Foolishness of the 4% rule

bostonerimus

OldScientist said:

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

The basic problem I have with a lifetime annuity today is locking in all time low payout rates. The longevity insurance is as expensive as it has ever been. If you use a fixed term saving bond initially you are not locked into historically low rates for life. Of course rates might fall even more, but there just isn't much room for them to go lower. I like the idea of partial annuitization to guarantee a certain minimum income in combination with something like SP, but you can do that later in retirement when the payout will be greater as you are closer to the grim reaper.

itwasntme001

Deleted_User said:

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?

And the "loss" in waiting for annuity rates to rise is not as large as you may have thought.  Equities and bonds have risen considerably over the last 5 and 10 years.  Depending on how the money, that would have otherwise been annuitised, had been invested, the loss in not locking in a higher rate 5/10 years ago is fairly minimal.

Terron

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.  

For anyone outside the US it is surely a gamble on the exchange rate.
My annuity was a bit of a gamble on inflation staying low, but the GAR of 10.6% made it worth taking anyway.

[Deleted User]

Terron 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.  

For anyone outside the US it is surely a gamble on the exchange rate.
My annuity was a bit of a gamble on inflation staying low, but the GAR of 10.6% made it worth taking anyway.

Replace with "gilt". 

[Deleted User]

itwasntme001 said:

Deleted_User said:

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?

And the "loss" in waiting for annuity rates to rise is not as large as you may have thought.  Equities and bonds have risen considerably over the last 5 and 10 years.  Depending on how the money, that would have otherwise been annuitised, had been invested, the loss in not locking in a higher rate 5/10 years ago is fairly minimal.

If you want certainty then you hold your government bond to maturity.  Otherwise it's a bet.  Someone doing that and relying on a bond ladder would have seen his income substantially diminish as one rung comes to an end and another one has to be bought into. . 

Bond funds or bonds not held to maturity are a different game.  If you want risk and volatility for the totality of your portfolio - go ahead. 

I agree that annuities are still a good buy for someone wanting to assure a guaranteed income for the "basic necessities" bucket. 

itwasntme001

Terron 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.  

For anyone outside the US it is surely a gamble on the exchange rate.
My annuity was a bit of a gamble on inflation staying low, but the GAR of 10.6% made it worth taking anyway.

Bonds are also a gamble on inflation, even if held to maturity.  Its just not nearly as explicit of a gamble as currency or selling the bond prior to maturity for less than you paid.

GAR at 10% is a no brainer.  Even if inflation were to double, its still worth doing.  My father had the same product, and whilst the capital would have otherwise more or less doubled, the annuity would easily pay for itself assuming normal life expectancy.  Longevity risk is expensive to hedge nowadays.

itwasntme001

Deleted_User said:

itwasntme001 said:

Deleted_User said:

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?

And the "loss" in waiting for annuity rates to rise is not as large as you may have thought.  Equities and bonds have risen considerably over the last 5 and 10 years.  Depending on how the money, that would have otherwise been annuitised, had been invested, the loss in not locking in a higher rate 5/10 years ago is fairly minimal.

If you want certainty then you hold your government bond to maturity.  Otherwise it's a bet.  Someone doing that and relying on a bond ladder would have seen his income substantially diminish as one rung comes to an end and another one has to be bought into. . 

Bond funds or bonds not held to maturity are a different game.  If you want risk and volatility for the totality of your portfolio - go ahead. 

I agree that annuities are still a good buy for someone wanting to assure a guaranteed income for the "basic necessities" bucket. 

Not really sure what point you are making?

[Deleted User]

itwasntme001 said:

Deleted_User said:

itwasntme001 said:

Deleted_User said:

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?

And the "loss" in waiting for annuity rates to rise is not as large as you may have thought.  Equities and bonds have risen considerably over the last 5 and 10 years.  Depending on how the money, that would have otherwise been annuitised, had been invested, the loss in not locking in a higher rate 5/10 years ago is fairly minimal.

If you want certainty then you hold your government bond to maturity.  Otherwise it's a bet.  Someone doing that and relying on a bond ladder would have seen his income substantially diminish as one rung comes to an end and another one has to be bought into. . 

Bond funds or bonds not held to maturity are a different game.  If you want risk and volatility for the totality of your portfolio - go ahead. 

I agree that annuities are still a good buy for someone wanting to assure a guaranteed income for the "basic necessities" bucket. 

Not really sure what point you are making?

You said that "bonds have risen considerably over the last 5 years".  That's true if you are selling a bond or a bond fund before maturity. That's not the scenario being discussed.   We are focusing on the portion of retirement income that needs to be covered by the guaranteed income.  Bond funds don't do that. 

Thrugelmir

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......

Annuities are a form of pooled risk. Guarantees shouldn't be underestimated. Majority of pensioners don't have the luxury of speculating with their retirement funds.  There's a concerning amount of naivety when it comes to investing generally.  

itwasntme001

Deleted_User said:

itwasntme001 said:

Deleted_User said:

itwasntme001 said:

Deleted_User said:

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?

And the "loss" in waiting for annuity rates to rise is not as large as you may have thought.  Equities and bonds have risen considerably over the last 5 and 10 years.  Depending on how the money, that would have otherwise been annuitised, had been invested, the loss in not locking in a higher rate 5/10 years ago is fairly minimal.

If you want certainty then you hold your government bond to maturity.  Otherwise it's a bet.  Someone doing that and relying on a bond ladder would have seen his income substantially diminish as one rung comes to an end and another one has to be bought into. . 

Bond funds or bonds not held to maturity are a different game.  If you want risk and volatility for the totality of your portfolio - go ahead. 

I agree that annuities are still a good buy for someone wanting to assure a guaranteed income for the "basic necessities" bucket. 

Not really sure what point you are making?

You said that "bonds have risen considerably over the last 5 years".  That's true if you are selling a bond or a bond fund before maturity. That's not the scenario being discussed.   We are focusing on the portion of retirement income that needs to be covered by the guaranteed income.  Bond funds don't do that. 

And I was referring to your point on people having waited for annuity rates to rise and how that turned out for them.  In reality, there was hardly anything lost providing the capital was instead invest in an appropriate way.  Maybe you know this already, but just wanted to highlight that in case anyone thought from your comment that people lost out in any meaningful way from waiting for annuity rates to rise.