Annuity Purchase Cost

Bostonerimus1

Here is the OP's IRR assuming 3% inflation. The curve flattens out at age 84 as I have assume that's the death of the first spouse and the payout drops to 50%. The 10 year guarantee will also mitigate the large negative IRR in the first years.

Bostonerimus1

FIREDreamer said:

Qyburn said:

OldScientist said:

The annuity puzzle (i.e., why, when there is a choice, relatively few annuities are purchased) has been puzzled over for  getting on for at least 40 years without (AFAIK) a clear unambiguous explanation being found. 

Not sure what would have been puzzled over 40 years ago, when private pensions didn't even exist, and over 30 years before there was any choice.

OldScientist said:

In the UK, there was a significant drop in annuity purchases after the so-called pension freedoms 

Really no surprise there, annuity purchases reducing when no longer compulsory.

.. and purchases presumably started increasing when they are close to SWR but without the sleepless nights!

I think that's true, but comparing annuity payout rates to retirement SWR from an investment portfolio is the wrong thing to do - it's very expensive apples and risky oranges.

FIREDreamer

Bostonerimus1 said:

FIREDreamer said:

Qyburn said:

OldScientist said:

The annuity puzzle (i.e., why, when there is a choice, relatively few annuities are purchased) has been puzzled over for  getting on for at least 40 years without (AFAIK) a clear unambiguous explanation being found. 

Not sure what would have been puzzled over 40 years ago, when private pensions didn't even exist, and over 30 years before there was any choice.

OldScientist said:

In the UK, there was a significant drop in annuity purchases after the so-called pension freedoms 

Really no surprise there, annuity purchases reducing when no longer compulsory.

.. and purchases presumably started increasing when they are close to SWR but without the sleepless nights!

I think that's true, but comparing annuity payout rates to retirement SWR from an investment portfolio is the wrong thing to do - it's very expensive apples and risky oranges.

I prefer the expensive apples. 😀

Without the annuity I don’t think I would have had the courage to retire (“what if my SIPP drops 30% or whatever?” Eek) and it provides me with 60% more than I would have got 2 years ago - I wasnt tempted at 2.3% but at 3.8% I thought it was a reasonable compromise between cost and peace of mind and also letting this coward finally retire this summer!

I will not run out of money before running out of life and that, to me, is priceless.

Bostonerimus1

FIREDreamer said:

Bostonerimus1 said:

FIREDreamer said:

Qyburn said:

OldScientist said:

The annuity puzzle (i.e., why, when there is a choice, relatively few annuities are purchased) has been puzzled over for  getting on for at least 40 years without (AFAIK) a clear unambiguous explanation being found. 

Not sure what would have been puzzled over 40 years ago, when private pensions didn't even exist, and over 30 years before there was any choice.

OldScientist said:

In the UK, there was a significant drop in annuity purchases after the so-called pension freedoms 

Really no surprise there, annuity purchases reducing when no longer compulsory.

.. and purchases presumably started increasing when they are close to SWR but without the sleepless nights!

I think that's true, but comparing annuity payout rates to retirement SWR from an investment portfolio is the wrong thing to do - it's very expensive apples and risky oranges.

I prefer the expensive apples. 😀

Without the annuity I don’t think I would have had the courage to retire (“what if my SIPP drops 30% or whatever?” Eek) and it provides me with 60% more than I would have got 2 years ago - I wasnt tempted at 2.3% but at 3.8% I thought it was a reasonable compromise between cost and peace of mind and also letting this coward finally retire this summer!

I will not run out of money before running out of life and that, to me, is priceless.

Yes, that's exactly how to use an annuity. They are always difficult to analyze because of their dependence on personal circumstances and unknowns like when you die and inflation, but you can say the same about SWR as well.

FIREDreamer

Bostonerimus1 said:

FIREDreamer said:

Bostonerimus1 said:

FIREDreamer said:

Qyburn said:

OldScientist said:

The annuity puzzle (i.e., why, when there is a choice, relatively few annuities are purchased) has been puzzled over for  getting on for at least 40 years without (AFAIK) a clear unambiguous explanation being found. 

Not sure what would have been puzzled over 40 years ago, when private pensions didn't even exist, and over 30 years before there was any choice.

OldScientist said:

In the UK, there was a significant drop in annuity purchases after the so-called pension freedoms 

Really no surprise there, annuity purchases reducing when no longer compulsory.

.. and purchases presumably started increasing when they are close to SWR but without the sleepless nights!

I think that's true, but comparing annuity payout rates to retirement SWR from an investment portfolio is the wrong thing to do - it's very expensive apples and risky oranges.

I prefer the expensive apples. 😀

Without the annuity I don’t think I would have had the courage to retire (“what if my SIPP drops 30% or whatever?” Eek) and it provides me with 60% more than I would have got 2 years ago - I wasnt tempted at 2.3% but at 3.8% I thought it was a reasonable compromise between cost and peace of mind and also letting this coward finally retire this summer!

I will not run out of money before running out of life and that, to me, is priceless.

Yes, that's exactly how to use an annuity. They are always difficult to analyze because of their dependence on personal circumstances and unknowns like when you die and inflation, but you can say the same about SWR as well.

Arguably a safe withdrawal rate is a safe withdrawal rate, until it isn’t. 😀

Bostonerimus1

FIREDreamer said:

Bostonerimus1 said:

FIREDreamer said:

Bostonerimus1 said:

FIREDreamer said:

Qyburn said:

OldScientist said:

The annuity puzzle (i.e., why, when there is a choice, relatively few annuities are purchased) has been puzzled over for  getting on for at least 40 years without (AFAIK) a clear unambiguous explanation being found. 

Not sure what would have been puzzled over 40 years ago, when private pensions didn't even exist, and over 30 years before there was any choice.

OldScientist said:

In the UK, there was a significant drop in annuity purchases after the so-called pension freedoms 

Really no surprise there, annuity purchases reducing when no longer compulsory.

.. and purchases presumably started increasing when they are close to SWR but without the sleepless nights!

I think that's true, but comparing annuity payout rates to retirement SWR from an investment portfolio is the wrong thing to do - it's very expensive apples and risky oranges.

I prefer the expensive apples. 😀

Without the annuity I don’t think I would have had the courage to retire (“what if my SIPP drops 30% or whatever?” Eek) and it provides me with 60% more than I would have got 2 years ago - I wasnt tempted at 2.3% but at 3.8% I thought it was a reasonable compromise between cost and peace of mind and also letting this coward finally retire this summer!

I will not run out of money before running out of life and that, to me, is priceless.

Yes, that's exactly how to use an annuity. They are always difficult to analyze because of their dependence on personal circumstances and unknowns like when you die and inflation, but you can say the same about SWR as well.

Arguably a safe withdrawal rate is a safe withdrawal rate, until it isn’t. 😀

I always think of SWR as "Sensible Withdrawal Rate", some say it stands for "Sustainable Withdrawal Rate". Either is better than "Safe Withdrawal Rate" IMO as that really hides the maybe 5% probability that you'll run out of money. 

It's important to distinguish between annuity payout rates, investment returns and SWRs when developing a plan for retirement income.

westv

I think "suggested withdrawal rate" is better.

OldScientist

Qyburn said:

OldScientist said:

The annuity puzzle (i.e., why, when there is a choice, relatively few annuities are purchased) has been puzzled over for  getting on for at least 40 years without (AFAIK) a clear unambiguous explanation being found. 

Not sure what would have been puzzled over 40 years ago, when private pensions didn't even exist, and over 30 years before there was any choice.

There are other countries apart from the UK - much of the early work was done in the US. Anyway, insurance based annuities have been available for sale in the UK for a very long time (1762 or thereabouts) but sales were boosted in 1956 when tax breaks for the self employed in approved schemes were made available (essentially so the self employed were treated the same as those with occupational pensions) and the run down of capital for purchased life annuities (i.e., voluntary) also became tax exempt.

Bostonerimus1

OldScientist said:

Qyburn said:

OldScientist said:

The annuity puzzle (i.e., why, when there is a choice, relatively few annuities are purchased) has been puzzled over for  getting on for at least 40 years without (AFAIK) a clear unambiguous explanation being found. 

Not sure what would have been puzzled over 40 years ago, when private pensions didn't even exist, and over 30 years before there was any choice.

There are other countries apart from the UK - much of the early work was done in the US. Anyway, insurance based annuities have been available for sale in the UK for a very long time (1762 or thereabouts) but sales were boosted in 1956 when tax breaks for the self employed in approved schemes were made available (essentially so the self employed were treated the same as those with occupational pensions) and the run down of capital for purchased life annuities (i.e., voluntary) also became tax exempt.

The drop in annuity take up must also have been due to the rise of retail mutual funds and tax wrappers like 401ks, and IRAs in the US and eventually SIPPs and ISAs in the UK. It also correlated with the drop in the DB pension which is obviously very similar to a commercial annuity.

Financial advisors and forum posters (like us) often criticize annuities because of their expenses, low IRR and some of the sales techniques used...particularly in the US where the annuity is often mis-sold as an investment. However, the financial industry also does some pretty bad things with DC plans when selling funds and charging administration fees for funds and platforms. It all just means that the investor needs to have some minimum level of education and understanding to sniff out the bad actors.

michaels

OldScientist said:

Bostonerimus1 said:

westv said:

Bostonerimus1 said:

FIREDreamer said:

Bostonerimus1 said:

FIREDreamer said:

Bostonerimus1 said:

FIREDreamer said:

dunstonh said:

Using an IFA might have taken longer and mean that my annuity would have been lower due to rates going down.

Although, it may have been higher?  Did you get the computer rate or did HL ring Just to get the uplifted rate?

The computer rate off the website was something like £24,100 which I was happy with. It took ages for the funds to go to Just as it kept bouncing back (return date matched the send date so no interest lost) as Hargreaves got the reference number wrong twice. When it did go through I found that the annuity had gone up a bit so I was happy with that.

As rates have come down since then I think the timing was good and if I had gone with an IFA it could have taken longer and the rate might more likely to been lower as a result.

I was able to answer health questions on the web site but whilst it did impact all the other providers it made no difference with Just (same rate with or without health questions - i have a login with health declaration and another without to do a comparison) who were higher anyway.

I might use an IFA if I buy an annuity with the rest of the pot in the future though. Annuity rates might have stabilised by then and we would also be older.

I'm generally against annuities for anything other than providing a bare minimum of income you need to survive as they are expensive and will probably reduce the amount you can leave to heirs. They do offer longevity insurance and the certainty of a lifetime cheque and with rates higher than they have been for a while people will start to consider them again, but make sure you understand the fees and costs and I'd keep most of your money liquid in stocks, bonds, cash etc and do drawdown for it's low cost, flexibility, potential investment returns and to pass money onto children and charities etc.

I used approx 70% of my drawdown pot to buy an annuity. This leaves £300k in drawdown plus another maybe £50k to crystallise once I retire in June.

Also have over £600k in an ISA fully invested in a portfolio of investment trusts yielding over 4%. The dividends plus £20k subscriptions are just reinvested. I might tidy this up this year and just go for global trackers like HMWO / VWRL for simplicity.

That’s enough in investments so I was happy to take an annuity.

I got a rate of about 3.8% joint life RPI with a 10 year guarantee for ages 59/58.

That purchase money (the post crystallisation gain anyway) has also been removed from any potential LTA charge should that be reintroduced in the future.

My wife isn’t going to be interested in investments so again the “needs and requirements” are covered. The drawdown can go to luxuries. Unless the tax thresholds move soon, the annuity plus db plus state pension will use up my basic rate tax and I will not drawdown at 40% tax! That can be inherited.

You've made choices applicable to your circumstances. I think the hostility to annuities comes from a purely financial return perspective and with the attitude that markets will always deliver robust returns. The "absolutely never" folks don't consider the psychology or personal circumstances of many retirees. Of course annuities also rely on market returns, but the buyer is insulated from market fluctuations by their policy. I'm a big advocate for diversity in income generation and how much annuity/DB/SP vs drawdown is a very personal decision, but my inclination is to cover essentials with guaranteed income and as I'm single I don't need to consider a spouse which is a big factor.

I had to buy an annuity because if I just relied on drawdown plus 2 db then I would have been stuck in one more year syndrome and being to afraid to retire. Buying the annuity has given me the confidence to hand in my notice and retire in June. That, to me, is priceless. 😀

I'm not sure that you actually "had to buy an annuity" as it was a choice you made given your circumstances and feelings. There was a time when everyone really had to buy an annuity. In my situation I'm in a long standing annuity contract anyway that's a result of how an old employer set up their retirement plan and there are restrictions on how I can get at my money. I'm only considering the lifetime annuity option because of the payout rate as I don't really need lifetime income.

"Had to" doesn't always imply there was no option. 
"I just had to book that wonderful holiday" for example.

Yes the term can be taken in different ways, it's just that historically people had no choice other than to take an annuity. With the annuity becoming more popular now that rates are higher it's important to be accurate and understand exactly what you are buying and why. I looked at the OP's joint lifetime annuity and assuming 3% inflation (a big assumption) and that someone dies at 84 and the other spouse at 91 (ie joint life expectancy for a couple aged 59/58) an income stream starting with 25499 in the first year from a 645000 lump sum payment is an Internal Rate of Return of 3.46%.

That's an IRR in real terms of about 0.5%, which, not surprisingly, is close enough to the real yields on inflation linked gilts.

I think the point is that there are a lot of different tools in the retirement finance toolbox that each have different characteristics. I fully agree that those different characteristics need to be understood and compared so that how they might fit into a particular retirement plan can also be understood. For example, the contents of a DC pension could be spent on
1) Drawdown from a portfolio of stocks and bonds. This has market, inflation, and longevity risks (the bonds also have default risk), but is generally good for a legacy (particular in the event of early death - the legacy after a late death depends on the market). It also requires sufficient cognitive function to organise withdrawals (although this can be automated to some extent) and portfolio management.
2) RPI annuity. This has no market, inflation or longevity risk (but still has insurance company risk, partly offset by the FSCS, and default risk), but is not good for a legacy in the event of an early death - while if there is remaining portfolio after purchase, then late death legacies may be higher than drawdown only. Once set up, no input is required from the annuitant.

Currently, the income rate for a joint RPI annuity at 65 (~3.7% depending on beneficiary payments) is a little higher than the historical 'safe' withdrawal rate for the UK (~3.0 to 3.5% for a 30 year retirement and 60/40 portfolio) which makes the use of such an annuity attractive.

A mixed approach allows some advantages to be gained from the strengths of each type of instrument. For example, with an RPI annuity and state pension (and DB pensions) covering a significant proportion of expenditure, the portfolio can be invested more aggressively (i.e., more stocks) while portfolio withdrawals can either be front loaded (to fund the early years of retirement), more flexible (i.e., allowed vary with the market so the risk of premature exhaustion is reduced) or even be zero (which allows a legacy to be built up).

The annuity puzzle (i.e., why, when there is a choice, relatively few annuities are purchased) has been puzzled over for  getting on for at least 40 years without (AFAIK) a clear unambiguous explanation being found. In the UK, there was a significant drop in annuity purchases after the so-called pension freedoms (e.g., see https://committees.parliament.uk/publications/8514/documents/86189/default/ ) but this also coincided with record low yields in gilts - it will be interesting to see whether this has increased again as yields (and annuity rates) have increased over the last 18 months or so. Anecdotal evidence from MSE suggests that there has been more interest and discussion over that period.

Could the answer to the 'annuity puzzle' relate to the amount of income IFAs and the investment industry won't earn if a DC pot holder buys an annuity on fixed commission?!