Annuities

michaels

westv said:

squirrelpie said:

The current bout of inflation is a good reminder of the shortcomings of flat rate annuities.

Depends what rate you get it at. 

6% of 100k will be worth 6k this year, 5.4k next year and about 4.8k the year after.  Sounds pretty scary to me.  Unless inflation disappears then in real terms you never get back anywhere near the 100k you have given up, however long you live.

I struggle to see the use case for a flat annuity.

westv

Pablo7474 said:

Pablootes said:

dunstonh said:

Would anyone now give annuities serious consideration?

Yes.   We did a quote for someone the other day that was just over 6% with value protect (return of unused fund).   We didnt proceed for the time being but we are getting close to the tipping point.

Totally aware of the problems of annuities but the benefits now seem much better.

what problems?    There are positives and negatives of any option but I am not sure what problems there would be. (maybe problem was the wrong word?)

Yes , wrong choice of word.
Meant shortcomings rather than problems 

What shortcomings? 

You can't amend once in payment
You might leave nothing as an inheritence
Annuities may be seen as expensive

Pablo7474

Are they shortcomings? 

Firstly, with drawdown your money could run out and based on current markets many retirees are suddenly more aware of this than believing they are going to achieve over inflation growth every year as they once did. Is the fact it can’t be amended really a problem? I also don’t understand why most people who earn a fixed wage all their life through work suddenly NEED a flexible income in retirement, particularly when they have little experience of investing and risk. 

As for inheritance, your comment is actually more suited to drawdown and the risk of the pot running out. At least with annuities you can know the minimum term an annuity will pay out and often a 20 year guarantee has little impact on the level of income. There are of course other options as well. 

As for annuities MAY be seen as expensive, well also I guess they MAY NOT. There are many costs for drawdown and the risks can be very costly too. A standard annuity rate is historically low but this is changing and there are plenty of impaired/enhanced rates too. 

westv

You asked what the disadvantages were with annuities. Nobody has said there are no downsides to drawdown so my examples are still valid.

DT2001

westv said:

Pablo7474 said:

Pablootes said:

dunstonh said:

Would anyone now give annuities serious consideration?

Yes.   We did a quote for someone the other day that was just over 6% with value protect (return of unused fund).   We didnt proceed for the time being but we are getting close to the tipping point.

Totally aware of the problems of annuities but the benefits now seem much better.

what problems?    There are positives and negatives of any option but I am not sure what problems there would be. (maybe problem was the wrong word?)

Yes , wrong choice of word.
Meant shortcomings rather than problems 

What shortcomings? 

You can't amend once in payment
You might leave nothing as an inheritence
Annuities may be seen as expensive

You can take an annuity for a fixed period with a residual some at the end of the term.
I think they have a place as part of a package to spread your risk.
If for example you retire early and want to bridge the gap to SPA you could use a fixed term annuity rather than cash/quasi cash. Inflation is your enemy but you could position another part of your portfolio to mitigate that problem (over a longer term) if you have certainty of income, even if being eroded, over the short term. It might allow part of your portfolio to be untouched and still therefore in the ‘accumulation stage’ when market volatility is less important.

OldScientist

westv said:

You asked what the disadvantages were with annuities. Nobody has said there are no downsides to drawdown so my examples are still valid.

Just to add to your list of potential disadvantages of annuities

- insurance company risk (largely offset by FSCS protection)
- hyperinflation (even for RPI linked annuities since, eventually, the underlying index-linked gilts would be defaulted on)
- government collapse (as above)

However, I think for a proper comparison the properties of annuities have to be set in context against the alternatives (which, I think is most likiely an investment portfolio).
                         
Flexibility of income
Annuity: No flexibility once purchased (but additional purchases could increase income)
Drawdown: Highly flexible (although income depends on portfolio performance and withdrawal method adopted)

Inheritance
Annuity: Guarantee period or value protection will allow for inheritance in case of early death (at cost of reduced income).
Drawdown: Depends on portfolio performance, withdrawal method, and eventual length of retirement.

Income rate
Annuity: In short term depends on interest rates. Currently, for a 67 year old, annuity rates for RPI protected annuities are comparable with historical safe withdrawal rates for the UK.
Drawdown: Depends on portfolio performance - for constant pound approaches, income can reduce to zero after portfolio exhaustion, while for percentage of portfolio approaches income can become very low in real terms following a decline in portfolio value.

Ongoing requirements
Annuity: None once purchased
Drawdown: Need to be able to undertake calculations and follow plan (may be difficult when markets are declining or following a decline in cognitive ability).

It is interesting that the characteristics of the two approaches largely offset each other meaning that a combination of both (if other forms of guaranteed income such as the state pension don't meet minimum income requirements) could be a good solution for some.

Linton

DT2001 said:

westv said:

Pablo7474 said:

Pablootes said:

dunstonh said:

Would anyone now give annuities serious consideration?

Yes.   We did a quote for someone the other day that was just over 6% with value protect (return of unused fund).   We didnt proceed for the time being but we are getting close to the tipping point.

Totally aware of the problems of annuities but the benefits now seem much better.

what problems?    There are positives and negatives of any option but I am not sure what problems there would be. (maybe problem was the wrong word?)

Yes , wrong choice of word.
Meant shortcomings rather than problems 

What shortcomings? 

You can't amend once in payment
You might leave nothing as an inheritence
Annuities may be seen as expensive

You can take an annuity for a fixed period with a residual some at the end of the term.
I think they have a place as part of a package to spread your risk.
If for example you retire early and want to bridge the gap to SPA you could use a fixed term annuity rather than cash/quasi cash. Inflation is your enemy but you could position another part of your portfolio to mitigate that problem (over a longer term) if you have certainty of income, even if being eroded, over the short term. It might allow part of your portfolio to be untouched and still therefore in the ‘accumulation stage’ when market volatility is less important.

Yes, the idea of using a fixed rate annuity to defer eating into your investment pot is well worth considering.  From some spreadsheet calculations assuming:

 -  expenditure at the SWR level of 3.5% of initial pot increasing with inflation 
 - an annuity rate of 6% for a lifetime annuity which is very close to HL's best buy
 - unused annuity income is re-invested
 - long term inflation at 3%
 - investment return of 5% in £ terms
 - death at 90
 
I find that the benefit of using a fixed rate annuity is marginal.  However were annuity rates to rise to 7% as (IIRC) they were prior to the 2008 crash it is better to take the fixed rate annuity and invest excess income.

A major risk of basing one's retirement on a fixed rate annuity is high inflation in the early years, the equivalent of the SOR risk of drawdown.  So I suggest a reasonable balance could be to buy a fixed rate annuity to cover all basic espenditure at its initial value alongside other guaranteed income and use drawdown for discretionary expenditure and to cover subsequent inflation.

Other factors include:
If fixed rate annuities rise to 7% we may find that RPI linked annuities rise to 3.5% which could be more attractive than drawdown.

It may be worth not buying the annuity until 70-75 to take advantage of the higher rates, or splitting between 65 and 75.

OldScientist

michaels said:

westv said:

squirrelpie said:

The current bout of inflation is a good reminder of the shortcomings of flat rate annuities.

Depends what rate you get it at. 

6% of 100k will be worth 6k this year, 5.4k next year and about 4.8k the year after.  Sounds pretty scary to me.  Unless inflation disappears then in real terms you never get back anywhere near the 100k you have given up, however long you live.

I struggle to see the use case for a flat annuity.

Of course, the higher initial payout is what attracts people to flat annuities (and thinking they won't live long enough to be affected by inflation) - after some time they'll be a crossover point in real income with the equivalent RPI annuity (£3300k, i.e. 3.3% of 100k) - if we really stay at 10% inflation, then that crossover point in real terms would be reached in about 5-6 years (most 65 year olds would still be alive then).

Historical inflation levels in the UK have been frightening. Annualised CPI rates (in %) at the 10th percentile (i.e. 10% of cases have higher inflation and 90% lower inflation) over different durations of rolling periods (data from 1872 to 2016, downloaded from https://www.macrohistory.net) were

Duration (yrs) 10th percentile
10                          8.5
20                          8.5
30                          7.1
40                          6.5

The median values were around the 2% to 3% mark. Anyway, brings our current bout of inflation into perspective! 

At 6% inflation, the crossover in real income between level and RPI annuities occurs after about 10 years (still plenty of 65 year olds would survive to 75).

Of course, the real* advantage of level annuities comes during deflation (there were a spate of articles on this back in 2008-09 when RPI went negative).

* sorry, not a deliberate pun!

OldScientist

Linton said:

DT2001 said:

westv said:

Pablo7474 said:

Pablootes said:

dunstonh said:

Would anyone now give annuities serious consideration?

Yes.   We did a quote for someone the other day that was just over 6% with value protect (return of unused fund).   We didnt proceed for the time being but we are getting close to the tipping point.

Totally aware of the problems of annuities but the benefits now seem much better.

what problems?    There are positives and negatives of any option but I am not sure what problems there would be. (maybe problem was the wrong word?)

Yes , wrong choice of word.
Meant shortcomings rather than problems 

What shortcomings? 

You can't amend once in payment
You might leave nothing as an inheritence
Annuities may be seen as expensive

You can take an annuity for a fixed period with a residual some at the end of the term.
I think they have a place as part of a package to spread your risk.
If for example you retire early and want to bridge the gap to SPA you could use a fixed term annuity rather than cash/quasi cash. Inflation is your enemy but you could position another part of your portfolio to mitigate that problem (over a longer term) if you have certainty of income, even if being eroded, over the short term. It might allow part of your portfolio to be untouched and still therefore in the ‘accumulation stage’ when market volatility is less important.

Yes, the idea of using a fixed rate annuity to defer eating into your investment pot is well worth considering.  From some spreadsheet calculations assuming:

 -  expenditure at the SWR level of 3.5% of initial pot increasing with inflation 
 - an annuity rate of 6% for a lifetime annuity which is very close to HL's best buy
 - unused annuity income is re-invested
 - long term inflation at 3%
 - investment return of 5% in £ terms
 - death at 90
 
I find that the benefit of using a fixed rate annuity is marginal.  However were annuity rates to rise to 7% as (IIRC) they were prior to the 2008 crash it is better to take the fixed rate annuity and invest excess income.

A major risk of basing one's retirement on a fixed rate annuity is high inflation in the early years, the equivalent of the SOR risk of drawdown.  So I suggest a reasonable balance could be to buy a fixed rate annuity to cover all basic espenditure at its initial value alongside other guaranteed income and use drawdown for discretionary expenditure and to cover subsequent inflation.

Other factors include:
If fixed rate annuities rise to 7% we may find that RPI linked annuities rise to 3.5% which could be more attractive than drawdown.

It may be worth not buying the annuity until 70-75 to take advantage of the higher rates, or splitting between 65 and 75.

Thanks for that analysis.

One of the purposes of annuities that I've seen stated is their use as longevity insurance - for a 67 year old male, there's a better than 25% chance of living to be 90 and a 3% of living to 100 (for females, the odds are somewhat better, how does the comparison stack up if death occurs at 95 (or 100)?

Your memory is correct - rates were greater than 7% pre-2008 (they were around 12% back at the beginning of the 1980s!).

westv

michaels said:

westv said:

squirrelpie said:

The current bout of inflation is a good reminder of the shortcomings of flat rate annuities.

Depends what rate you get it at. 

6% of 100k will be worth 6k this year, 5.4k next year and about 4.8k the year after.  Sounds pretty scary to me.  Unless inflation disappears then in real terms you never get back anywhere near the 100k you have given up, however long you live.

I struggle to see the use case for a flat annuity.

A level annuity is roughly double the income of an RPI annuity so it takes a number of years for it to catch up and then a further number of years for the total income to exceed the former.