Annuity vs Savings Interest Rate

Catapult

Is there ever a scenario where the interest paid on money in a high interest savings account is better then the same invested amount paid-out from an annuity (lasting 25 years'ish)? For example, if I were to take the 25% tax-free lump sum from my DC and put it into a high-interest (5%+) savings account, could that provide a better return vs the same amount retained in an annuity?

The question is really about whether I should take the 25% lump sum or whether it's better kept in the DC and used towards the annuity.

I know that probably doesn't make any sense - apologies in advance! 

dunstonh

 For example, if I were to take the 25% tax-free lump sum from my DC and put it into a high-interest (5%+) savings account, could that provide a better return vs the same amount retained in an annuity?

Unless you have a GAR, you would always take the tax free cash when buying an annuity.

amanda1024

If you could find historic data on annuity rates and savings interest rates you could try to work out whether this has been true in the past - but nobody can tell you for the future! Note that as well as the annual % figure, a big difference is that if you put the cash into savings and only spend the interest, the cash will still be there, whereas an annuity will use up the cash - but can give an inflation-linked income, guaranteed for life 

QrizB

Catapult said:

Is there ever a scenario where the interest paid on money in a high interest savings account is better then the same invested amount paid-out from an annuity

In January 2020 a level annuity for a 60-year-old was paying roughly 4%. So £100k would get you a fixed £4k pa. See table here:

https://forums.moneysavingexpert.com/discussion/comment/77427196/#Comment_77427196

That's less than the current returns you'd get on a savings account, and in the savings account your capital is preserved.

But in January 2020 you wouldn't have known that. And by January 2025 you might find that interest rates have fallen again.

I don't know if that answers your question or not!

Bostonerimus1

As annuity rates are linked to the same interest rates that are driving the rates on savings the comparisons between them remain the same. An annuity is not an investment, it's an expensive form of longevity insurance, and it will give you a worse overall financial performance than a savings account if you die before mortality credits start to kick in. Additionally you will very probably get far more income from a lump sum invested in an equity and bond portfolio.

Catapult

Bostonerimus1 said:

Additionally you will very probably get far more income from a lump sum invested in an equity and bond portfolio.

Agreed - but I'm useless at choosing good equity/bond portfolios, otherwise I'd be right there 

OldScientist

Catapult said:

Is there ever a scenario where the interest paid on money in a high interest savings account is better then the same invested amount paid-out from an annuity (lasting 25 years'ish)? For example, if I were to take the 25% tax-free lump sum from my DC and put it into a high-interest (5%+) savings account, could that provide a better return vs the same amount retained in an annuity?

The question is really about whether I should take the 25% lump sum or whether it's better kept in the DC and used towards the annuity.

I know that probably doesn't make any sense - apologies in advance! 

Leaving aside any other considerations (e.g. tax), you can use the nper function in excel (or most/all other spreadsheet programs) to calculate the number of years a pot of money will last assuming a constant interest rate and a constant withdrawal rate.

For example, I note that single life level annuities at 65yo currently pay about 7.2%. Taking your 5% interest rate then

nper(5%,7.2,-100,0,1)=22.2 years

I note that this assumes you will get 5% interest every year for the next 22 years. If the interest rate was 3% instead, then the pot of money would last just under 18 years with 7.2% withdrawals.

I also note that a 65yo female has a chance of living for 22 years of approx 55%, and a 70% chance of living for 18 years (percentages are less for males) - see https://www.ons.gov.uk/peoplepopulationandcommunity/healthandsocialcare/healthandlifeexpectancies/articles/lifeexpectancycalculator/2019-06-07 .

Of course, if you wanted to compare an RPI annuity (current payout rate of 4.6%) with a constant inflation adjusted amount from a nominal pot, then you would have to make an estimate of the real interest rates over the next 20 odd years and redo the calculation. For example, if you assume 3% nominal interest rates and 3% inflation, then the real rate is (roughly) 0%, so

nper(0%,4.6,-100,0,1)=21.7 years (i.e., similar enough to the previous case given the rough nature of assumptions made)

From your question it appears you are already considering using 75% of your DC pot to buy an annuity. Assuming this is an RPI annuity, a different question might be whether the income from the annuity combined with your state pension will be sufficient for your lifetime needs? If so, then it might be worth considering whether dynamic/ad-hoc withdrawals from the lump sum invested in a simple two fund portfolio (e.g., world shares index fund and a bond index fund) might be good enough to provide additional income over a 20-25 year period.

Bostonerimus1

Catapult said:

Bostonerimus1 said:

Additionally you will very probably get far more income from a lump sum invested in an equity and bond portfolio.

Agreed - but I'm useless at choosing good equity/bond portfolios, otherwise I'd be right there 

You've fallen for all the financial industry rubbish about portfolio building being difficult. A global equity index fund and maybe a bond index fund is all you need. Or just buy one of the many multi-asset funds like the VLS series.

Albermarle

The question is really about whether I should take the 25% lump sum or whether it's better kept in the DC and used towards the annuity.

Nearly all annuity rates are based on you getting the 25% tax free cash and the rest being used for an annuity.

You can buy a purchased life annuity with your own money, but they are a niche product and offer less good annuity rates.