Are RPI annuities very expensive?

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  • Linton
    Linton Posts: 17,014
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    In later life, say 80+, I think an annuity to ensure that all day to day living expenses are covered by inflation linked income makes a lot of sense. At that age IL annuity rates could be around 9% (rough estimate).  Prior to then the flexibility of having a large pot of money is in my view more valuable than the added security of income particullarly if one wishes to make large one-off discretionary expenditures - eg travel whilst one is fit enough to enjoy it. Buying an index linked annuity at 65 could cost about twice as much.
     
    Furthermore, if one has planned cautiously, there should be more money available in one's 80s than soon after the start of retirement since the planned-for Sequence of Returns Risks of early crashes probably won't happen.

    Delaying buying an inflation linked annuity is also advantageous for those people who are aiming to maximise inheritance.

    On the other hand, I think buying a fixed lifetime annuity at any age is rather more difficult to justify if one is reasonably confident in managing investments.
  • Linton said:
    In later life, say 80+, I think an annuity to ensure that all day to day living expenses are covered by inflation linked income makes a lot of sense. At that age IL annuity rates could be around 9% (rough estimate).  Prior to then the flexibility of having a large pot of money is in my view more valuable than the added security of income particullarly if one wishes to make large one-off discretionary expenditures - eg travel whilst one is fit enough to enjoy it. Buying an index linked annuity at 65 could cost about twice as much.
     
    Furthermore, if one has planned cautiously, there should be more money available in one's 80s than soon after the start of retirement since the planned-for Sequence of Returns Risks of early crashes probably won't happen.

    Delaying buying an inflation linked annuity is also advantageous for those people who are aiming to maximise inheritance.

    On the other hand, I think buying a fixed lifetime annuity at any age is rather more difficult to justify if one is reasonably confident in managing investments.
    The problem with delaying is that you do not know for certain what the value of your portfolio will be when you get to the age when you want to buy it. 

    For example, since the rate at 60 is about 3.5% and (for sake of argument, lets take your number of 9% at 80), then in order to be able to buy the same amount of annuity income, your portfolio has to be larger, in real terms, than about 40% of the initial value. Using a 60/20/20 portfolio (stocks/bonds/cash) with a 3.5% inflation adjusted withdrawal rate, the portfolio values fell below 40% after 10 years in about 10% of historical retirements (my own calculations using asset return and cpi data from macrohistory.net). After 15 years, the number was 20% and after 20 years about 30%. In other words, the longer it is left, the more chance there is of being able to buy less annuity income.

    Of course, there is also the possibility that bonds yields will be lower and, consequently, annuity rates will be lower which makes the effect of delaying purchase worse (conversely, the rates might be higher which would make things better).


  • An RPI annuity is expensive as the provider has to calculate in the possibility of a sustained period of high inflation. I might be wrong here but I believe they are not that popular due to their high cost/reduced pension.
    If you throw in guarantees and 100% spouse pension on your death, then the pension just gets smaller and smaller. It is a kind of overinsurance.
    As @QrizB mentions, a compromise is a fixed 3% escalation, or similar.

    OP - Another compromise is to annuitize just a part of the pot and keep the rest invested. Maybe even reinvest the tax free cash.

    To support RPI annuities, the insurer has to match liabilities with inflation linked gilts (ILG). ILG have lower yields to maturity than nominal gilts and there are few commercial IL bonds available, so the insurance company cannot get extra yield from buying AAA corporate bonds. I suspect (based on a very limited amount of data), that insurance companies charge slightly higher overheads on RPI annuities than level ones since they sell fewer of them (so potentially larger variations from the average mortality statistics).

  • Looking at all of this from a survivor's viewpoint, I am glad that my partner bought an annuity (think it was around 2009/10) from Standard Life.  50% to survivor after death of purchaser and 4% increase p.a. for life of survivor.  For last 13 years it has beaten inflation.  

    I am very grateful for this - I would not have been able to manage a DC pot.  When partner died, from memory it was about 6K and now up to 10k gross.  (Not checked so maybe suspect figures - but def 10K gross this year).

    This gives me certainty - just like the SP.  I agree that if I was more confident with managing SIPPs via various platforms I might have got a better return.  Check with your partner whether they would be happy managing your SIPP.  If you are really good at it why not teach them how?


  • Linton
    Linton Posts: 17,014
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    Linton said:
    In later life, say 80+, I think an annuity to ensure that all day to day living expenses are covered by inflation linked income makes a lot of sense. At that age IL annuity rates could be around 9% (rough estimate).  Prior to then the flexibility of having a large pot of money is in my view more valuable than the added security of income particullarly if one wishes to make large one-off discretionary expenditures - eg travel whilst one is fit enough to enjoy it. Buying an index linked annuity at 65 could cost about twice as much.
     
    Furthermore, if one has planned cautiously, there should be more money available in one's 80s than soon after the start of retirement since the planned-for Sequence of Returns Risks of early crashes probably won't happen.

    Delaying buying an inflation linked annuity is also advantageous for those people who are aiming to maximise inheritance.

    On the other hand, I think buying a fixed lifetime annuity at any age is rather more difficult to justify if one is reasonably confident in managing investments.
    1)The problem with delaying is that you do not know for certain what the value of your portfolio will be when you get to the age when you want to buy it. 

    For example, since the rate at 60 is about 3.5% and (for sake of argument, lets take your number of 9% at 80), then in order to be able to buy the same amount of annuity income, your portfolio has to be larger, in real terms, than about 40% of the initial value. Using a 60/20/20 portfolio (stocks/bonds/cash) with a 3.5% inflation adjusted withdrawal rate, the portfolio values fell below 40% after 10 years in about 10% of historical retirements (my own calculations using asset return and cpi data from macrohistory.net.   After 15 years, the number was 20% and after 20 years about 30%. In other words, the longer it is left, the more chance there is of being able to buy less annuity income.

    Of course, there is also the possibility that bonds yields will be lower and, consequently, annuity rates will be lower which makes the effect of delaying purchase worse (conversely, the rates might be higher which would make things better).


    1) True, but you dont know that either if you dont buy an annuity. .Buying an annuity in your 80's will be much cheaper than implementing drawdown for a worst case scenario (you live far too long). The relative difference between worst case and average outlook becomes greater as you age.

    2) The SWR runs show that if you dont lose out because of SORR there is a good chance that you die wealthier than when you started.   If your portfolio is down 60% in real terms by the time you are 70 after just 10 years of retirement you would probably change your plans anyway well before you get to your 80's, unless of course you had a blind faith in your pre-retirement SWR calculations.

    Some other points...
    a) If you had a zero acceptance of any mitigatible risk then you should buy an inflation linked annuity as soon as you retire.  But that has the downside of requiring a larger pot if you also want the flexibility given by holding a substantial lump sum.
    b) If you are going to take an annuity there are significant advantages in taking it later than at retirement, say 80.
     - iat 80  you will have a much better idea of your actual expenditure needs in real old age than when you retired.  You may well find that you can live happily on less than the initial 3.5%.
     - you or your spouse may die before you are 80 so you would not need a joint annuity. if you needed one at all.
    -  you are more likely to benefit from impaired (ill health) pension rates at 80 than 60.




  • Qyburn
    Qyburn Posts: 2,068
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    I don't think its been mentioned, but as I understand it the main point about RPI is that it takesvaccount of mortgage interest rates, whereas CPI does not. Since most people dont have a mortgage in retirement is CPI linking worth looking at?
  • Albermarle
    Albermarle Posts: 21,027
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    Qyburn said:
    I don't think its been mentioned, but as I understand it the main point about RPI is that it takesvaccount of mortgage interest rates, whereas CPI does not. Since most people dont have a mortgage in retirement is CPI linking worth looking at?
    Also any RPI linking will end in 2030, as figures will not be published anymore. It will be replaced by CPIH ( CPI + housing costs) As far as I know There seems to be little difference between CPI and CPIH and both are normally lower than RPI.
  • Linton said:
    Linton said:
    In later life, say 80+, I think an annuity to ensure that all day to day living expenses are covered by inflation linked income makes a lot of sense. At that age IL annuity rates could be around 9% (rough estimate).  Prior to then the flexibility of having a large pot of money is in my view more valuable than the added security of income particullarly if one wishes to make large one-off discretionary expenditures - eg travel whilst one is fit enough to enjoy it. Buying an index linked annuity at 65 could cost about twice as much.
     
    Furthermore, if one has planned cautiously, there should be more money available in one's 80s than soon after the start of retirement since the planned-for Sequence of Returns Risks of early crashes probably won't happen.

    Delaying buying an inflation linked annuity is also advantageous for those people who are aiming to maximise inheritance.

    On the other hand, I think buying a fixed lifetime annuity at any age is rather more difficult to justify if one is reasonably confident in managing investments.
    1)The problem with delaying is that you do not know for certain what the value of your portfolio will be when you get to the age when you want to buy it. 

    For example, since the rate at 60 is about 3.5% and (for sake of argument, lets take your number of 9% at 80), then in order to be able to buy the same amount of annuity income, your portfolio has to be larger, in real terms, than about 40% of the initial value. Using a 60/20/20 portfolio (stocks/bonds/cash) with a 3.5% inflation adjusted withdrawal rate, the portfolio values fell below 40% after 10 years in about 10% of historical retirements (my own calculations using asset return and cpi data from macrohistory.net.   After 15 years, the number was 20% and after 20 years about 30%. In other words, the longer it is left, the more chance there is of being able to buy less annuity income.

    Of course, there is also the possibility that bonds yields will be lower and, consequently, annuity rates will be lower which makes the effect of delaying purchase worse (conversely, the rates might be higher which would make things better).


    1) True, but you dont know that either if you dont buy an annuity. .Buying an annuity in your 80's will be much cheaper than implementing drawdown for a worst case scenario (you live far too long). The relative difference between worst case and average outlook becomes greater as you age.

    2) The SWR runs show that if you dont lose out because of SORR there is a good chance that you die wealthier than when you started.   If your portfolio is down 60% in real terms by the time you are 70 after just 10 years of retirement you would probably change your plans anyway well before you get to your 80's, unless of course you had a blind faith in your pre-retirement SWR calculations.

    Some other points...
    a) If you had a zero acceptance of any mitigatible risk then you should buy an inflation linked annuity as soon as you retire.  But that has the downside of requiring a larger pot if you also want the flexibility given by holding a substantial lump sum.
    b) If you are going to take an annuity there are significant advantages in taking it later than at retirement, say 80.
     - iat 80  you will have a much better idea of your actual expenditure needs in real old age than when you retired.  You may well find that you can live happily on less than the initial 3.5%.
     - you or your spouse may die before you are 80 so you would not need a joint annuity. if you needed one at all.
    -  you are more likely to benefit from impaired (ill health) pension rates at 80 than 60.




    1) There is certainty in buying an annuity early (leaving aside insurance company risks and government risks) - providing that you have enough money to provide the desired floor (your point a).
    2) There is no certainty with SWR - however, as you say, the difference between best and worst cases gets much larger with time. So, there is a balance between upside and downside to be made that will likely look different for each of us. For those wanting the certainty of an income floor, early purchase probably makes most sense.

    I'd agree with the advantages you've expressed in point b.

    For level annuities, there is definitely a case to be made for later purchase in that inflation then has less time to reduce the income. This appears to be the case in the US where they no longer have access to RPI annuities.

  • Pat38493
    Pat38493 Posts: 2,465
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    This is a bit of an aside comment, but I heard an economist recently making some interesting comments about how the UK government has been issuing a lot of inflation linked gilts and bonds in recent times, and that this means that government debt in the UK does not get eroded by inflation to the same extent that it does in many other countries.
  • michaels
    michaels Posts: 27,867
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    Pat38493 said:
    This is a bit of an aside comment, but I heard an economist recently making some interesting comments about how the UK government has been issuing a lot of inflation linked gilts and bonds in recent times, and that this means that government debt in the UK does not get eroded by inflation to the same extent that it does in many other countries.
    Isn't this partly as a result of wanting companies to be able to meet pension commitments.  There are no other real volume sellers of index linked low risk bonds.  If the govt didn't issue them then DB pension companies and annuity companies would be screwed.  In theory this captive market should mean the govt get good prices when they sell the debt but of course it also means they are less able to deflate the national debt via unexpected inflation.
    I think....
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