Reducing volatility risk prior to retirement

[Deleted User]

michaels said:

Linton said:

Deleted_User said:

If you want to bet then just put everything into equities and take your chances.  Of course then people are talking about “SWR” of 3% rather than guaranteed 5% from an annuity and the 3% isn’t actually “safe”. Thats a massive difference in spending cash. 

The problem with your last scenario is that you keep talking about “most people” and “bets”. Many don’t want to play Russian Roulette when the losers get to beg for food in their twilight years. A 5% chance of that happening is way too high in my book, let alone 45% in your example. And life expectancy for someone who lives to 85 years is 7 years. Thats a nightmare scenario you’ve just drawn for that person. 

Seems to me that a risk averse 65 year old who buys a 5% annuity to cover the delta between his DB income and minimum needs, and still has a sizeable stock portfolio to deal with the inflation, “extras” and legacy might well buy both peace of mind and more spending money than your betting person. He can afford to take lots of risk with the remaining liquid portfolio vs a person who has to worry about providing for his very basic needs. So based on “betting” he might come out ahead as well. An annuity would provide a great value to him/her. 

Agree with the general principle apart from one detail - a 5% annuity would be fixed rate that is 99.9% guaranteed to reduce in real value over time whereas a 3% SWR (3% is lower than most people quote) is by definition 100% inflation linked so the two are not comparable.   Fixed rate income is high risk in my view unless you have a low risk strategy to replace it in later years.

Agree, compare apples with apples; age 55,index linked annuity 1.6% vs swr 3.5% - problem is that is historically safe rather than guaranteed safe.

Some chocholate tastes bad. Does it mean that all chocolate tastes bad? Why would you pick a terrible annuity option given the number of far superior alternatives? 

bostonerimus

Deleted_User said:

Linton said:

Deleted_User said:

If you want to bet then just put everything into equities and take your chances.  Of course then people are talking about “SWR” of 3% rather than guaranteed 5% from an annuity and the 3% isn’t actually “safe”. Thats a massive difference in spending cash. 

The problem with your last scenario is that you keep talking about “most people” and “bets”. Many don’t want to play Russian Roulette when the losers get to beg for food in their twilight years. A 5% chance of that happening is way too high in my book, let alone 45% in your example. And life expectancy for someone who lives to 85 years is 7 years. Thats a nightmare scenario you’ve just drawn for that person. 

Seems to me that a risk averse 65 year old who buys a 5% annuity to cover the delta between his DB income and minimum needs, and still has a sizeable stock portfolio to deal with the inflation, “extras” and legacy might well buy both peace of mind and more spending money than your betting person. He can afford to take lots of risk with the remaining liquid portfolio vs a person who has to worry about providing for his very basic needs. So based on “betting” he might come out ahead as well. An annuity would provide a great value to him/her. 

Agree with the general principle apart from one detail - a 5% annuity would be fixed rate that is 99.9% guaranteed to reduce in real value over time whereas a 3% SWR (3% is lower than most people quote) is by definition 100% inflation linked so the two are not comparable.   Fixed rate income is high risk in my view unless you have a low risk strategy to replace it in later years.

SWR isn’t actually anywhere near as “safe” as annuity income whether its 3% or not. Perhaps 3% is too high in my example.  It is true that inflation linked annuities provide poor value. In my example you deal with inflation by leaving some of your portfolio in 100% stocks and using annuity for the FI portion of your portfolio.  The other point is that statistically  people tend to spend less as they grow older. Perhaps inflation isnt an issue?  Not sure about that. 

I agree with the basic principle here, just not now as annuities are such bad value. It's the ongoing problem of generating "safe" retirement income when interest rates are tending toward 0%.

[Deleted User]

bostonerimus said:

Deleted_User said:

If you want to bet then just put everything into equities and take your chances.  Of course then people are talking about “SWR” of 3% rather than guaranteed 5% from an annuity and the 3% isn’t actually “safe”. Thats a massive difference in spending cash. 

The problem with your last scenario is that you keep talking about “most people” and “bets”. Many don’t want to play Russian Roulette when the losers get to beg for food in their twilight years. A 5% chance of that happening is way too high in my book, let alone 45% in your example. And life expectancy for someone who lives to 85 years is 7 years. Thats a nightmare scenario you’ve just drawn for that person. 

Seems to me that a risk averse 65 year old who buys a 5% annuity to cover the delta between his DB income and minimum needs, and still has a sizeable stock portfolio to deal with the inflation, “extras” and legacy might well buy both peace of mind and more spending money than your betting person. An annuity would provide a great value to him/her. 

That 3% is index linked so you need to compare it with the 2% index linked annuity. 

I don’t. SWR is anything but guaranteed. It has the advantage of supposedly being linked to inflation but the disadvantage that its based on the past 100 years and s far from assured.  Insurance companies rarely fail, and even then there is lots of protection. An annuity is safer than relying on a 3% SWR. 

[Deleted User]

“ I would not lock in today's historically low annuity rates. I would annuitize later on if necessary.”

We don’t know future annuity rates. Life expectancy may increase. Bond returns may decrease.  

Linton

Thrugelmir said:

Linton said:

Deleted_User said:

If you want to bet then just put everything into equities and take your chances.  Of course then people are talking about “SWR” of 3% rather than guaranteed 5% from an annuity and the 3% isn’t actually “safe”. Thats a massive difference in spending cash. 

The problem with your last scenario is that you keep talking about “most people” and “bets”. Many don’t want to play Russian Roulette when the losers get to beg for food in their twilight years. A 5% chance of that happening is way too high in my book, let alone 45% in your example. And life expectancy for someone who lives to 85 years is 7 years. Thats a nightmare scenario you’ve just drawn for that person. 

Seems to me that a risk averse 65 year old who buys a 5% annuity to cover the delta between his DB income and minimum needs, and still has a sizeable stock portfolio to deal with the inflation, “extras” and legacy might well buy both peace of mind and more spending money than your betting person. He can afford to take lots of risk with the remaining liquid portfolio vs a person who has to worry about providing for his very basic needs. So based on “betting” he might come out ahead as well. An annuity would provide a great value to him/her. 

Agree with the general principle apart from one detail - a 5% annuity would be fixed rate that is 99.9% guaranteed to reduce in real value over time whereas a 3% SWR (3% is lower than most people quote) is by definition 100% inflation linked so the two are not comparable.   Fixed rate income is high risk in my view unless you have a low risk strategy to replace it in later years.

By whose definition?  

For example https://monevator.com/how-to-choose-an-swr-for-your-isa-and-your-pension-to-hit-financial-independence-fast/

Says:

• …SWR strategies enable you to withdraw a consistent, inflation-adjusted income for the duration of your retirement (subject to all-important caveats that you need to understand).

bostonerimus

Deleted_User said:

“ I would not lock in today's historically low annuity rates. I would annuitize later on if necessary.”

We don’t know future annuity rates. Life expectancy may increase. Bond returns may decrease.  

True enough, but we can make sensible assumptions and play the probabilities.

[Deleted User]

Annuities are not for people enjoying “playing probabilities”… But maybe they are. One could use annuities for the 40% portion of a 60/40 portfolio instead of bonds. With a rate of 0.5% on a 10 year bond, a 5% life annuity looks like a far superior option based on probabilities. 

Robert_McGeddon

An annuity dies with you (or perhaps your spouse) whilst a DC arrangement under SWR does not. If you have depentants to pass you estate on to the DC has an advantage over the annuity. It also offers flexibility in drawdown that an annuity doesn't match - a source for funding a new roof  or reducing the withdrawal rate some years if your spending decreases.  At the moment I don't think annuities are particularly attractive to me, but if the rate of return improves and/or as I age I'm prepared to change my mind.

[Deleted User]

Discussion above is about a part of your DC pot being used for annuities. That deals with both issues to some extent.  And there are annuity products which guarantee a legacy.  Not that I am a fan of focusing on legacies. 

People concerned that they could be losing out on far superior future annuity rates could use annuity ladders. 

Thrugelmir

Linton said:

Thrugelmir said:

Linton said:

Deleted_User said:

If you want to bet then just put everything into equities and take your chances.  Of course then people are talking about “SWR” of 3% rather than guaranteed 5% from an annuity and the 3% isn’t actually “safe”. Thats a massive difference in spending cash. 

The problem with your last scenario is that you keep talking about “most people” and “bets”. Many don’t want to play Russian Roulette when the losers get to beg for food in their twilight years. A 5% chance of that happening is way too high in my book, let alone 45% in your example. And life expectancy for someone who lives to 85 years is 7 years. Thats a nightmare scenario you’ve just drawn for that person. 

Seems to me that a risk averse 65 year old who buys a 5% annuity to cover the delta between his DB income and minimum needs, and still has a sizeable stock portfolio to deal with the inflation, “extras” and legacy might well buy both peace of mind and more spending money than your betting person. He can afford to take lots of risk with the remaining liquid portfolio vs a person who has to worry about providing for his very basic needs. So based on “betting” he might come out ahead as well. An annuity would provide a great value to him/her. 

Agree with the general principle apart from one detail - a 5% annuity would be fixed rate that is 99.9% guaranteed to reduce in real value over time whereas a 3% SWR (3% is lower than most people quote) is by definition 100% inflation linked so the two are not comparable.   Fixed rate income is high risk in my view unless you have a low risk strategy to replace it in later years.

By whose definition?  

For example https://monevator.com/how-to-choose-an-swr-for-your-isa-and-your-pension-to-hit-financial-independence-fast/

Says:

• …SWR strategies enable you to withdraw a consistent, inflation-adjusted income for the duration of your retirement (subject to all-important caveats that you need to understand).

That's based on US historical returns of 15-40 year periods to 2014.  Not very usefull to a UK based investor who will experienced a very different scenario of inflation, interest rates and market returns.  

The fact that the choosen starting point of the data is 1974 at the start of the bond bull market appears somewhat selective. 

Nor does it address the issue of constructing a portfolio today that will perform over the next 40 years.