Inflation again

Thrugelmir

michaels said:

Thrugelmir said:

tichtich said:

Thrugelmir said:

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, 

I'm not sure what point you're making,  so let me return to my point that I think you were responding to, which was my suggestion that, in a period of high inflation, investing in the stock market would be a better bet over the long term than investing with a fixed 6% return. I didn't say how high inflation. For the sake of making the point clearer, let's assume a very high rate of inflation. Suppose that you were investing for the long term (say 25 years) and you expected inflation to be 20% p.a. over that period. Would you prefer investing over that period at 6% fixed return or investing in the stock market (let's say in global tracker fund)? Even if 20% inflation is bad for the economy and Biden hurts the economy by putting up taxes, the stock market is still going to give better than -14% p.a. real return over those 25 years (which is what the 6% fixed would return). A -14% real return over 25 years would be a loss of 97.7%! I think the stock market can do better than that,  even in unfavourable conditions. 

Rather than bet better to understand fully how markets function. My question to you is.  If inflation were to rise to 20%, why would fixed interest stocks (i.e. Government bonds) remain at a 6% yield?   

Bonds will always return the yield at which you purchased them, so if you purchased a £100 20 year gov bond paying 1.5% it will pay 1.50 per year for 20 years, whatever happens to inflation.  If inflation rises in the mean time there will also be a capital loss if you want to sell before the end of the term as the relative value of that fixed return diminishes.

Doesn't address the question I posed. 

tichtich

Thrugelmir said:

tichtich said:

Thrugelmir said:

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, 

I'm not sure what point you're making,  so let me return to my point that I think you were responding to, which was my suggestion that, in a period of high inflation, investing in the stock market would be a better bet over the long term than investing with a fixed 6% return. I didn't say how high inflation. For the sake of making the point clearer, let's assume a very high rate of inflation. Suppose that you were investing for the long term (say 25 years) and you expected inflation to be 20% p.a. over that period. Would you prefer investing over that period at 6% fixed return or investing in the stock market (let's say in global tracker fund)? Even if 20% inflation is bad for the economy and Biden hurts the economy by putting up taxes, the stock market is still going to give better than -14% p.a. real return over those 25 years (which is what the 6% fixed would return). A -14% real return over 25 years would be a loss of 97.7%! I think the stock market can do better than that,  even in unfavourable conditions. 

Rather than bet better to understand fully how markets function. My question to you is.  If inflation were to rise to 20%, why would fixed interest stocks (i.e. Government bonds) remain at a 6% yield?   

You've clearly forgotten what my original point was (it wasn't about fixed interest stocks). So I'll leave it there. 

sheslookinhot

I do understand the attraction of a bigger SP by deferral, but is it really necessary as we are getting to an age that we may not live to see the benefit of a few extra pounds.

jamesd

tichtich said:

 Deferral for 1 year at SRA gives you a 5.8% annuity rate, which I believe is nearly double what you can get on the open market for index linked (if you're healthy). The benefit declines slowly each year, as the 5.8% stays fixed and doesn't reflect your increased age, and because it isn't compounded. (At least I think it isn't. I hope someone will tell me I'm wrong.)

You take the state pension level at the time you stop deferring* and get an increase of 5.8% times the number of years deferred. No compounding of the 5.8% but you do benefit from the triple lock increases applied while deferring.

*This answer assumes residence in the UK or another country that gets annual increase for all of the deferral duration.

jamesd

sheslookinhot said:

Why defer the SP ? Is it not better to take when due and enjoy the benefits it brings. All you would be doing is getting a slightly increased amount for a shorter time period in which to spend it.

sheslookinhot said:

I do understand the attraction of a bigger SP by deferral, but is it really necessary as we are getting to an age that we may not live to see the benefit of a few extra pounds.

Deferring increases your income from the moment you start to defer, if in an income drawdown context.

What deferring does is:

1. Swaps invested money that may be paying you 3-3.8% to buy 5.8%. You can start drawing that higher income immediately. Note, though, that while the SWR may start at 3-3.8% by the time deferral comes along capital drawing might have been needed and there's even a chance that the SWR spending exceeds 5.8% of then-current capital.

2. Lets you use a lower success rate when calculating an income level, because you've increased your guaranteed income and reduced the consequence - lowered drawdown income - from failure of the drawdown rule to handle something worse than they were designed for. In the extreme, all of your normal spending might now be guaranteed and only optional things affected 

3. Provides longevity insurance. A forty year plan is pretty prudent but you could live longer after experiencing a bad sequence of returns that drained your pot. The state pension money will still be there.

tichtich

sheslookinhot said:

I do understand the attraction of a bigger SP by deferral, but is it really necessary as we are getting to an age that we may not live to see the benefit of a few extra pounds.

I look at it this way. Assuming that you have a pension pot,  then each £100 of state pension you take means an extra £100 in your pension pot. You can put the pension payment straight into your pot. Or you can spend it, and leave £100 in your pot that you would otherwise have withdrawn and spent. The other alternative is to not take the £100 pension payment, and have an extra state pension of £5.80 per year.

So the choice is between (a) the income you can get from an extra £100 in your pension pot, or (b) an income of £5.80 guaranteed for life and inflation-proofed.

There's no absolute right answer as to which is best. But at least looking at it this way reduces the choice to a more direct comparison,  so makes it easier to decide which suits you better. 

[Deleted User]

jamesd said:

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.

The premium you pay for inflation protected annuities is too high. Its a completely separate equation and issue from delaying state pension.  The latter is a great idea for anyone who has enough funds to bridge because the benefit per year of delay is so high. 

Part of the problem with inflation linked annuities isnt just the cost of such insurance but that you are buying something you don’t need.  Stats are showing that the rate of expenditure declines with age, including among people who can afford to spend more.  So, the erosion you get from inflation on a portion of your income isn’t a big deal.  Obviously one has to assume its not 1930s Germany but in he latter case insurance companies are going bankrupt and you have other issues. 

The books which discuss this and reference studies:
1. Safety first retirement planning
2. Retirement income for life. 

My personal approach is to take an annuity out for a portion of my portfolio around 75, if I get there.  Inflation is dealt with by the remaining equity portion.  If I spend 20% of the portfolio on an annuity, that combined with other DB and state pensions should cover basic needs until death. 

jamesd

Here's UK inflation for a few decades before the drop to 2-3% consistent level that started in 1993, final column is change from previous year:

1992	4.59%	-2.87%
1991	7.46%	-0.60%
1990	8.06%	2.30%
1989	5.76%	1.60%
1988	4.16%	0.01%
1987	4.15%	0.72%
1986	3.43%	-2.64%
1985	6.07%	1.11%
1984	4.96%	0.35%
1983	4.61%	-3.99%
1982	8.60%	-3.28%
1981	11.88%	-6.09%
1980	17.97%	4.54%
1979	13.42%	5.16%
1978	8.26%	-7.58%
1977	15.84%	-0.72%
1976	16.56%	-7.65%
1975	24.21%	8.16%
1974	16.04%	6.85%
1973	9.20%	2.12%
1972	7.07%	-2.37%
1971	9.44%	3.08%
1970	6.37%	0.92%
1969	5.45%	0.75%
1968	4.70%	2.22%
1967	2.48%	-1.43%
1966	3.91%	-0.86%
1965	4.77%	1.49%
1964	3.28%	1.26%
1963	2.02%	-2.18%
1962	4.20%	0.75%
1961	3.45%	2.44%
1960	1.00%	2.44%

jamesd

The five years from 1973 to 1977 cut income to 47% of its starting value. The next five cut it to 57% and the combination to 27% of starting income.

Of course I agree that spending tends to drop as people get older and 1% at the low income end to 2% at high wouldn't be too bad an approximation of that. It's something I suggest people plan for because it boosts early years income.

Your own plan, and indeed my own as well, of annuitising after age 75 at some point, or when annuities look to be good value, isn't too greatly harmed by those bad ten years because there's lots of other income and likely remaining life is most likely to be less than fifteen years.

It's a much bigger issue if it happens in say the first ten years of someone who retired at 55 and uses most of their money on a level annuity.

[Deleted User]

Agree that if you are buying an annuity at 55, it’s very different from 75.  

However, an inflation protected version might not be the best option.  For a 55 year old (if he wants an annuity), a fixed term annuity would likely be the best value, with the proceeds going into bonds. 

In general, an annuity isn’t the best instrument for dealing with inflation risks.  Equity is probably the best bet.