Inflation again

tichtich

Thrugelmir said:

tichtich said:

Thrugelmir said:

tichtich said:

Also relating to inflation, what do you think about the fixed annuities that are still being given out? At 60 I was entitled to a section 32 fixed annuity and had to choose whether to take that or the transfer value I was offered. Reassure warned me against giving up the "valuable guaranteed income for life" (as they were probably obliged to do). But of course a fixed annuity is not really a guaranteed income for life. Inflation will certainly reduce it and could wipe it out almost entirely.

While I certainly wouldn't consider buying a fixed annuity at current rates, I did decide to take the fixed annuity on offer, as the transfer value available was only half the cost of buying the annuity on the open market. So effectively I was buying a fixed annuity at double the market annuity rate. (I assumed that if I took the transfer value I could have put it in a SIPP, but now I'm not sure if that was the case.) At that price I decided to take it, seeing it not as a pension for life, but just as a source of funds spread over time which I would invest in my SIPP (until I stop work) or use it to reduce withdrawals from my SIPP (later), and hopefully this would work out slightly better value than just investing the transfer value immediately. I just assumed that getting the annuity at half the market price made it decent value, but I didn't do any calculations. However, the other day I did a rough calculation and I reckon that the purchase amounted to getting a return of about 6% p.a. (allowing for mortality). With inflation at 2%, that amounts to a real return of 4%, which I'm happy with. But if inflation rises (which I expect), it doesn't look so good. In retrospect I don't think it was the right choice (assuming that the alternative was to invest the transfer value in a SIPP). But it wasn't an awful choice. I've already had 3 years annuity with inflation low, hopefully inflation won't go up too quickly, and--who knows--we could some time have a long period of deflation, in which case I would benefit.

It seems to me that the idea behind buying an annuity is that you get a guaranteed income for life by sacrificing the _probably_ higher (but uncertain) returns you could have got from investments. That makes sense if the annuity is index-linked (assuming you get an attractive enough rate). But with a fixed annuity you're sacrificing probable returns and getting no certainty in return. So a fixed annuity makes no sense (unless it's high enough above market rate to give you a higher expected return than the alternative).

My section 32 was probably better than the norm, as it was payable from age 60. (I also got more than just the GMP.) I suspect that in the typical case, the transfer value would be a larger proportion of the market cost of the annuity, in which case the choice to take the annuity would be poorer than in my case. So probably most people being offered fixed annuities would be better off taking the transfer value and putting it in a SIPP (if that's an option). I'm curious to know what the usual advice is in these cases.

What was the transfer value you were offered and the annuity you accepted. 

Transfer value was £44,288, Annuity is about £3,600 (of which £2,814 was GMP).

That's an exceptionally good yield. There's no risk free fixed interest investments that come anywhere close. Shares aren't correlated to rise with inflation if that was your thinking behind transferring to the SIPP. In fact research studies have shown the majority of shares underperform the return cash in the longer term. 

Yes, it's good if you compare with current fixed interest rates. But I wouldn't for a moment consider investing in long-term fixed-interest bonds at current rates. (The comparison should probably be with 25-year bonds, as male life expectancy at 60 is 25 years.)  Such investments are not really risk free, because of the risk of inflation. And even on the current inflation rate I think they are giving negative real returns. I would much rather risk the stock market than settle for that.

"Shares aren't correlated to rise with inflation if that was your thinking behind transferring to the SIPP."

I'm not sure what you mean here by "correlated", but I would expect the stock market to provide a real return over the long term. If that's not the case, it would largely undermine the idea of using the stock market to save for retirement. You'd be better off buying property, gold, or maybe just filling a warehouse with non-perishable goods!

jamesd

The inflation calculation approach is fine.

The growth assumptions aren't. We're at high equity and bond valuations and our starting point implies that even Which pessimistic is too optimistic unless you're using lots of small cap equity or something else to deviate upwards from UK large caps, which have a historic long term average return of about 5% plus inflation.

Linton

jamesd said:

The inflation calculation approach is fine.

The growth assumptions aren't. We're at high equity and bond valuations and our starting point implies that even Which pessimistic is too optimistic unless you're using lots of small cap equity or something else to deviate upwards from UK large caps, which have a historic long term average return of about 5% plus inflation.

And you dont want to plan on average returns since even if the future does match the past you have a 50% chance of missing your target return.

jamesd

Depends how you're planning. I'd say that using returns at all is wrong because safe withdrawal rates should be used instead. And those at anything close to 100% success rate more than amply allow for current market conditions.

My guess is that the Which calculator isn't using SWRs so it'll be overstating safe income levels by 1-2% of starting capital because of the sequence of returns risk problem.

[Deleted User]

There is no SWR. There is no 100% success rate. 

tichtich

Deleted_User said:

I’ve read a couple of studies showing that putting part of their investments into an annuity allows retirees to spend more. Even with current rates.

Any such conclusion must be conditional on some assumption about future inflation. In the extreme, if inflation next year was 1,000,000%, a fixed annuity would be worthless within a year. If future inflation turned out to be 0% forever (let alone negative) then a fixed annuity would turn out very well.

A fixed annuity might be OK for someone who doesn't have long to live,  so probably won't have time to be affected much by inflation. But such a person would not pay much extra for index-linking anyway, so why not pay the extra, just in case? 

You said, correctly, that an annuity is a form of insurance.  My point (put another way) was that it doesn't make much sense to pay a premium to insure against the 2 risks you mentioned, while exposing your income to another major risk, namely inflation. 

Thrugelmir

tichtich said:

Thrugelmir said:

tichtich said:

Thrugelmir said:

tichtich said:

Also relating to inflation, what do you think about the fixed annuities that are still being given out? At 60 I was entitled to a section 32 fixed annuity and had to choose whether to take that or the transfer value I was offered. Reassure warned me against giving up the "valuable guaranteed income for life" (as they were probably obliged to do). But of course a fixed annuity is not really a guaranteed income for life. Inflation will certainly reduce it and could wipe it out almost entirely.

While I certainly wouldn't consider buying a fixed annuity at current rates, I did decide to take the fixed annuity on offer, as the transfer value available was only half the cost of buying the annuity on the open market. So effectively I was buying a fixed annuity at double the market annuity rate. (I assumed that if I took the transfer value I could have put it in a SIPP, but now I'm not sure if that was the case.) At that price I decided to take it, seeing it not as a pension for life, but just as a source of funds spread over time which I would invest in my SIPP (until I stop work) or use it to reduce withdrawals from my SIPP (later), and hopefully this would work out slightly better value than just investing the transfer value immediately. I just assumed that getting the annuity at half the market price made it decent value, but I didn't do any calculations. However, the other day I did a rough calculation and I reckon that the purchase amounted to getting a return of about 6% p.a. (allowing for mortality). With inflation at 2%, that amounts to a real return of 4%, which I'm happy with. But if inflation rises (which I expect), it doesn't look so good. In retrospect I don't think it was the right choice (assuming that the alternative was to invest the transfer value in a SIPP). But it wasn't an awful choice. I've already had 3 years annuity with inflation low, hopefully inflation won't go up too quickly, and--who knows--we could some time have a long period of deflation, in which case I would benefit.

It seems to me that the idea behind buying an annuity is that you get a guaranteed income for life by sacrificing the _probably_ higher (but uncertain) returns you could have got from investments. That makes sense if the annuity is index-linked (assuming you get an attractive enough rate). But with a fixed annuity you're sacrificing probable returns and getting no certainty in return. So a fixed annuity makes no sense (unless it's high enough above market rate to give you a higher expected return than the alternative).

My section 32 was probably better than the norm, as it was payable from age 60. (I also got more than just the GMP.) I suspect that in the typical case, the transfer value would be a larger proportion of the market cost of the annuity, in which case the choice to take the annuity would be poorer than in my case. So probably most people being offered fixed annuities would be better off taking the transfer value and putting it in a SIPP (if that's an option). I'm curious to know what the usual advice is in these cases.

What was the transfer value you were offered and the annuity you accepted. 

Transfer value was £44,288, Annuity is about £3,600 (of which £2,814 was GMP).

That's an exceptionally good yield. There's no risk free fixed interest investments that come anywhere close. Shares aren't correlated to rise with inflation if that was your thinking behind transferring to the SIPP. In fact research studies have shown the majority of shares underperform the return cash in the longer term. 

Yes, it's good if you compare with current fixed interest rates. But I wouldn't for a moment consider investing in long-term fixed-interest bonds at current rates. (The comparison should probably be with 25-year bonds, as male life expectancy at 60 is 25 years.)  Such investments are not really risk free, because of the risk of inflation. And even on the current inflation rate I think they are giving negative real returns. I would much rather risk the stock market than settle for that.

"Shares aren't correlated to rise with inflation if that was your thinking behind transferring to the SIPP."

I'm not sure what you mean here by "correlated", but I would expect the stock market to provide a real return over the long term. If that's not the case, it would largely undermine the idea of using the stock market to save for retirement. You'd be better off buying property, gold, or maybe just filling a warehouse with non-perishable goods!

A higher rate of inflation does not correspond to a higher level of company profitability. Other factors influence overall company profitability. Such as employee costs and higher rates of corporate taxation. Both items on Biden's reform agenda, 

[Deleted User]

Sure, if inflation is one million million billion gazillion  then the studies will be proven wrong.  For most plausible scenarios for a couple “joint and thirds survivor” annuity gives the best value.

jamesd

Deleted_User said:

There is no SWR. There is no 100% success rate. 

Strictly true, as it is for private sector DB and to a lesser extent for level annuities. But in the SWR context you know that it means vs historic or similar experience.

jamesd

Deleted_User said:

Inflation protected annuities do not make mathematical sense under most foreseeable scenarios. You pay too much premium for that kind of insurance. 

I’ve read a couple of studies showing that putting part of their investments into an annuity allows retirees to spend more. Even with current rates.

If you're old or ill enough then inflation protected annuities can make sense even now.

Which studies are you thinking of?

In the SWR context the inflation-protected types can allow a lower success rate to be used because the consequences of failure are reduced. But those without inflation protection are a very mixed bag because well respected people consider high inflation to be the greatest threat to retirement plans.


I still suggest level sometimes, mostly for the early years, say before state pension age and deferral of that. But for a thirty to forty year retirement even the BoEs 2% inflation target implies an eventual income cut to 54.5% or 44.6%. Inflation linked are expensive but they do handle longevity and higher inflation risk better.

In the drawdown context the most common SWR approach has uncapped inflation increases for the whole plan duration so when it comes to longevity risk vs the level annuity you have to posit something so much worse than the last hundred plus years that you're forced to take a substantial cut to make it.

Still, I like guaranteed and inflation protected income so much that I usually want to recommend state pension deferral and eventual annuity buying.