'Annuities are poor value' - what do they know that we don't?

BritishInvestor

Thrugelmir said:

BritishInvestor said:

Thrugelmir said:

BritishInvestor said:

Deleted_User said:

zagfles said:

michaels said:

Deleted_User said:

michaels said:

Deleted_User said:

1. “No failure SWR” does not exist. Its a misnomer.  There is a conceptual problem with defining a constant withdrawal rate from an inherently volatile asset like stocks. SWR is based on a portfolio of mostly stocks.  

2. SWR is typically calculated based on past 100 years’ worth of data for the next 30 years. Annuity has no expiry. The main risk for the vendor is that you will live way too long. 

3. You pay for buying an insurance policy. Thats what annuity is.  A company is pooling risks and providing you with an insurance product. They take a cut. 

4. You should really compare annuity rates to coupons on long term government bonds.  Thats a truly safe product, up to the point of expiry.  Makes annuities look pretty good, huh? In fact, one of the strategies in this environment involves a 60 year old buying an annuity with a portion of your portfolio and spending the proceeds to buy bonds. You gain vs just holding bonds right away if you live to 75 or so. 

Part of what the markets do is pool and share risk, thus we would expect an annuity provider to be able to provide a higher return that simply buying govt bonds to cover the likely distribution of policy holder longevities.

Seems like the big discrepancy is telling us that SWRs based on historical returns are actually higher than current market consensus for probable future returns and if you believe in efficient markets you are basically betting on the market being wrong if you plump for a 'historically conservative' 3.25% SWR for a retirement that might last more than 30 years.

You are discovering that SWR does not exist. Otherwise insurance companies selling annuities would have used it.  Instead they use long term government bonds because SWR isn’t for real. 

So given an annuity pools longevity risk, despite the provider profit margin it is actually probably better value for an individual than drawdown - is that the conclusion I should be drawing?

Yes, if you want a guaranteed income for life, then index linked annuities are what you should go for. As above, there's no such thing as a "SWR" from a drawdown pension. There's only speculation, usually based on the assumption that the future will be similar to the past.

Personally I'm willing to tolerate some financial risk, after all we tolerate risk in virtually every other walk of life, if I can live with a 1 in 2 chance of getting cancer I can certainly live with a chance my pension might be less than I'd hoped for. Like all things you weigh up the risk and cost/benefit of your options.

Cancer is something we can’t control so its different.  Having a pension “less than hoped” isn’t a problem. The main risk is outliving your money.  Not a pleasant scenario. Even a 5% probability seems unacceptable to me. 

Agreed that outliving your money is not the outcome you desire. But assuming that monitor your retirement journey periodically (e.g. annually), you should get plenty of warning that adjustments might need to be made. Taking the worst case outcome for a random case study....someone retiring in 1968 at aged 60 would be hit early in retirement by the prolonged market falls and lumpy inflation in the 1970s (in sharp contrast to our Covid discussion), and withdrawals may need to be adjusted. 



Assuming spending was cut by 5% at this point (aged 66, so for example an inflation-adjusted £40k is reduced to £38k going forwards), the eventual outcome is a lot more favourable. 

How many people in 1968 could afford early retirement?  My late father spent 8 years in the British Army in Palestine between 1940 and 1948. Never had a DB pension scheme despite a successfull career post war.  Never recovered those best earning years of his life that he lost. Ended up working part time well into retirement. As no family inheritances to speak of.  

I'm not sure re your answer of 1968 and early retirement, but the age chosen was just to demonstrate the impact a small adjustment early on in retirement can have on plan sustainability. 
Re your father, did he get nothing from the Army in terms of pension? My Grandpa (RIP) was in the Army around the same time but I've no idea what he got.

Numbers mean very little unless put into context of the era and the years that went before. State pension entitlements for example. 

We're discussing sustainability for withdrawals from a given retirement pot (using the late 1960 as a poor series of returns). State pension entitlement is not particularly relevant to the point I'm trying to make. 

arnoldy

Google the HQs of some of the big annuity providers - lots of prestigious glass and marble palaces paid for by those who brought annuities. And then look at the CEO pay, bonus and expenses for the big insurers, & assume that there are probably hundreds, maybe thousands on 100k plus in a long tail of highly paid suits. 
All feeding on your annuity.
And then look at the dividends paid out.
Really can't understand why anyone would buy an annuity - unless its a form of UK financial services charity donation.

[Deleted User]

newatc said:

With Covid being an additional risk, I would have thought that should translate into higher annuities (which I suppose it may have done but is hidden by low bond yields).

I am not sure the impact on average life expectancy has been statistically significant.  Unless you are over 70. 

itwasntme001

A 30 year index linked gilt yields -2.2%.  A RPI linked annuity for a 60 year old "yields" +1.7%.  That is a near 4% difference in yield.  It takes about 25 years to recover the capital for the annuity to be "equivalent" to a linker.  Therefore an annuity seems pretty fair value if you expect to live for 25 years from 60, which is what the average in UK is anyway.

[Deleted User]

itwasntme001 said:

A 30 year index linked gilt yields -2.2%.  A RPI linked annuity for a 60 year old "yields" +1.7%.  That is a near 4% difference in yield.  It takes about 25 years to recover the capital for the annuity to be "equivalent" to a linker.  Therefore an annuity seems pretty fair value if you expect to live for 25 years from 60, which is what the average in UK is anyway.

Right. 

An interesting strategy of dealing with the longevity risk is to buy annuity, say with 30%  of your portfolio when you are 60.  Use the 70% for day-to day spending.  Buy bonds with the annuity income.  This strategy is supposed to provide more safety than having 30% in bonds to start with.

Linton

itwasntme001 said:

A 30 year index linked gilt yields -2.2%.  A RPI linked annuity for a 60 year old "yields" +1.7%.  That is a near 4% difference in yield.  It takes about 25 years to recover the capital for the annuity to be "equivalent" to a linker.  Therefore an annuity seems pretty fair value if you expect to live for 25 years from 60, which is what the average in UK is anyway.

AIUI index linked gilt YTM values are based on the assumption of 3% inflation.  So -2.2% is equivalent to about +0.8% in cash terms if we did get 3% inflation.

itwasntme001

Deleted_User said:

itwasntme001 said:

A 30 year index linked gilt yields -2.2%.  A RPI linked annuity for a 60 year old "yields" +1.7%.  That is a near 4% difference in yield.  It takes about 25 years to recover the capital for the annuity to be "equivalent" to a linker.  Therefore an annuity seems pretty fair value if you expect to live for 25 years from 60, which is what the average in UK is anyway.

Right. 

An interesting strategy of dealing with the longevity risk is to buy annuity, say with 30%  of your portfolio when you are 60.  Use the 70% for day-to day spending.  Buy bonds with the annuity income.  This strategy is supposed to provide more safety than having 30% in bonds to start with.

Yeh I think there is a strong case for replacing the bond part of your portfolio with an annuity.  They appear even better than linkers because of the added longevity risk hedge.  So unless you have reason to believe a shorter than average life expectancy, an annuity wins over a linker.  And you certainly want inflation protection over the longer term so an annuity over a nominal gilt is probably an even bigger win.

You also don't have to worry about managing that bond part of your portfolio any more, no broker fees to pay to hold it for you, nothing to administer and an annuity is 100% backed by the UK taxpayer.  All of which are very valuable into old age.  There maybe some tax implications however, especially if you receive income from other sources such as state pension.

itwasntme001

Linton said:

itwasntme001 said:

A 30 year index linked gilt yields -2.2%.  A RPI linked annuity for a 60 year old "yields" +1.7%.  That is a near 4% difference in yield.  It takes about 25 years to recover the capital for the annuity to be "equivalent" to a linker.  Therefore an annuity seems pretty fair value if you expect to live for 25 years from 60, which is what the average in UK is anyway.

AIUI index linked gilt YTM values are based on the assumption of 3% inflation.  So -2.2% is equivalent to about +0.8% in cash terms if we did get 3% inflation.

The linker yield i quoted is already a real yield so -2.2% can be compared to an index linked annuity rate of +1.7%.  If we get exactly the expected inflation (3% if you say it is that), then the linker will yield -2.2% in real terms if held to maturity.

[Deleted User]

The other aspect of this strategy is that it is supposed to allow a larger withdrawal in your 60s because you don’t need to hold back quite so much to mitigate longevity risk.  I haven’t looked into this properly but could be a good approach given what’s happening with bonds. 

itwasntme001

It is crazy that the market thinks its ok to lose 50% in real terms on an index linked gilt if inflation turns out to be as expected, but that is the crazy world we live in today.

Obviously people buy it as they expect inflation to rise by more for buy and hold OR expect real yields to fall for trading.