Foolishness of the 4% rule

Terron

Deleted_User said:

They have been forced to shift as much as permitted into stocks and private equity to juice returns.  And many (most?) are underwater wth typically just 60% funding level.  I believe some UK schemes purchased annuities to ensure adequate funding provisions but many can’t afford it exactly because they are underfunded. 

The majority of UK pensions schemes that are still open are public sector ones and most of them are not funded at all. Current pensioners are paid out of current contributions. The exception in the public sector is the local government scheme. That had a return of -4.8% last year, but is 98% funded. It has 1.8 million pensioners, 6.2 million members and assets of £276 billion.

According to PWC the over 5k UK corporate pension schemes moved into overall surplus this year for the first time since they started measuring in 2014. 

My first DB pension is 103% funded - though their policy of not giving any rises once in payment probably helps that.

My other one is 52% funded.

[Deleted User]

The part you are completely missing is that with a bond you can’t safely spend anywhere near as much as you can with annuity. Bonds could deal with longevity risk if you knew your  duration but of course you don’t. So you buy US 10 yr treasuries at 1.3%.  The rate you are quoting is a commercial risky asset which does not begin to compare to annuities in terms of safety. But you have no idea what rate you’ll get in 10 years when your bond comes up for renewal. Could be 0.5%.   Are you ok with a risk of your safe fixed income asset paying you less than half in 10 years’? A ladder would make the fall smoother but its still a fall. 

 “Return” will depend on longevity but if your bond is a part of an SWR type portfolio, the invested money is committed.  You can’t afford to withdraw beyond “swr” which is unsafe even so.  Your draw 4% of initial amount only, and you carry the risk of outliving all your money.  People live beyond 95 and for a 65 year old the chances are very high. 

And if all you care about is returns, there are lots of examples showing you can buy a fixed term 20 year annuity, reinvest into bonds and still do much better than with just a bond ladder. I am too lazy to google.

Audaxer

I wouldn't hold individual bonds, but I think bond funds can be a useful part of a balanced portfolio. For example the Jupiter Strategic Bond fund currently has a yield of 3.7%, and a 10 year annualised Total Return of 5.74%.

[Deleted User]

Of course bonds are useful. If this is the yield, the fund holds quite a few junk bonds.  By all means, go for it but please don’t compare to something that does not get impacted during major downturns. 

bostonerimus

Deleted_User said:

The part you are completely missing is that with a bond you can’t safely spend anywhere near as much as you can with annuity. Bonds could deal with longevity risk if you knew your  duration but of course you don’t. So you buy US 10 yr treasuries at 1.3%.  The rate you are quoting is a commercial risky asset which does not begin to compare to annuities in terms of safety. But you have no idea what rate you’ll get in 10 years when your bond comes up for renewal. Could be 0.5%.   Are you ok with a risk of your safe fixed income asset paying you less than half in 10 years’? A ladder would make the fall smoother but its still a fall. 

 “Return” will depend on longevity but if your bond is a part of an SWR type portfolio, the invested money is committed.  You can’t afford to withdraw beyond “swr” which is unsafe even so.  Your draw 4% of initial amount only, and you carry the risk of outliving all your money.  People live beyond 95 and for a 65 year old the chances are very high. 

And if all you care about is returns, there are lots of examples showing you can buy a fixed term 20 year annuity, reinvest into bonds and still do much better than with just a bond ladder. I am too lazy to google.

I'm not proposing a "bond" ladder I'm proposing a ladder of "fixed rate saving bonds". If you lock your money up for 5 years you will get a guaranteed 1.75% annual interest and as each saving bond matures you get the opportunity to reinvest, hopefully at a higher rate, rather than locking in 0% if you live an average life span or 2% if you live 5 years longer than expected. I think it's a very good bet that interest rates will rise and you can take advantage of that with a saving bond ladder. Of course you could buy as ladder of 5 year annuities too. 

bostonerimus

Deleted_User said:

bostonerimus said:

Thrugelmir said:

bostonerimus said:

Deleted_User said:

Linton said:

Deleted_User said:

I think that “low annuity rates”  are a red herring.  The past does not matter. We dont know the future. Lots of great and highly competitive rates are available today. 

Agree that combining a “guarantee” with market exposure is the best solution for retirees. Which is readily available to DC pension holders. 

Really? What rates available in the UK do you consider "great"? What are they competitive with?

They are extremely competitive when pitched against other fixed income instruments.  Do you want a steady guaranteed income for some of your portfolio?  And, given the title of this thread, they are very competitive with SWR (which isnt even guaranteed). 

When you compare !!!!!! with !!!!!! then that will be true. You are basically just buying longevity insurance with an annuity today. You will lock in very low income and most people will be better off with the flexibility of a savings bond ladder. A 60 year old male can get a flat lifetime payout rate of 4.9% today which equates to an annual return of about 2% over the 25 years of their expected average lifespan of 85. No wonder annuities are not that popular.

Be foolish to work on an average expected. Many people do live into their 90's. 

Agreed and then the equivalent annual return of the annuity goes up to a "whopping" 3%. People do need to have longevity insurance, but right now buying an annuity at age 65 is an expensive way to do it.

Annuity is a fixed income product.  What is your return on your bonds with similar level of risk to annuities right now? Of course annuity companies get better returns then you would on a bond. For one thing, their duration is far longer and costs far lower. 

Below is an example for a life-only income annuity.  Returns start out negative and exceed 3% at age 88. Age 90 represents the median life expectancy for a female 65 year old.  That means half of them live longer. You’ll find a surprisingly large percent expected to live to 100 and beyond.  Particularly so among wealthier people who are into retirement instruments. 

Return isnt the best parameter in my book, unless you are using annuities like bonds. Payout ratio is what we are after. Its the guarantee regardless of your duration. 

Think of it like a game. You all get together and whoever lives longer than average wins.  Whoever lives less than average does not lose. He still gets to safely spend more than otherwise. 

A 65 year old single life payout rate is 5% today (according to H&L), not 6% so the the break even point is 20 years ie age 85. Females born today are predicted to have a median life expectancy of 90, but at age 65 it is 87 for a woman and 85 for a man according to the ONS calculator. If I was to use a ladder of fixed rate saving accounts and lets be pessimistic and say that the interest rate stays at today's value of 1.75% that will allow a 5% withdrawal until age 90 so for most people (particularly men) it is a less expensive option.  I won't say better because, of course, if you live past 90 the annuity starts to win out and the longevity insurance really kicks in. But if interest rates start to creep up by a couple of percent over the duration of your retirement the saving account ladder isn't beaten by the annuity until the mid 90s. 

I think longevity insurance is a good thing and the key is always to carefully pick how much insurance you need. Saying most people won't need the longevity insurance of an annuity isn't of any use if you turn out to be someone who gets a telegram from the Queen...or does she now just send an text. But if you are looking for some guaranteed income to supplement a DC drawdown from risky assets I would not use an annuity today as the payout is too low - I would stick the money into a long term bank saving account ladder and see what happens.

[Deleted User]

If you lock your money up for 5 years you will get a guaranteed 1.75% annual interest

Not if the company you bought it from goes bankrupt. That’s a lot over US 5 year treasuries paying 0.8%. 

you get the opportunity to reinvest, hopefully at a higher rate

That’s what they said 5 years ago. And 10. And 15. And 20. How is that working out?   Now compare to people who bought annuities at those points in time. See? 

I think it's a very good bet 

Thats what casinos are for. But again, if that’s your bet, you can buy a fixed term annuity, reinvest proceeds into bonds and you would do a lot better than from a government bond of the same duration.  Annuities are backed by governments so that’s the risk level which drives your choice of bonds. 

bostonerimus

Deleted_User said:

If you lock your money up for 5 years you will get a guaranteed 1.75% annual interest

Not if the company you bought it from goes bankrupt. That’s a lot over US 5 year treasuries paying 0.8%. 

you get the opportunity to reinvest, hopefully at a higher rate

That’s what they said 5 years ago. And 10. And 15. And 20. How is that working out?   Now compare to people who bought annuities at those points in time. See? 

I think it's a very good bet 

Thats what casinos are for. But again, if that’s your bet, you can buy a fixed term annuity, reinvest proceeds into bonds and you would do a lot better than from a government bond of the same duration.  Annuities are backed by governments so that’s the risk level which drives your choice of bonds. 

You could say that about any financial institution, but both annuities and saving accounts have Government protections - $85k with a bank so you should use a few "fixed rate saving bonds" if necessary.

10, 15, 20 years ago annuities looked more sensible, right now they do not and they will be even worse if rates continue to fall, but for that to happen the BoE will be giving money away for free.

Sure we are dealing with choices, estimates and gambles on factors that we cannot control. Interest rates might stay very low for a while, they might go down, but there is more space for them to increase and if I was at all interested in using annuities for retirement income...as I think more people should do at the right time...I would not buy one today. I'd stick to cash in a fixed saving account ladder.

[Deleted User]

Sure we are dealing with choices, estimates and gambles on factors that we cannot control.

Yes, everything is a choice. Treasury isn’t a gamble; not if you hold it to maturity. Annuity is not a gamble.  The risk is there but its extremely small.  A sensible annuity is much better than a treasury right now for similar level of risk.  I hold fixed income in bucket 1 for certainty.  That’s the bucket I can’t live without.  Annuity looks like a highly competitive option vs government bonds.  Which is the only alternative on the market for genuinely safe income.  And that permits me to avoid junk bonds and even commercial bonds in the other buckets. I can afford to invest in 100% stocks within buckets 3 and 4 exactly because I will have enough DB income. And then I don’t care if 4% from stocks is unachievable during major downturns and happy to deal in probabilities. 

Having said it, I have quite a bit of DB income from pensions (eventually) so don’t need a lot of annuity income. 

MK62

Deleted_User said:

Sure we are dealing with choices, estimates and gambles on factors that we cannot control.

Yes, everything is a choice. Treasury isn’t a gamble; not if you hold it to maturity. Annuity is not a gamble.  The risk is there but its extremely small.

Risk takes many forms.......and with an annuity you are ignoring the very high risk that you won't even get your capital back.

That's the "gamble" with annuities.......