Creating a Gilt ladder for income

MK62

DRS1 said:

I confess that I do not understand how a gilt ladder could be constructed as a proxy for an annuity.  With the annuity you get a monthly income of equal amounts (perhaps increasing annually if you pick that option).  With a gilt ladder most of the return is on maturity of the gilt (the coupons are usually peanuts especially on Index Linked Gilts).  So if you wanted monthly income you would have to buy gilts maturing one month apart!  For an 8 year period that is 96 different investments (assuming you could find that many maturing with that frequency which I doubt).  Think of the commission!
OK Pensioncraft talk about a ladder with gilts maturing a year apart.  Fine so just 8 needed as long as you can save up your expenditure till the end of the year.  But then he goes on about reinvesting the maturity proceeds - so is the ladder meant to go on for ever?  And are you meant to live on the coupons?  You'd need an awfully big investment to give you a decent income from just coupons alone.   I understand that is not what you are trying to mirror - you are prepared to spend capital as well as income over the period but with annually maturing gilts you are going to get lumpy returns.  Do let us know what you come up with. 

If you want a monthly income using a gilt ladder, you simply use cash plus coupons for the the first year's monthly payments, and then use the gilt maturing in a year, plus coupons, for the second year's monthly payments.....and so on.
If comparing to an annuity, make sure you are comparing like for like, especially if you have a spouse.

incus432

There is a big difference between a rolling ladder (where maturing gilts and coupons are reinvested) which is essentially similar to a bond fund and a collapsing ladder where coupons and maturing gilts are spent. With the latter it is set up once at the beginning with no need for any work (apart from withdrawing cash out). Unfortunately, this difference is not always made plain.

Ah thanks so much for clarifying this. The example is also helpful

I'd agree that the FT annuity is simpler and lifetime annuities definitely so (I note that guarantee periods can be used to effect a legacy in the latter case).

The guarantee option was there on the FT annuity too - and we took that for the full term (8yr) as the cost in terms of income reduction seemed reasonable.  So it continues to pay out monthly to the beneficiary in the event of death. The other option was value protection which just pays back the original pot less payments already made

incus432

Just to update. Out of interest I have been using this useful tool https://lategenxer.streamlit.app/Gilt_Ladder mentioned above to look at creating a (collapsing) bond ladder to match the L&G 8 year fixed term level annuity we recently bought via a broker (single life, with 8 year guarantee period). I made the figures identical, with monthly withdrawals, assumed the ladder was held in a SIPP so no tax until the withdrawals. and included the cash interest rate that AJ Bell pay on drawdown SIPPs. 

The gross cost of the bond ladder was just 0.5% less than the annuity cost, but after including platform costs of the SIPP and bond purchases it was 0.2% more.  So no advantage at all.  If you were to take annual withdrawals from the bond ladder (which I would probably do if you have to do manual withdrawals) the ladder is 2% dearer.

This surprised me. It is almost universally said that creating your own bond ladder is likely to be much cheaper than buying an annuity because of high fees charged by annuity providers (Ramin of Pensioncraft mentions 4% as an annuity admin estimate and talks about 'egregiously high fees'). 

Have I missed something?

Paging @zagfles

OldScientist

incus432 said:

Just to update. Out of interest I have been using this useful tool https://lategenxer.streamlit.app/Gilt_Ladder mentionefd above to look at creating a (collapsing) bond ladder to match the L&G 8 year fixed term level annuity we recently bought via a broker (single life, with 8 year guarantee period). I made the figures identical, with monthly withdrawals, assumed the ladder was held in a SIPP so no tax until the withdrawals. and included the cash interest rate that AJ Bell pay on drawdown SIPPs. 

The gross cost of the bond ladder was just 0.5% less than the annuity cost, but after including platform costs of the SIPP and bond purchases it was 0.2% more.  So no advantage at all.  If you were to take annual withdrawals from the bond ladder (which I would probably do if you have to do manual withdrawals) the ladder is 2% dearer.

This surprised me. It is almost universally said that creating your own bond ladder is likely to be much cheaper than buying an annuity because of high fees charged by annuity providers (Ramin of Pensioncraft mentions 4% as an annuity admin estimate and talks about 'egregiously high fees'). 

Have I missed something?

That's an interesting calculation and a similar outcome to the comparison I've done between payout rates of lifetime RPI annuities with a collapsing linker ladder, since, even without taking costs into account (although platform and other costs can vary a lot from platform to platform), the single life the annuity wins by quite a lot, although it was closer for a joint life annuity.

It might not be a surprise since insurance companies are investing in corporate debt with higher yields than gilts (as well as other more exotic instruments) and have economies of scale and can offset their annuity business against their insurance business (although, AFAIK, the former is small compared to the latter). While annuities may not always be the 'best' solution, there does appear to be a lack of willingness to engage in quantitative analysis of the sort you've done!

cfw1994

MK62 said:

There's a tool here that you might find useful for your research https://lategenxer.streamlit.app/Gilt_Ladder

Yikes!
Just looking at that sends my head in a spin.

I do feel that if you want to invest in something, it ought to be something that is easy to understand.   Dirty price, clean price, TIDM, GRY….lost me already 🫣

incus432

OldScientist said:

That's an interesting calculation and a similar outcome to the comparison I've done between payout rates of lifetime RPI annuities with a collapsing linker ladder, since, even without taking costs into account (although platform and other costs can vary a lot from platform to platform), the single life the annuity wins by quite a lot, although it was closer for a joint life annuity.

It might not be a surprise since insurance companies are investing in corporate debt with higher yields than gilts (as well as other more exotic instruments) and have economies of scale and can offset their annuity business against their insurance business (although, AFAIK, the former is small compared to the latter). While annuities may not always be the 'best' solution, there does appear to be a lack of willingness to engage in quantitative analysis of the sort you've done!

Interesting your comparisons came to a similar conclusion!  I was expecting there to be a significant cost advantage for the gilt ladder (not least because L&G paid the broker 1.5% commission). I would have been happy to pay a reasonable premium for the annuity to avoid the hassle of setting up the ladder and then administrating withdrawals etc.  Surprising as well if insurance companies are indeed using riskier corporate bonds and absorbing that risk. As you say it's time some of the negative comments about annuity costs were reviewed, although I wouldn't argue about them being 'opaque'.

MarkCarnage

Yes, insurers hedge interest rate and inflation risk using derivatives to a varying degree with only some physical gilts/ILGs. Most of the rest is in corporate credit for the yield spread plus some other matching longer dated secure assets (often illiquid but that doesn't tend to matter). The yield pick up from all these accounts for the better rates over and above a gilt ladder. 

incus432

cfw1994 said:

MK62 said:

There's a tool here that you might find useful for your research https://lategenxer.streamlit.app/Gilt_Ladder

Yikes!
Just looking at that sends my head in a spin.

I do feel that if you want to invest in something, it ought to be something that is easy to understand.   Dirty price, clean price, TIDM, GRY….lost me already 🫣

A few weeks ago that was precisely my reaction! The subject and jargon is arcane and initally confusing. However I've enjoyed learning - and knowing how to buy gilts/bonds and what they yield is already proving very useful, even if I never build a ladder.