Foolishness of the 4% rule

[Deleted User]

Suspect that a lot of people who look at a constant level of expenditure from invested portfolio are extremely conservative and leave large unspent portfolios.  

For someone focused on ensuring a guaranteed minimal level of expenditure and not having enough DB income, use of a portion of the portfolio to buy annuities is the only way of ensuring this minimal level of expenditure.  The balance can then be both invested and used more aggressively.  In practice this strategy would translate in retiree’s ability to safely spend a lot more, even though annuities are unpopular. 

MK62

Deleted_User said:

Suspect that a lot of people who look at a constant level of expenditure from invested portfolio are extremely conservative and leave large unspent portfolios.  

For someone focused on ensuring a guaranteed minimal level of expenditure and not having enough DB income, use of a portion of the portfolio to buy annuities is the only way of ensuring this minimal level of expenditure.  The balance can then be both invested and used more aggressively.  In practice this strategy would translate in retiree’s ability to safely spend a lot more, even though annuities are unpopular. 

......though after buying the annuity to fund his/her minimal level of expenditure, this retiree may not have enough left to "safely spend a lot more".

[Deleted User]

MK62 said:

Deleted_User said:

Suspect that a lot of people who look at a constant level of expenditure from invested portfolio are extremely conservative and leave large unspent portfolios.  

For someone focused on ensuring a guaranteed minimal level of expenditure and not having enough DB income, use of a portion of the portfolio to buy annuities is the only way of ensuring this minimal level of expenditure.  The balance can then be both invested and used more aggressively.  In practice this strategy would translate in retiree’s ability to safely spend a lot more, even though annuities are unpopular. 

......though after buying the annuity to fund his/her minimal level of expenditure, this retiree may not have enough left to "safely spend a lot more".

Given that people seem to be brave enough to only withdraw 2 or 3% of their investments, an annuity would jack up their safe incomes by quite a bit. 

MK62

Deleted_User said:

MK62 said:

Deleted_User said:

Suspect that a lot of people who look at a constant level of expenditure from invested portfolio are extremely conservative and leave large unspent portfolios.  

For someone focused on ensuring a guaranteed minimal level of expenditure and not having enough DB income, use of a portion of the portfolio to buy annuities is the only way of ensuring this minimal level of expenditure.  The balance can then be both invested and used more aggressively.  In practice this strategy would translate in retiree’s ability to safely spend a lot more, even though annuities are unpopular. 

......though after buying the annuity to fund his/her minimal level of expenditure, this retiree may not have enough left to "safely spend a lot more".

Given that people seem to be brave enough to only withdraw 2 or 3% of their investments, an annuity would jack up their safe incomes by quite a bit. 

How so?

Given that 3% of eg £500k gives an income of £15k pa........how does buying an annuity "jack up" the safe income "by quite a bit"?

An RPI linked annuity, at 60, to supply a starting income of £10k pa, would currently cost a little under £500k.......there'd be very little left to cover the shortfall, let alone any increase.

DT2001

Deleted_User said:

Suspect that a lot of people who look at a constant level of expenditure from invested portfolio are extremely conservative and leave large unspent portfolios.  

For someone focused on ensuring a guaranteed minimal level of expenditure and not having enough DB income, use of a portion of the portfolio to buy annuities is the only way of ensuring this minimal level of expenditure.  The balance can then be both invested and used more aggressively.  In practice this strategy would translate in retiree’s ability to safely spend a lot more, even though annuities are unpopular. 

Odds are it wouldn’t work.
The concept, which if my memory serves me well, you have suggested before with the exception of buying an annuity when your older (and thus better rates) is sensible to cover ‘basic’ level spending.
The problem is that your Person is extremely conservative and it is unlikely he/she either invest with more volatility or spend aggressively.

The key is to work out a way to get people more interested in their own finances but also tailor the ‘rules’ to differing levels of interest. Some of the discussions on this forum are beyond me. I do not know if I could understand if I undertook sufficient research but I am happy to remain in the dark.
I like Guyton-Klinger because I’m happy to be flexible with expenditure but know others who want a monthly ‘pay cheque’ equivalent in retirement so need a 4% rule or an annuity.

[Deleted User]

MK62 said:

Deleted_User said:

MK62 said:

Deleted_User said:

Suspect that a lot of people who look at a constant level of expenditure from invested portfolio are extremely conservative and leave large unspent portfolios.  

For someone focused on ensuring a guaranteed minimal level of expenditure and not having enough DB income, use of a portion of the portfolio to buy annuities is the only way of ensuring this minimal level of expenditure.  The balance can then be both invested and used more aggressively.  In practice this strategy would translate in retiree’s ability to safely spend a lot more, even though annuities are unpopular. 

......though after buying the annuity to fund his/her minimal level of expenditure, this retiree may not have enough left to "safely spend a lot more".

Given that people seem to be brave enough to only withdraw 2 or 3% of their investments, an annuity would jack up their safe incomes by quite a bit. 

How so?

Given that 3% of eg £500k gives an income of £15k pa........how does buying an annuity "jack up" the safe income "by quite a bit"?

An RPI linked annuity, at 60, to supply a starting income of £10k pa, would currently cost a little under £500k.......there'd be very little left to cover the shortfall, let alone any increase.

RPI linked annuities are rare and non-competitive.  Should not be used.  Products worth buying are level annuities.  You use the remainder of portfolio which stays invested to deal with inflation.  Another option is escalating annuity with payments increasing by the same 1 or 2%. And keep in mind that statistically retirees spend less as they get older so inflation might not even be an issue in practical terms - but I wouldn’t want to rely on this statistics. 

Starting life annuity at 20, 30, 40, 50 or 60 is kinda silly.  Anything can be made look absurd using this approach.  You can however buy an annuity at 60 to start at 65 or 70 or 75.  Then you get extra mortality credits as well as investment growth over the period before payments start. 

[Deleted User]

DT2001 said:

Deleted_User said:

Suspect that a lot of people who look at a constant level of expenditure from invested portfolio are extremely conservative and leave large unspent portfolios.  

For someone focused on ensuring a guaranteed minimal level of expenditure and not having enough DB income, use of a portion of the portfolio to buy annuities is the only way of ensuring this minimal level of expenditure.  The balance can then be both invested and used more aggressively.  In practice this strategy would translate in retiree’s ability to safely spend a lot more, even though annuities are unpopular. 

Odds are it wouldn’t work.
The concept, which if my memory serves me well, you have suggested before with the exception of buying an annuity when your older (and thus better rates) is sensible to cover ‘basic’ level spending.
The problem is that your Person is extremely conservative and it is unlikely he/she either invest with more volatility or spend aggressively.

I think my “person” is so conservative because he is scared that money will run out and he’ll die from having nothing to eat.  And for someone without sufficient DB it makes sense to be worried.  Investments could crash at the worst possible time.  Or he/she could live till 110.  Or he/she could make an investment error - our ability to manage money diminishes with age.  Also, psychologically its hard to sell units/shares which you have been accumulating all your life.  Thats why many people try to live on dividends/interest which is usually a bad idea.  

The key is to work out a way to get people more interested in their own finances but also tailor the ‘rules’ to differing levels of interest. Some of the discussions on this forum are beyond me. I do not know if I could understand if I undertook sufficient research but I am happy to remain in the dark.
I like Guyton-Klinger because I’m happy to be flexible with expenditure but know others who want a monthly ‘pay cheque’ equivalent in retirement so need a 4% rule or an annuity.

Either GK or an annuity combined with aggressive investments  would be fine  but any strategy based on a 4% rule is a really bad idea. 

pensionpawn

Deleted_User said:

MK62 said:

Deleted_User said:

Suspect that a lot of people who look at a constant level of expenditure from invested portfolio are extremely conservative and leave large unspent portfolios.  

For someone focused on ensuring a guaranteed minimal level of expenditure and not having enough DB income, use of a portion of the portfolio to buy annuities is the only way of ensuring this minimal level of expenditure.  The balance can then be both invested and used more aggressively.  In practice this strategy would translate in retiree’s ability to safely spend a lot more, even though annuities are unpopular. 

......though after buying the annuity to fund his/her minimal level of expenditure, this retiree may not have enough left to "safely spend a lot more".

Given that people seem to be brave enough to only withdraw 2 or 3% of their investments, an annuity would jack up their safe incomes by quite a bit. 

I intend to draw down much more than 2% - 3% as I don't intend being buried with a huge pension pot.... The excess you between what you draw and what you need could be placed in a SAS ISA, held in cash, put into rolling 5 year saving plans, help offspring or reduce any still outstanding debt. For anyone with a full SP (or couple with 2 x SP) are you really on the poverty line wondering if you can go to the chip shop, turn up the gas? I understand the point you are lobbying for however I can't accept the risk that you drop £100k's into an annuity and drop dead shortly after. My security is the equity in my house and many years (due to pension moves etc and not yet reinvesting, which is for another thread...) draw down available in cash. I see 4% as a guideline to indicate the aspirational pension pot size, however we will be slowly eroding our pots over time I'm quite happy with a higher percentage as in bad times I can swap to cash. The first ten years after retirement are the golden years where the money you've saved shouldn't be held in a vault for your 80s+ Thus for us we'll not be mortgaging those golden years by remaining in work to create the enormous pension pot(s) size that 4% dictates we need. Horses for courses...... 

MK62

Deleted_User said:

RPI linked annuities are rare and non-competitive.  Should not be used.  Products worth buying are level annuities.  You use the remainder of portfolio which stays invested to deal with inflation. 

Hmm, the maths just doesn't seem to add up here.....

At 60yo, a single life level annuity (let's assume no partner or dependants) paying £15k pa would cost c£360k (using HL's Best Annuity Rate table). The remaining £140k would then be used to deal with inflation.....so where does this increase in safe income come from?

The remaining £140k, supplying the inflation protection, may or may not last 30 years (assuming 30 years is a reasonable target) - depends on the level of returns, the volatility of the investments, and the level of inflation.....it may not even be able to cover the inflation protection alone, let alone be enough to fund any "safe" increase in base income as well......

Deleted_User said:

Starting life annuity at 20, 30, 40, 50 or 60 is kinda silly.

In the UK, we cannot access pensions until we are 55yo (apart from special circumstances).

Looking at annuities before that might be "kinda silly".......but why do you think it's silly to look at annuities at 60yo?

PS - it was actually your suggestion to buy an annuity, as you said that "Given that people seem to be brave enough to only withdraw 2 or 3% of their investments, an annuity would jack up their safe incomes by quite a bit. " - I'm merely asking how?

Deleted_User said:

You can however buy an annuity at 60 to start at 65 or 70 or 75.

True, but what does this retiree live on while he/she awaits the payout?

OldScientist

Deleted_User said:

MK62 said:

Deleted_User said:

MK62 said:

Deleted_User said:

Suspect that a lot of people who look at a constant level of expenditure from invested portfolio are extremely conservative and leave large unspent portfolios.  

For someone focused on ensuring a guaranteed minimal level of expenditure and not having enough DB income, use of a portion of the portfolio to buy annuities is the only way of ensuring this minimal level of expenditure.  The balance can then be both invested and used more aggressively.  In practice this strategy would translate in retiree’s ability to safely spend a lot more, even though annuities are unpopular. 

......though after buying the annuity to fund his/her minimal level of expenditure, this retiree may not have enough left to "safely spend a lot more".

Given that people seem to be brave enough to only withdraw 2 or 3% of their investments, an annuity would jack up their safe incomes by quite a bit. 

How so?

Given that 3% of eg £500k gives an income of £15k pa........how does buying an annuity "jack up" the safe income "by quite a bit"?

An RPI linked annuity, at 60, to supply a starting income of £10k pa, would currently cost a little under £500k.......there'd be very little left to cover the shortfall, let alone any increase.

RPI linked annuities are rare and non-competitive.  Should not be used.  Products worth buying are level annuities.  You use the remainder of portfolio which stays invested to deal with inflation.  Another option is escalating annuity with payments increasing by the same 1 or 2%. And keep in mind that statistically retirees spend less as they get older so inflation might not even be an issue in practical terms - but I wouldn’t want to rely on this statistics. 

Starting life annuity at 20, 30, 40, 50 or 60 is kinda silly.  Anything can be made look absurd using this approach.  You can however buy an annuity at 60 to start at 65 or 70 or 75.  Then you get extra mortality credits as well as investment growth over the period before payments start. 

With a rate of 2.7% for a RPI annuity at 65 (with a 5 year guarantee that will not have a large effect at that age, see https://www.hl.co.uk/retirement/annuities/best-buy-rates) the actuaries appear to be expecting annualised inflation at about the 5% mark (if my rough calculations are correct) - so currently you are overpaying for inflation protection provided the BoE's target of 2% is met! Under those conditions, an annuity with a 3% escalation with a rate of 3.3% at least looks more reasonable. A possible rule of thumb (as if we didn't have enough of those!) is that if the annuity rate is greater than your intended withdrawal rate, then purchase may be useful (since it will then reduce the amount required to be withdrawn from the portfolio). So, if your target withdrawal was 4%, then a level annuity might be OK from 60 (rate is 4.2%), while one with 3% escalation meets the rule of thumb from 70 (4.1%). If your spend target is 3%, then an annuity with 3% escalation meets the rule of thumb at 65 (since the rate is 3.3%).

Level annuities may be useful for covering relatively short periods (since inflation doesn't have too much time to operate) - the median annualised inflation rate over 30 year periods in the US is around 3% (sorry, I don't have the UK figures to hand), so a level annuity bought at 65 would be worth about 40% of its original value in real terms by the time the annuitant was 95 (this average might explain the popularity of 3% escalations).

Purchasing annuities over several years (e.g. at ages 65, 70, 75, etc.) can also make sense (e.g. see Milevsky and Young, Annuitization and asset allocation, 2007 who said  where “annuitization can take place in small portions and at anytime, we find that utility-maximizing investors should acquire a base amount of annuity income (i.e. Social Security or a DB pension) and then annuitize additional amounts if and when their wealth-to-income ratio exceeds a certain level”.

Annuities are certainly not the bargain they were even 30 years ago with increases in life expectancies of about 20% for 65 year old males and decreases in interest rates. For example, according to Cannon and Tonks, UK annuity price series, 1957–2002, 2004, a 65 year old male would have got a level annuity with 5 year guarantee at a rate of 13.8% in 1990 and 8.5% in 2000 compared to the 4.9% now available.