Foolishness of the 4% rule

pensionpawn

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. 

Two questions. Can annuity companies go bankrupt or are they immune / protected from such disasters? What is wrong with some method of equity release at 85 if you feel that you need some extra cash?

OldScientist

MK62 said:

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.......

In this context annuities are both a type of fixed income product and an insurance product - you are correct, with annuities if you live a long time you win, if you die young you (or at least your spouse/descendants) lose (although guarantee, or certain periods in the US, help with legacy at the cost of income) - the same is true for any sort of insurance - house insurance is a complete waste of money right up until you get burgled or your house burns down!

OldScientist

bostonerimus said:

Yes, I'm sorry I made some mistakes that make the annuity look better than it actually is. So here we go for real

at 65 a man has a life expectancy of 20 years and today can get a payout rate of 4.9% - women on average live a little longer so the numbers are a bit better for them. So it's easy to see that the annuity actually costs him money if he lives for 20 years or less, but if he lives to 91 ie 26 years beyond 65 then he'll get the implied annual growth of 2% that I worked out. Today you can get a 5 year fixed bond around 1.75% so the majority of people will be better off with that than buying an annuity and they will be able to buy new saving bonds at better rates if they go up...Today annuities are purely about longevity insurance as even if you live a couple of years longer than the average you'll be better off just keeping the money in a saving account at 0.6% interest and if you use a 5 years saving ladder paying a constant 1.75% you'll still be better off than the annuity holder up to age 90.

The comparison between fixed rate savings bonds and annuities is interesting - with a payout rate of 4.9% you get the following number of annual payments before the savings bonds are exhausted (the last payment could be much less than 4.9%). The current probability of survival for a 65 year old UK male to the point where saving bonds are exhausted is given in Psurvival column

Interest Rate Npayments   Psurvival (%)
0.5                    21                   43
1.0                    22                   38
1.5                    24                   29
2.0                    25                   25
2.5                    27                   17

A number of provisos
1) If the interest rates increase then the initial annuity payout would also increase (very roughly, every percentage point that interest rates increase lead to a 0.5 percentage point increase in annuity payout) and Npayments would then decrease.
2) This assumes that the savings bond interest rate remains fixed over the entire period

So, with 5 year savings bond currently somewhere between 1.5-2.0%, the bet you are making is just over the 25% mark that you will outlive this pot of money - whether these are good or poor odds is definitely down to the individual.

You also don't have to annuitize everything in one go - this could be done gradually over a period of years (even decades), picking up both increased mortality credits and any potential increases in interest rates.

For those interested, there is an excellent list of pros and cons of annuities at https://www.bogleheads.org/wiki/Immediate_fixed_annuity

Thrugelmir

MK62 said:

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.......

Will the UK Government default. I'd say not. 

Those with global bond funds may be more exposed i.e. Evergrande. 

MK62

Thrugelmir said:

MK62 said:

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.......

Will the UK Government default. I'd say not. 

Those with global bond funds may be more exposed i.e. Evergrande. 

I didn't mean the risk of default.....I meant the risk of not getting out what you put in, as there is a high risk that you'll die before the break even point......as OldScientist said, that's a judgement call on the probabilities......and any judgement call on probabilities is the arguably the very definition of a gamble.....

PS....fair enough, I suppose this is of little concern to those with no partner,  dependants or heirs......

michaels

MK62 said:

Thrugelmir said:

MK62 said:

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.......

Will the UK Government default. I'd say not. 

Those with global bond funds may be more exposed i.e. Evergrande. 

I didn't mean the risk of default.....I meant the risk of not getting out what you put in, as there is a high risk that you'll die before the break even point......as OldScientist said, that's a judgement call on the probabilities......and any judgement call on probabilities is the arguably the very definition of a gamble.....

Depends if you care about pot D - legacy or not.  And even then, no annuity and you are potentially making any legacy very small and very far into the future if you are unlucky enough to live to long.... 

[Deleted User]

MK62 said:

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.......

There are different types of annuities. If thats your concerns you can ensure that you get your capital back if you die early.  But in general, the objective is to allow you to spend more safely before you die rather than inheritance. Again, annuity does not have to be purchased with 100% of everything you own.

[Deleted User]

pensionpawn said:

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. 

Two questions. Can annuity companies go bankrupt or are they immune / protected from such disasters? What is wrong with some method of equity release at 85 if you feel that you need some extra cash?

This is a risk.  Failure of insurance companies is extremely rare but possible.  Provider creditworthiness is something to consider when buying.  However even if the provider fails, the state protects annuity holders.

[Deleted User]

MK62 said:

Thrugelmir said:

MK62 said:

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.......

Will the UK Government default. I'd say not. 

Those with global bond funds may be more exposed i.e. Evergrande. 

I didn't mean the risk of default.....I meant the risk of not getting out what you put in, as there is a high risk that you'll die before the break even point......as OldScientist said, that's a judgement call on the probabilities......and any judgement call on probabilities is the arguably the very definition of a gamble.....

PS....fair enough, I suppose this is of little concern to those with no partner,  dependants or heirs......

You can buy annuities which give your partner 100%,, 50% or 2/3 of the income. And even to guarantee inheritance, although thats a vanity project. You could also buy life insurance.

shinytop

Whether cash savings or annuities are better is an interesting discussion but unless you end up at one of the extremes (dropping dead next week or living to 110) the differences may be small.  The really important choice to make is the one that makes sure you have that cash available at the right time to back your chosen horse.