalating Rate for Annuity?

Channelman

I have a sum of money, currently with Scottish Widows, which was the
'SERPS equivalent' part of a company pension scheme. I am due to
claim this soon and buy an annuity.
It stands at £37,200 at the moment and after taking the 25% cash part I
have been quoted either £1425 increasing at 3% per year or £2042 flat rate.
Both these figures are for a 'single life' annuity but the 'dual life' figures
differ by a similar ratio.
Putting these two figures into a spread sheet it appears to me that
for the excalating rate to attain the flat rate income would take 12 years
(when I would be 77) and for the total amount of cash received to
'break even', would take 23 years (when I would be 88).
If I was to take the flat rate I would like to think that I would live long
enough for them to 'win', but I thought that the average life expectancy
for a male to be about 75.
Have I missed something here or is my reasoning flawed?

EdInvestor

Channelman wrote: »

Have I missed something here or is my reasoning flawed?

No.Index linked annuities are not popular because they are such poor value.

dunstonh

EdInvestor wrote: »

No.Index linked annuities are not popular because they are such poor value.

Apart from when they are good value and best advice based on your age or the type of increase you are using.

RPI linking often assumes a level increase p.a. for illustration purposes but in reality, you break even much earlier than the 20 odd years that level increases would take.

Channelman

dunstonh wrote: »

RPI linking often assumes a level increase p.a. for illustration purposes but in reality, you break even much earlier than the 20 odd years that level increases would take.

The quote was not for RPI linking.....just a straight 3% pa.....so no risk for them.

[Deleted User]

I think it's fine to gamble with taking the flat rate SO LONG AS you will have enough money should you live to be 120. Remember that inflation will reduce the flat rate sum to a tiny fraction of its current worth in 20 years.

Also, remember you can partially hedge against longevity by investing the extra element you get from the flat rate.

Make sure you get the best rate from your annuity (sure you are if you're posting here). And be aware that there are various different extra options, including guaranteeing the income for a certain number of years depending on how long you survive.

And finally - don't forget the 25% tax free lump sum you can take! Definitely worth it.

[Deleted User]

EdInvestor wrote: »

No.Index linked annuities are not popular because they are such poor value.

That's not true! On average people receive the same whichever they sign up for. It's a gamble, so if your annuity is your only major asset and you couldn't afford to live if its value fell in real terms by 90% (which can happen surprisingly quickly thanks to inflation) then it is definitely sensible to RPI-link your annuity.

Ultimately, if you don't need the money, I wouldn't index link it. If you do, I would absolutely index link it. Ultimately you may receive less (even substantially less), but the upside is reducing the risk of living the last years of your life in poverty.

Xbigman

Deleted_User wrote: »

That's not true! On average people receive the same whichever they sign up for. It's a gamble, so if your annuity is your only major asset and you couldn't afford to live if its value fell in real terms by 90% (which can happen surprisingly quickly thanks to inflation) then it is definitely sensible to RPI-link your annuity.

Ultimately, if you don't need the money, I wouldn't index link it. If you do, I would absolutely index link it. Ultimately you may receive less (even substantially less), but the upside is reducing the risk of living the last years of your life in poverty.

Would your advice be the same if the index linking was capped at 2.5%?

Surely a 2.5% cap just prolongs the erosion of the pension in real terms, instead of stopping it?
Regards




X

ManAtHome

From memory, I worked out a few years back the same "break-even point" at 3%, and pretty sure RPI would have had to average 5% ish to hit the same target (as RPI-linked start lower than 3% escalating). Obviously things look up after this, but...

Also if you take a level annuity and bank the difference between that and the escalating value each year, the interest on your "extra" capital can stretch things a bit further...

EdInvestor

Deleted_User wrote: »

Remember that inflation will reduce the flat rate sum to a tiny fraction of its current worth in 20 years.

At current levels its spending power will be reduced by a bit less than half in 20 years. Not great, but a bit better than a "tiny fraction".

I guess the main change in recent years in this area is that many people are now retiring on bigger state pensions than in the past because of SERPS/S2P. An annual state pension of 10k is not unusual, and this is index linked at RPI, guaranteed by the Government and carries a 100% spouse's pension.A quality final salary company pension will offer similar security.

An additional personal pension fund can thus perhaps be better deployed in a drawdown plan giving the potential of beating inflation through long term growth at much lower cost.

Channelman

Deleted_User wrote: »

Ultimately you may receive less (even substantially less), but the upside is reducing the risk of living the last years of your life in poverty.

BUT....to loose out don't I have to live longer than 88 years?
Not very likely....but if I do then that's a bonus alone.
Looks like the flat rate is a win-win situation.
Nothing anyone has said has convinced me otherwise.
Thanks for all your opinions and views.
Channelman

EdInvestor

Channelman wrote: »

Looks like the flat rate is a win-win situation.

Would have to agree, as mentioned if inflation is a concern, then save, don't spend the difference between the index linked annuity payment and the flat rate payment, so you can top up the flat rate later on to compensate.

There is a risk if inflation goes haywire again as in the 1970s that this would not be enough.However, authorities in developed countries have in recent years demonstrated their ability to keep inflation in low single digits despite repeated recurrences of 1970s type inflation triggers ( oil price hikes, Middle East wars, stockmarket booms and crashes,increased asset prices etc).

But it's your call whether this will continue throughout your lifetime.In any case there are other ways of coping apart from index linked annuities.