Tempted by an annuity - comments please

zagfles

OldScientist said:

zagfles said:

OldScientist said:

Mutton_Geoff said:

I'm fortunate to have just retired at 65 with a DB pension, SP about to be paid next month and a crystallised SIPP worth £1m. I've extracted all my TFC and leveraged that on property developments meaning I now live in a house with no mortgage.

My SIPP is self invested with medium to high risk tolerance since I have the stability of index linked DB (RPI capped 5%) and SP pensions as a backdrop. My intention was to drawdown the SIPP at a higher rate in the early years and slow down later in life and then exhaust the pot by a 1/n drawdown where n is 20 years 65-85 years old.

The DB & SP take me into the higher rate tax bracket so all SIPP drawdown is taxed at 40% or higher. My plan next year onwards is to cap regular income at £100k to avoid loss of personal tax code (ie 60%) then 45% tax.

As I'm eligible for an enhanced annuity, I have a range of quotes and am tempted by the level rate offer since this will fit my plan of higher income in the early years rather than everything escalating into the twilight of my life. Inflation can then deplete it's value for me.

Although I'm happy watching my SIPP, I am very tempted to derisk 60% of my SIPP investment by buying an annuity. Since tax rates are not scheduled to change until at least 2028, working forward inflation on my DB & SP, I could buy an level annuity at 7.5% paying £44k which means a gross guaranteed income of £90k now, £100k in 2028 and leaving £400k in my SIPP to be used as and when albeit with a high rate of income tax on any drawdown.

The question is whether to buy that annuity and lock in 7.5% and guaranteed income up to the loss of tax code/additional rate bands. The only downside I can see is massive growth in the SIPP (which would then lose almost 50% to tax in any case). I don't have any need to leave a legacy.

Plan A £100k income - keep SIPP & assume 5% inflation
DB £35k (2028 = £42k)
SP £11k (2028 = £14k)
SIPP £54k (5.4%) (2028 = £44k - unknown %)

Plan B £100k income - via £600k annuity
DB £35k (2028 = £42k)
SP £11k (2028 = £14k)
ANNUITY £44k (2028 = £44k)
SIPP £10k (2.5% drawdown) (2028 = £0k - unknown SIPP value)

I'm sorely tempted by buying some stability since any downside on a SIPP cost me money, the upside is skewed (ie taxed) by around 50%.

By comparison, the annuity quote offered 4.8% RPI linked but for reasons above, tempted by high ("jam today") level rate.

I really appreciate thoughts from the experts here.

Good analysis, although another thing to account for is sequence of inflation risk. Just like SORR with an equity based drawdown, with a fixed/capped income stream like DB pension or level annuities, high inflation towards the start of retirement will have a far bigger impact than high inflation towards the end. So modelling assuming a constant inflation rate, whatever that rate is, could be misleading. If inflation is 10% for the first 3 years of retirement then that's a permanent 25% reduction in the value of a level annuity, or a 13% reduction in a 5% capped DB

You are correct - sequence of inflation is important. So, let's have a look at an example where we use the inflation (and asset returns) for 30 years starting in 1970.

I've assumed
A portfolio with 60% UK stocks and 40% UK intermediate gilts with a withdrawal of 1/n over 20 years (i.e., the first withdrawal is 5% of the portfolio, the last 100%).
A level annuity bought with £720k a 7.5% payout rate
DB and state pensions as per original post.

The plot shows the contributions of the various sources of income, as well as the total income, plotted in real (i.e., inflation adjusted) terms as a function of time for this one historical example (one of the worst periods for UK inflation).



A few things to note:
1) High inflation meant that the real purchasing power of the annuity and DB pension both decline with time. By the late 70s, the complete lack of inflation protection for the level annuity meant that the real income fell below that of the DB pension and was less than half of its original value. By the mid, 1980s, the purchasing power of the annuity had even fallen below that of the state pension.
2) The income from the portfolio was highly variable (e.g., falling by nearly half after the stock market crash in the early 70s), but gradually increases as 1/n becomes larger (e.g., in the last two years, 50% and then 100% of the portfolio are taken as income) before falling to zero after 20 years. If a max income of £100k is required, then portfolio withdrawals could be delayed for a couple of years and the fall to zero delayed (the 1/n can also be capped at, say 20% of the portfolio value rather than being allowed to go to 100%).
3) The overall income is certainly front loaded with a strong decline over the first 10 years. If the retiree survived the first 20 years, then purchasing power of the remaining income was about a third of that of the original income.

To reiterate, this was a nasty historical period for retirees with non inflation protected income (i.e., it is about as bad as it has got for UK retirees). I've assumed the state pension was index linked throughout (i.e., the other two parts of the triple lock were not triggered), but for those wanting to know how the state pension was actually uprated during this period, there an interesting (at least to me) history at https://ifs.org.uk/sites/default/files/output_url_files/bn105.pdf

Thanks - good analysis. It'll be even worse if you look at other countries, even some European ones. With UK govt debt now over 100% GDP, and the cost of govt borrowing having risen massively with the fall of gilt prices (and so rise in yields, the interest the govt has to pay), it must be tempting for any govt to reduce the debt through inflation. 75% of UK govt debt isn't index linked. There've already been calls for the govt to raise the BoE inflation target.

RogerPensionGuy

OldScientist said:

zagfles said:

OldScientist said:

Mutton_Geoff said:

I'm fortunate to have just retired at 65 with a DB pension, SP about to be paid next month and a crystallised SIPP worth £1m. I've extracted all my TFC and leveraged that on property developments meaning I now live in a house with no mortgage.

My SIPP is self invested with medium to high risk tolerance since I have the stability of index linked DB (RPI capped 5%) and SP pensions as a backdrop. My intention was to drawdown the SIPP at a higher rate in the early years and slow down later in life and then exhaust the pot by a 1/n drawdown where n is 20 years 65-85 years old.

The DB & SP take me into the higher rate tax bracket so all SIPP drawdown is taxed at 40% or higher. My plan next year onwards is to cap regular income at £100k to avoid loss of personal tax code (ie 60%) then 45% tax.

As I'm eligible for an enhanced annuity, I have a range of quotes and am tempted by the level rate offer since this will fit my plan of higher income in the early years rather than everything escalating into the twilight of my life. Inflation can then deplete it's value for me.

Although I'm happy watching my SIPP, I am very tempted to derisk 60% of my SIPP investment by buying an annuity. Since tax rates are not scheduled to change until at least 2028, working forward inflation on my DB & SP, I could buy an level annuity at 7.5% paying £44k which means a gross guaranteed income of £90k now, £100k in 2028 and leaving £400k in my SIPP to be used as and when albeit with a high rate of income tax on any drawdown.

The question is whether to buy that annuity and lock in 7.5% and guaranteed income up to the loss of tax code/additional rate bands. The only downside I can see is massive growth in the SIPP (which would then lose almost 50% to tax in any case). I don't have any need to leave a legacy.

Plan A £100k income - keep SIPP & assume 5% inflation
DB £35k (2028 = £42k)
SP £11k (2028 = £14k)
SIPP £54k (5.4%) (2028 = £44k - unknown %)

Plan B £100k income - via £600k annuity
DB £35k (2028 = £42k)
SP £11k (2028 = £14k)
ANNUITY £44k (2028 = £44k)
SIPP £10k (2.5% drawdown) (2028 = £0k - unknown SIPP value)

I'm sorely tempted by buying some stability since any downside on a SIPP cost me money, the upside is skewed (ie taxed) by around 50%.

By comparison, the annuity quote offered 4.8% RPI linked but for reasons above, tempted by high ("jam today") level rate.

I really appreciate thoughts from the experts here.

Good analysis, although another thing to account for is sequence of inflation risk. Just like SORR with an equity based drawdown, with a fixed/capped income stream like DB pension or level annuities, high inflation towards the start of retirement will have a far bigger impact than high inflation towards the end. So modelling assuming a constant inflation rate, whatever that rate is, could be misleading. If inflation is 10% for the first 3 years of retirement then that's a permanent 25% reduction in the value of a level annuity, or a 13% reduction in a 5% capped DB

You are correct - sequence of inflation is important. So, let's have a look at an example where we use the inflation (and asset returns) for 30 years starting in 1970.

I've assumed
A portfolio with 60% UK stocks and 40% UK intermediate gilts with a withdrawal of 1/n over 20 years (i.e., the first withdrawal is 5% of the portfolio, the last 100%).
A level annuity bought with £720k a 7.5% payout rate
DB and state pensions as per original post.

The plot shows the contributions of the various sources of income, as well as the total income, plotted in real (i.e., inflation adjusted) terms as a function of time for this one historical example (one of the worst periods for UK inflation).



A few things to note:
1) High inflation meant that the real purchasing power of the annuity and DB pension both decline with time. By the late 70s, the complete lack of inflation protection for the level annuity meant that the real income fell below that of the DB pension and was less than half of its original value. By the mid, 1980s, the purchasing power of the annuity had even fallen below that of the state pension.
2) The income from the portfolio was highly variable (e.g., falling by nearly half after the stock market crash in the early 70s), but gradually increases as 1/n becomes larger (e.g., in the last two years, 50% and then 100% of the portfolio are taken as income) before falling to zero after 20 years. If a max income of £100k is required, then portfolio withdrawals could be delayed for a couple of years and the fall to zero delayed (the 1/n can also be capped at, say 20% of the portfolio value rather than being allowed to go to 100%).
3) The overall income is certainly front loaded with a strong decline over the first 10 years. If the retiree survived the first 20 years, then purchasing power of the remaining income was about a third of that of the original income.

To reiterate, this was a nasty historical period for retirees with non inflation protected income (i.e., it is about as bad as it has got for UK retirees). I've assumed the state pension was index linked throughout (i.e., the other two parts of the triple lock were not triggered), but for those wanting to know how the state pension was actually uprated during this period, there an interesting (at least to me) history at https://ifs.org.uk/sites/default/files/output_url_files/bn105.pdf

OldScientist said:

zagfles said:

OldScientist said:

Mutton_Geoff said:

I'm fortunate to have just retired at 65 with a DB pension, SP about to be paid next month and a crystallised SIPP worth £1m. I've extracted all my TFC and leveraged that on property developments meaning I now live in a house with no mortgage.

My SIPP is self invested with medium to high risk tolerance since I have the stability of index linked DB (RPI capped 5%) and SP pensions as a backdrop. My intention was to drawdown the SIPP at a higher rate in the early years and slow down later in life and then exhaust the pot by a 1/n drawdown where n is 20 years 65-85 years old.

The DB & SP take me into the higher rate tax bracket so all SIPP drawdown is taxed at 40% or higher. My plan next year onwards is to cap regular income at £100k to avoid loss of personal tax code (ie 60%) then 45% tax.

As I'm eligible for an enhanced annuity, I have a range of quotes and am tempted by the level rate offer since this will fit my plan of higher income in the early years rather than everything escalating into the twilight of my life. Inflation can then deplete it's value for me.

Although I'm happy watching my SIPP, I am very tempted to derisk 60% of my SIPP investment by buying an annuity. Since tax rates are not scheduled to change until at least 2028, working forward inflation on my DB & SP, I could buy an level annuity at 7.5% paying £44k which means a gross guaranteed income of £90k now, £100k in 2028 and leaving £400k in my SIPP to be used as and when albeit with a high rate of income tax on any drawdown.

The question is whether to buy that annuity and lock in 7.5% and guaranteed income up to the loss of tax code/additional rate bands. The only downside I can see is massive growth in the SIPP (which would then lose almost 50% to tax in any case). I don't have any need to leave a legacy.

Plan A £100k income - keep SIPP & assume 5% inflation
DB £35k (2028 = £42k)
SP £11k (2028 = £14k)
SIPP £54k (5.4%) (2028 = £44k - unknown %)

Plan B £100k income - via £600k annuity
DB £35k (2028 = £42k)
SP £11k (2028 = £14k)
ANNUITY £44k (2028 = £44k)
SIPP £10k (2.5% drawdown) (2028 = £0k - unknown SIPP value)

I'm sorely tempted by buying some stability since any downside on a SIPP cost me money, the upside is skewed (ie taxed) by around 50%.

By comparison, the annuity quote offered 4.8% RPI linked but for reasons above, tempted by high ("jam today") level rate.

I really appreciate thoughts from the experts here.

Good analysis, although another thing to account for is sequence of inflation risk. Just like SORR with an equity based drawdown, with a fixed/capped income stream like DB pension or level annuities, high inflation towards the start of retirement will have a far bigger impact than high inflation towards the end. So modelling assuming a constant inflation rate, whatever that rate is, could be misleading. If inflation is 10% for the first 3 years of retirement then that's a permanent 25% reduction in the value of a level annuity, or a 13% reduction in a 5% capped DB

You are correct - sequence of inflation is important. So, let's have a look at an example where we use the inflation (and asset returns) for 30 years starting in 1970.

I've assumed
A portfolio with 60% UK stocks and 40% UK intermediate gilts with a withdrawal of 1/n over 20 years (i.e., the first withdrawal is 5% of the portfolio, the last 100%).
A level annuity bought with £720k a 7.5% payout rate
DB and state pensions as per original post.

The plot shows the contributions of the various sources of income, as well as the total income, plotted in real (i.e., inflation adjusted) terms as a function of time for this one historical example (one of the worst periods for UK inflation).



A few things to note:
1) High inflation meant that the real purchasing power of the annuity and DB pension both decline with time. By the late 70s, the complete lack of inflation protection for the level annuity meant that the real income fell below that of the DB pension and was less than half of its original value. By the mid, 1980s, the purchasing power of the annuity had even fallen below that of the state pension.
2) The income from the portfolio was highly variable (e.g., falling by nearly half after the stock market crash in the early 70s), but gradually increases as 1/n becomes larger (e.g., in the last two years, 50% and then 100% of the portfolio are taken as income) before falling to zero after 20 years. If a max income of £100k is required, then portfolio withdrawals could be delayed for a couple of years and the fall to zero delayed (the 1/n can also be capped at, say 20% of the portfolio value rather than being allowed to go to 100%).
3) The overall income is certainly front loaded with a strong decline over the first 10 years. If the retiree survived the first 20 years, then purchasing power of the remaining income was about a third of that of the original income.

To reiterate, this was a nasty historical period for retirees with non inflation protected income (i.e., it is about as bad as it has got for UK retirees). I've assumed the state pension was index linked throughout (i.e., the other two parts of the triple lock were not triggered), but for those wanting to know how the state pension was actually uprated during this period, there an interesting (at least to me) history at https://ifs.org.uk/sites/default/files/output_url_files/bn105.pdf

Another example of an amazing post here, thanks so much for this and indeed all you posts.

I really enjoy reading and trying to understand stuff on these threads, unfortunately my pick understanding is often slow as undoubtedly must be obvious. 

I must say 99.99% content here is just superb and has helped me a lot, OldScientist and a good few others are just top class posters, so a general thanks to all posters on here.

Cheers Roger.