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Why buy annuity
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zagfles said: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.
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).
(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.
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.0 -
arthur_fowler said:zagfles said: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.
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).
(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.
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.
Of course it's possible this won't be enough in which case you might need to take a risk, but I wonder if historically drawdown invested in equites would have been a safer gamble than a flat annuity? Say you want about the income level of a flat annuity initially, say 7.5% of the pot, reducing by 4% a year in real terms (sort of replicating average inflation so the average real loss of a flat annuity), what age does your plan "fail" for various starting dates (ie your income drops to below what you wanted, or your pot runs out).
I might have a go at analysing it, unless OldScientist wants a challenge! But someone has probably already done it...
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zagfles said:arthur_fowler said:zagfles said: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.
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).
(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.
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.
Of course it's possible this won't be enough in which case you might need to take a risk, but I wonder if historically drawdown invested in equites would have been a safer gamble than a flat annuity? Say you want about the income level of a flat annuity initially, say 7.5% of the pot, reducing by 4% a year in real terms (sort of replicating average inflation so the average real loss of a flat annuity), what age does your plan "fail" for various starting dates (ie your income drops to below what you wanted, or your pot runs out).
I might have a go at analysing it, unless OldScientist wants a challenge! But someone has probably already done it...0 -
I've just bought my 2nd annuity, in my case flat, 30 year guaranteed. I still have a fair bit of drawdown available and that plus the SP is my inflation protection. Having a guaranteed basic income means the Drawdown pension level of risk/growth potential can be increased too.0
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zagfles said: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.
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).
(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.
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.
Of course, it all depends on the level and sequence of the inflation and returns, but historically it's not as clear cut as some might think.1 -
MK62 said: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.
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).
(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.
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........
But you're right, the actual outcome results from a complex (and unpredictable) interplay between inflation and returns. What are tolerable risks will vary from retiree to retiree, so there is no single 'ideal' solution.
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MK62 said:zagfles said: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.
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).
(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.
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.
In 1970 the basic state pension was £260 a year. Not really enough to live on, but plenty of people did. Someone then who was retiring and had built up a massive pension pot of £10k would have done very well. £10k was a massive amount of money then, enough to buy a 4 bed detached house in a decent area of London.
What are they going to do with that £10k? (assuming today's pension freedoms/option)
1) Buy a flat annuity at say £750 a year. That plus the state pension of £260 would be a 4 figure income, a target in those days, around the average wage and a luxury retirement then. Maybe they'd be worried about inflation. Buy why? Inflation had averaged 3.5% over the previous 10 years, and under 4% over the previous 20. Inflation wouldn't have looked any more of an issue then than now.
2) An index linked annuity at £480 a year. Total of £740 a year. Still a good retirement income, but below average wage.
3) Go into drawdown, say drawing 4.5% increasing with inflation. Even less income. But hindsight says that would be worked according to https://forums.moneysavingexpert.com/discussion/comment/80495432#Comment_80495432
4) Or a mix, say a flat annuity with 2/3rds of the pot and drawdown with a third. We can draw more because we have the "security" of the flat annuity, haven't we? So £500 annuity and 7.5% drawdown on £3333 giving £250. Got our 4 figure income with the state pension.
By 1980 (age 75):
1) would be living on an income of £2162 (£750 annuity plus £1412 state pension). Average wage then was £6000. They'd have gone from living on an average wage to living on just over a third of the average wage.
2) would be living on £2972 (£1560 annuity plus £1412 state pension), about half the average wage.
3) would be about £2850, slightly lower than 2)
4) would be £2712 even if the 7.5% drawdown increased with inflation. However the pot would be running dangerously low if they'd done that.
By 1990 (age 85):
1) would be living on an income of £3189 (£750 annuity plus £2439 state pension). Average wage was £15k.
2) would be living on an income of £5615 (£2439 state pension plus £3176 annuity)
3) would be be living on £5417
4) would be living on £2939 as the drawdown pot would have probably run out. Either than or they'd have had to reduce the DD and cut their spending to the bone. Utter disaster.
So it seems mixing a flat annuity with drawdown proves even worse than using the whole lot for a flat annuity in the worst case scenario (ie 1970). Pure drawdown gives a much better result, but not as good as an IL annuity.
A far better mix would likely be an index linked annuity with drawdown. You can use the IL annuity to secure a guaranteed real terms income you're happy with, and then it doesn't really matter what happens to the drawdown, you can spend it all in the early years on luxury holidays etc and if it does well that could last for 20 years, if it does badly maybe 10 years, but you know you'll be OK when it runs out. You don't know that with a flat annuity.3 -
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?0
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Another aspect is the amount of management needed - and annuity seems comparatively simple. Some other pension arrangements need ongoing calculations, management, decisions and faff which someone may decide they can do without when they are older and may or may not have a good choice for someone able and willing to take over this.
But a banker, engaged at enormous expense,Had the whole of their cash in his care.
Lewis Carroll4 -
Hoenir said: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?The 1970's economic crisis was sparked by the near 400% rise in oil prices. An event which shook global stock markets. Insurers carry sizable reserves to maintain solvency and provide buffers against the unexpected
Insurers use IL gilts to hedge inflation for IL annuities. The govt/taxpayer effectively provides the guarantee.
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