RPI - linked annuity

Bostonerimus1

MK62 said:

Bostonerimus1 said:

MK62 said:

Pedantic perhaps but the BoE inflation target is 2% CPI.....RPI isn't a factor.

Also, most people already have an "index linked" income source (currently triple locked) to cover the essentials in retirement.......the state pension, so a level annuity might be an option for someone who believes their spending will reduce as they age, and who wants to maximise income earlier in their retirement........it doesn't need to be either/or though, you can have both, say 50% level and 50% index linked (or whatever % suits). I'm not saying anyone should go for a level annuity, or an index linked version....just that there are options which may or may not fit, depending on the individual's circumstances.

As a further aside, the new state pension, even triple locked, has not kept pace with RPI since 2016 (when the NSP was intoduced).......if it had, it would be c.£11920 this tax year, as opposed to the actual level of £11502.
It has however outpaced CPI........if locked to CPI, it would be c.£10784 this tax year.
Just shows there's inflation.....and there's inflation.....

My point was mostly to point out the good news that most people's spending doesn't simply compound every year with inflation and that's something to consider when planning, especially when politicians are mentioning means testing of the triple lock.

I agree......my point was really just that a level annuity might be a valid option for some, depending on circumstances.

Drawdown and retirement income planning is probably the most complex financial situation anyone will face. The design of a combination of annuities, DB, SP, and drawdown from an investment portfolio and also things like equity release make it a difficult problem. It's one time when I think the right IFA could be useful.

Yorkie1

When I went on a retirement planning session a year or two ago, they showed a spending curve for retirement. Obviously very general, but it suggested greater spending in the first part of retirement, when you are (hopefully) fit enough to do the exciting things you planned on, such as travel. Middle section, you're less active or adventurous and spending less. Then later on again, even if not needing to spend on carers or supported etc. accommodation, you might pay for a gardener, etc.

So it wouldn't necessary be wise to assume that expenditure needs will decrease as you age.

Bostonerimus1

Yorkie1 said:

When I went on a retirement planning session a year or two ago, they showed a spending curve for retirement. Obviously very general, but it suggested greater spending in the first part of retirement, when you are (hopefully) fit enough to do the exciting things you planned on, such as travel. Middle section, you're less active or adventurous and spending less. Then later on again, even if not needing to spend on carers or supported etc. accommodation, you might pay for a gardener, etc.

So it wouldn't necessary be wise to assume that expenditure needs will decrease as you age.

Index adjusted spending in retirement is often modeled as a "smile" ie decreasing to a minimum and then increasing in the latter years. These changes in spending might make the additional income you need to generate less than inflation for a large part of retirement. If you are doing drawdown this might give you a bit of relief and it's something to be factored into annuity decisions.

OldScientist

Bostonerimus1 said:

Yorkie1 said:

When I went on a retirement planning session a year or two ago, they showed a spending curve for retirement. Obviously very general, but it suggested greater spending in the first part of retirement, when you are (hopefully) fit enough to do the exciting things you planned on, such as travel. Middle section, you're less active or adventurous and spending less. Then later on again, even if not needing to spend on carers or supported etc. accommodation, you might pay for a gardener, etc.

So it wouldn't necessary be wise to assume that expenditure needs will decrease as you age.

Index adjusted spending in retirement is often modeled as a "smile" ie decreasing to a minimum and then increasing in the latter years. These changes in spending might make the additional income you need to generate less than inflation for a large part of retirement. If you are doing drawdown this might give you a bit of relief and it's something to be factored into annuity decisions.

Here is what Blanchett had to say in his original paper on the 'smile' (https://www.financialplanningassociation.org/sites/default/files/2020-09/MAY14%20JFP%20Blanchett_0.pdf ),

Rather, a “retirement spending smile” was noted with respect to changes in real spending overtime, where overall change in real spending was negative (approximately –1 percent per year during retirement, on average), although higher during both early and late retirement.

In other words, the 'smile' is in 'change in spending' and not in spending itself. It is also useful to note that the scatter in the data used (Figure 2 in the paper) was quite large.

In-terms of front loading income, a level annuity is one way of doing this, but, IMV, should be made with the expectation that the income from the annuity cannot be relied on later in retirement.

For example, currently, a joint life (100% benefit) level annuity at 65yo would pay out 6.4% compared to 4.0% for the equivalent RPI annuity (https://www.williamburrows.com/calculators/annuity-tables/ ) meaning that, provided annualised inflation was less than about 5% over the first 10 years, the real instantaneous income from the level annuity would exceed that of the RPI annuity. Of course, it is quite possible (and has happened in the past) that inflation over a decade will exceed that value or that much higher levels of inflation occur in the first few years after annuity purchase (e.g., 5 years of 10% inflation would reduce the real income of the level annuity to that of the RPI annuity). For a historical worst case, using RPI values from the 1970s, a purchase in 1974 would have seen the real income of the level annuity fall to that of the RPI annuity after 3 years.

westv

The Williamburrows website looks interesting.
Pity it doesn't work on my Amazon fire tablet.

Bostonerimus1

OldScientist said:

Bostonerimus1 said:

Yorkie1 said:

When I went on a retirement planning session a year or two ago, they showed a spending curve for retirement. Obviously very general, but it suggested greater spending in the first part of retirement, when you are (hopefully) fit enough to do the exciting things you planned on, such as travel. Middle section, you're less active or adventurous and spending less. Then later on again, even if not needing to spend on carers or supported etc. accommodation, you might pay for a gardener, etc.

So it wouldn't necessary be wise to assume that expenditure needs will decrease as you age.

Index adjusted spending in retirement is often modeled as a "smile" ie decreasing to a minimum and then increasing in the latter years. These changes in spending might make the additional income you need to generate less than inflation for a large part of retirement. If you are doing drawdown this might give you a bit of relief and it's something to be factored into annuity decisions.

Here is what Blanchett had to say in his original paper on the 'smile' (https://www.financialplanningassociation.org/sites/default/files/2020-09/MAY14%20JFP%20Blanchett_0.pdf ),

Rather, a “retirement spending smile” was noted with respect to changes in real spending overtime, where overall change in real spending was negative (approximately –1 percent per year during retirement, on average), although higher during both early and late retirement.

In other words, the 'smile' is in 'change in spending' and not in spending itself. It is also useful to note that the scatter in the data used (Figure 2 in the paper) was quite large.

In-terms of front loading income, a level annuity is one way of doing this, but, IMV, should be made with the expectation that the income from the annuity cannot be relied on later in retirement.

For example, currently, a joint life (100% benefit) level annuity at 65yo would pay out 6.4% compared to 4.0% for the equivalent RPI annuity (https://www.williamburrows.com/calculators/annuity-tables/ ) meaning that, provided annualised inflation was less than about 5% over the first 10 years, the real instantaneous income from the level annuity would exceed that of the RPI annuity. Of course, it is quite possible (and has happened in the past) that inflation over a decade will exceed that value or that much higher levels of inflation occur in the first few years after annuity purchase (e.g., 5 years of 10% inflation would reduce the real income of the level annuity to that of the RPI annuity). For a historical worst case, using RPI values from the 1970s, a purchase in 1974 would have seen the real income of the level annuity fall to that of the RPI annuity after 3 years.

Of course the usual US caveat needs to be applied to that study. An important factor in US retirement spending is health care as far more people in the US will have out of pocket costs for medical treatment than in the UK and it would be expected that those costs rise as people age. So the decline in inflation adjusted spending observed in the US study might be more pronounced in the UK where medical costs aren't as large a part of annual spending.

Here's a rather out of date (and academic) UK study.

Something often neglected in retirement planning is budgeting and spending. You probably have a greater amount of control over spending than over any other financial parameter so it's something to be given close attention.

TheGreenFrog

I did a bit of reserach on annuity terms so far as they reference RPI.  L&G's policy terms state that if RPI ceases to be published then they can substitute it with whatever the UK uses as a reference for index linked gilts (so I think that is CPI not CPIH) or any other index it considers appropriate.  Other providers I looked at have the last bit but not the first.

MarkCarnage

RPI is set to become the same as CPIH after 2030 so it's probably academic.