Why buy annuity

LHW99

We had planned drawdown to around 75, then annuitise part of the larger DC pot on a joint basis to equalise what funds were left in both DC's, against one needing care later.

As ill health has started as we get older, and annuity rates have improved generally, we are looking into this now.

It ensures income is more than adequate as marbles start to slip, and incidentally will mitigate the proposed IHT on total assets including DC pensions in due course.

tigerspill

What protection does an annuity have should the company providing the product fail?

Linton

tigerspill said:

What protection does an annuity have should the company providing the product fail?

Ultimately, annuities in payment are fully protected by FSCS.  In practice it is likely that they will simply be moved to another provider.

OldScientist

arthur_fowler said:

zagfles said:

arthur_fowler said:

zagfles said:

I can't see the point of flat annuities. You just replace investment risk with inflation risk. Even IFAs don't seem to understand this when they waffle on about breakeven points based on guesses about inflation. The point of an annuity isn't to do what maximises lifetime income. Use drawdown for that. The point is to provide a guaranteed income for the rest of your life to pay bills, shopping etc, which will likely increase with inflation, which is unknown just like stockmarket returns. 

Again, it depends......

For us a flat annuity I believe was the correct route to take. Rationale is:
1) We have various DB pensions plus full SPx2 that will kick in over the next 7 years (retiring at 60). These will mitigate (but not remove) inflation risk
2) We want a (relatively) higher income in the next ten years while we are hopefully fit and well enough to travel a lot (which is what we like to do).

1) If private sector DB pensions which usually have caps on inflation increases, that's even more reason to mitigate with something fully inflation protected. A decade like the 1970's would about halve the DB pension value if inflation increases are capped at 5%. Even one off high inflation will permanently dent a DB pension in payment, a single year of 10% as we've seen recently would chop about 5% real value off a DB pension if capped at 5% inflation increase, or 7% if capped at 3%, every year into the future, even if inflation returns to 2% or so.
(It's not so bad in deferment as the cap applies across the entire period of deferment, but once in payment lumpy inflation can serious dent DB pensions)

2) Front loading retirement spend may be sensible but a flat annuity fronts loads by an unknown amount. You can easily front load retirement income to get predictable real income for instance using an IL gilts ladder, or a short term annuity, in addition to a lifetime IL annuity. 

Yes, of course mitigating inflation risk entirely is possible but it is very expensive

While I agree that front loading using a level annuity is a reasonable case (IMO, probably the only reasonable one) but the outcome depends on sequence of inflation. A run of nasty years (annual inflation of 20% plus occurred several times in the UK in the 20th century) very early on after purchase will destroy the purchasing power of a level annuity in both the short, and particularly, the long term. How expensive IL protection turns out to be can only be determined in retrospect (if inflation is low, then very expensive, if inflation is high, very cheap!).

MK62

OldScientist said:

arthur_fowler said:

zagfles said:

arthur_fowler said:

zagfles said:

I can't see the point of flat annuities. You just replace investment risk with inflation risk. Even IFAs don't seem to understand this when they waffle on about breakeven points based on guesses about inflation. The point of an annuity isn't to do what maximises lifetime income. Use drawdown for that. The point is to provide a guaranteed income for the rest of your life to pay bills, shopping etc, which will likely increase with inflation, which is unknown just like stockmarket returns. 

Again, it depends......

For us a flat annuity I believe was the correct route to take. Rationale is:
1) We have various DB pensions plus full SPx2 that will kick in over the next 7 years (retiring at 60). These will mitigate (but not remove) inflation risk
2) We want a (relatively) higher income in the next ten years while we are hopefully fit and well enough to travel a lot (which is what we like to do).

1) If private sector DB pensions which usually have caps on inflation increases, that's even more reason to mitigate with something fully inflation protected. A decade like the 1970's would about halve the DB pension value if inflation increases are capped at 5%. Even one off high inflation will permanently dent a DB pension in payment, a single year of 10% as we've seen recently would chop about 5% real value off a DB pension if capped at 5% inflation increase, or 7% if capped at 3%, every year into the future, even if inflation returns to 2% or so.
(It's not so bad in deferment as the cap applies across the entire period of deferment, but once in payment lumpy inflation can serious dent DB pensions)

2) Front loading retirement spend may be sensible but a flat annuity fronts loads by an unknown amount. You can easily front load retirement income to get predictable real income for instance using an IL gilts ladder, or a short term annuity, in addition to a lifetime IL annuity. 

Yes, of course mitigating inflation risk entirely is possible but it is very expensive

While I agree that front loading using a level annuity is a reasonable case (IMO, probably the only reasonable one) but the outcome depends on sequence of inflation. A run of nasty years (annual inflation of 20% plus occurred several times in the UK in the 20th century) very early on after purchase will destroy the purchasing power of a level annuity in both the short, and particularly, the long term. How expensive IL protection turns out to be can only be determined in retrospect (if inflation is low, then very expensive, if inflation is high, very cheap!).

True enough, but if you split your pot between an annuity and drawdown, then an IL annuity will force you into a higher withdrawal rate from the drawdown pot vs a flat annuity, right during the period of your retirement when the drawdown pot is most vulnerable to sequence risk.....as is often the case, protection from one risk can expose you to other risks.
Of course, it all depends on the level and sequence of inflation and returns......and as there is no way to know those upfront, we can only speculate on a what-if basis........

Bostonerimus1

You buy a lifetime annuity as longevity insurance...it is not an investment. The longer you live the closer the "return" on your money comes to the payout rate, but you'll never reach that amount. So if your annuity payout rate is 6% and your expected investment return is 8% then the investment return will always win out on purely financial terms. The critical word in the last sentence is "expected". 

arthur_fowler

OldScientist said:

arthur_fowler said:

zagfles said:

arthur_fowler said:

zagfles said:

I can't see the point of flat annuities. You just replace investment risk with inflation risk. Even IFAs don't seem to understand this when they waffle on about breakeven points based on guesses about inflation. The point of an annuity isn't to do what maximises lifetime income. Use drawdown for that. The point is to provide a guaranteed income for the rest of your life to pay bills, shopping etc, which will likely increase with inflation, which is unknown just like stockmarket returns. 

Again, it depends......

For us a flat annuity I believe was the correct route to take. Rationale is:
1) We have various DB pensions plus full SPx2 that will kick in over the next 7 years (retiring at 60). These will mitigate (but not remove) inflation risk
2) We want a (relatively) higher income in the next ten years while we are hopefully fit and well enough to travel a lot (which is what we like to do).

1) If private sector DB pensions which usually have caps on inflation increases, that's even more reason to mitigate with something fully inflation protected. A decade like the 1970's would about halve the DB pension value if inflation increases are capped at 5%. Even one off high inflation will permanently dent a DB pension in payment, a single year of 10% as we've seen recently would chop about 5% real value off a DB pension if capped at 5% inflation increase, or 7% if capped at 3%, every year into the future, even if inflation returns to 2% or so.
(It's not so bad in deferment as the cap applies across the entire period of deferment, but once in payment lumpy inflation can serious dent DB pensions)

2) Front loading retirement spend may be sensible but a flat annuity fronts loads by an unknown amount. You can easily front load retirement income to get predictable real income for instance using an IL gilts ladder, or a short term annuity, in addition to a lifetime IL annuity. 

Yes, of course mitigating inflation risk entirely is possible but it is very expensive

While I agree that front loading using a level annuity is a reasonable case (IMO, probably the only reasonable one) but the outcome depends on sequence of inflation. A run of nasty years (annual inflation of 20% plus occurred several times in the UK in the 20th century) very early on after purchase will destroy the purchasing power of a level annuity in both the short, and particularly, the long term. How expensive IL protection turns out to be can only be determined in retrospect (if inflation is low, then very expensive, if inflation is high, very cheap!).

Yes, agreed. If we have a long run of high inflation as you mention, then, no it won't be ideal but we will still have plenty to live on and will need to adjust our lifestyle accordingly.

zagfles

OldScientist said:

arthur_fowler said:

zagfles said:

arthur_fowler said:

zagfles said:

I can't see the point of flat annuities. You just replace investment risk with inflation risk. Even IFAs don't seem to understand this when they waffle on about breakeven points based on guesses about inflation. The point of an annuity isn't to do what maximises lifetime income. Use drawdown for that. The point is to provide a guaranteed income for the rest of your life to pay bills, shopping etc, which will likely increase with inflation, which is unknown just like stockmarket returns. 

Again, it depends......

For us a flat annuity I believe was the correct route to take. Rationale is:
1) We have various DB pensions plus full SPx2 that will kick in over the next 7 years (retiring at 60). These will mitigate (but not remove) inflation risk
2) We want a (relatively) higher income in the next ten years while we are hopefully fit and well enough to travel a lot (which is what we like to do).

1) If private sector DB pensions which usually have caps on inflation increases, that's even more reason to mitigate with something fully inflation protected. A decade like the 1970's would about halve the DB pension value if inflation increases are capped at 5%. Even one off high inflation will permanently dent a DB pension in payment, a single year of 10% as we've seen recently would chop about 5% real value off a DB pension if capped at 5% inflation increase, or 7% if capped at 3%, every year into the future, even if inflation returns to 2% or so.
(It's not so bad in deferment as the cap applies across the entire period of deferment, but once in payment lumpy inflation can serious dent DB pensions)

2) Front loading retirement spend may be sensible but a flat annuity fronts loads by an unknown amount. You can easily front load retirement income to get predictable real income for instance using an IL gilts ladder, or a short term annuity, in addition to a lifetime IL annuity. 

Yes, of course mitigating inflation risk entirely is possible but it is very expensive

While I agree that front loading using a level annuity is a reasonable case (IMO, probably the only reasonable one) but the outcome depends on sequence of inflation. A run of nasty years (annual inflation of 20% plus occurred several times in the UK in the 20th century) very early on after purchase will destroy the purchasing power of a level annuity in both the short, and particularly, the long term. How expensive IL protection turns out to be can only be determined in retrospect (if inflation is low, then very expensive, if inflation is high, very cheap!).

Yes sequence of inflation is very important, just as important as sequence of returns when talking about drawdown. But I suspect most people, maybe even advisors, who model flat vs RPI annuities just assume constant inflation. 

I've modelled retirement at 65 assuming that the uplift for a flat annuity is 56% (as per Annuity Rates: View Best Annuity Rates from the UK Market) 

At 3% inflation, the flat annuity pays more until age 80 and the cumulative (real term) total income is higher for flat until 98. Looks like a no-brainer, right? 

Even at 5% inflation, the flat annuity pays more till 74 and the cumulative is more till 85. 

But put in some real sequences. 

1970: the flat pays more for just 4 years, till 69, and the cumulative total is more till just 73. At 74 you're now down overall and living on an income a third of the initial real value and half what you'd have had with an index linked annuity.  By age 80 your income is less than 20% of its initial value and 30% of the index linked annuity. 

1980: the flat pays more till age 72 and the cumulative cut over is age 80, when you're now on 70% of what the IL would have paid and reducing in your 80's down to 55%

1990: A lot better for flat, pays more till age 80 and the cumulative cut over would have been last year, age 98. 

2000: Flat pays more till 81, cumulative cut over not happened yet (now aged 89), current income just under half initial and 76% of what an IL would have been. 

So a flat annuity would have been a disaster in 1970, it would have been bad in 1980 assuming average life expectancy, and it would have likely been better in 1990 and 2000. But the downside of a 1970's like start is far worse than the upside of later years. 

DRS1

What interests me is what inflation rate insurers assume when pricing IL annuities.  The prices I got earlier in the year showed that an IL annuity was cheaper than one with flat 5% increases built in.  Maybe they have forgotten the 1970s?

zagfles

DRS1 said:

What interests me is what inflation rate insurers assume when pricing IL annuities.  The prices I got earlier in the year showed that an IL annuity was cheaper than one with flat 5% increases built in.  Maybe they have forgotten the 1970s?

It's not insurers assuming anything. It's the market which sets the price of IL gilts vs flat gilts.