Annuity like investments from pension

Cus

If you wanted to replicate an annuity using a portion of your SIPP funds, to lock in a fixed rate for life when rates are high, but you were under 55, what's the closest  way you could you do it without falling foul of the rules of using SIPP funds as leverage under age 55?

SVaz

Well you could make a gilt ladder for as many years as are available.  It would cost a fortune to have it indexed linked I bet.   I think I’ve seen them up to 2060.    

SVaz

£215k for 30 years index linked £10k annual income starting 2030. 

OldScientist

Just to add to the excellent suggestion from @Svaz a ladder calculator can be found at https://lategenxer.streamlit.app/Gilt_Ladder . At retirement, the ladder could be sold to purchase an annuity.

A simple alternative to the ladder is to purchase a single inflation linked gilt that matures around the expected (RPI) annuity purchase date. The amount at maturity will be known (in real terms), although the annuity payout rate will not, so this does not fulfil the requirement of locking in the high rates.

A more complex alternative is to attempt to duration match an RPI annuity purchased at a later date. At its simplest, this approach involves purchasing a single inflation linked gilt (ILG), assuming an RPI annuity, that will have the same response as the annuity to changes in yields.

The detailed calculations are somewhat involved, but for sake of an example assume an RPI annuity purchased at 65yo has a modified duration of about 10 (it depends on yields and mortality rates). This means that the payout rate will change by 10 percent for every one percentage point change in gilt yields with increases in yields leading to an increase in payout rate and vice versa. If an ILG with a duration of 10 is purchased, a one percentage point increase in yield will lead to a 10% decrease in price (and vice versa). Combining the behaviour of the two means that the amount of purchasable annuity income will remain fairly constant regardless of what happens to gilt yields.

TheGreenFrog

OldScientist said:

Just to add to the excellent suggestion from @Svaz a ladder calculator can be found at https://lategenxer.streamlit.app/Gilt_Ladder . At retirement, the ladder could be sold to purchase an annuity.

A simple alternative to the ladder is to purchase a single inflation linked gilt that matures around the expected (RPI) annuity purchase date. The amount at maturity will be known (in real terms), although the annuity payout rate will not, so this does not fulfil the requirement of locking in the high rates.

A more complex alternative is to attempt to duration match an RPI annuity purchased at a later date. At its simplest, this approach involves purchasing a single inflation linked gilt (ILG), assuming an RPI annuity, that will have the same response as the annuity to changes in yields.

The detailed calculations are somewhat involved, but for sake of an example assume an RPI annuity purchased at 65yo has a modified duration of about 10 (it depends on yields and mortality rates). This means that the payout rate will change by 10 percent for every one percentage point change in gilt yields with increases in yields leading to an increase in payout rate and vice versa. If an ILG with a duration of 10 is purchased, a one percentage point increase in yield will lead to a 10% decrease in price (and vice versa). Combining the behaviour of the two means that the amount of purchasable annuity income will remain fairly constant regardless of what happens to gilt yields.

I don't quite understand.  I would have thought that you need to purchase a gilt that as closely as possible matches the annuity you will be purchasing.  So for example if you will go for single term simple annuity, you need to know what mortality assumption annuity providers typically use.  That is presumably available now (I don't know what it is), and you then buy a conventional gilt with that maturity.  If you want inflation linked annuity then you buy an inflation linked gilt with that maturity.  There is of course a risk that mortality assumptions have changed when you come to buy the annuity.  Key point is that your chosen gilt will not have matured when you purchase the annuity, it will have a remaining term equal to expected mortality (expected when you bought it) and you will sell it in order to purchase the annuity.  You will also want low coupon so reinvestment of coupon is not a big issue.

Hoenir

Annuities are a pooled risk. Returns are therefore elevated above those that an individual can potentially achieve alone. Downside is that you forego access to your capital in exchange for this guarantee. There's no free lunches when achieving enhanced returns. 

MK62

Whether the "returns" are enhanced is debatable......an RPI linked annuity for an average 60yo male pays around 4.4% at the moment......about the same as a 28 year IL gilt ladder (which would take you past average life expectancy)........but what you do get is a longevity guarantee that your income will not stop if you live past those 28 years......at the potential cost of loss of capital if you happen to end up in the unluckier cohort who expire in less than 28 years. No way to know today which will turn out the better option, so in the end its a personal decision. You can always do half and half as well though.
Joint life 100% IL annuities are more expensive.....c.3.6% at the moment.

SVaz

The main advantage of a gilt ladder is that it can be sold if needed/ if the person dies.  

OldScientist

TheGreenFrog said:

OldScientist said:

Just to add to the excellent suggestion from @Svaz a ladder calculator can be found at https://lategenxer.streamlit.app/Gilt_Ladder . At retirement, the ladder could be sold to purchase an annuity.

A simple alternative to the ladder is to purchase a single inflation linked gilt that matures around the expected (RPI) annuity purchase date. The amount at maturity will be known (in real terms), although the annuity payout rate will not, so this does not fulfil the requirement of locking in the high rates.

A more complex alternative is to attempt to duration match an RPI annuity purchased at a later date. At its simplest, this approach involves purchasing a single inflation linked gilt (ILG), assuming an RPI annuity, that will have the same response as the annuity to changes in yields.

The detailed calculations are somewhat involved, but for sake of an example assume an RPI annuity purchased at 65yo has a modified duration of about 10 (it depends on yields and mortality rates). This means that the payout rate will change by 10 percent for every one percentage point change in gilt yields with increases in yields leading to an increase in payout rate and vice versa. If an ILG with a duration of 10 is purchased, a one percentage point increase in yield will lead to a 10% decrease in price (and vice versa). Combining the behaviour of the two means that the amount of purchasable annuity income will remain fairly constant regardless of what happens to gilt yields.

I don't quite understand.  I would have thought that you need to purchase a gilt that as closely as possible matches the annuity you will be purchasing.  So for example if you will go for single term simple annuity, you need to know what mortality assumption annuity providers typically use.  That is presumably available now (I don't know what it is), and you then buy a conventional gilt with that maturity.  If you want inflation linked annuity then you buy an inflation linked gilt with that maturity.  There is of course a risk that mortality assumptions have changed when you come to buy the annuity.  Key point is that your chosen gilt will not have matured when you purchase the annuity, it will have a remaining term equal to expected mortality (expected when you bought it) and you will sell it in order to purchase the annuity.  You will also want low coupon so reinvestment of coupon is not a big issue.

If you mean the more complex approach, yes the duration of the gilt and annuity 'constantly' have to be matched so that at purchase, the gilt would have a maturity date in the future (in other words, every so often, the gilt would have to be sold and a new one purchased). UK mortality stats (both general and those used by insurance companies) are available although annuity durations can also be tracked by measuring how payout rates change with changes in yields.

I agree, that mortality assumptions can change (although this will usually be gradual) and that low coupons would make life easier.

Hoenir

MK62 said:

Whether the "returns" are enhanced is debatable......

All one has to do is compare Gilt Yields to those of Annuities.  Not as if annuities are anything new. More the case that people believe that self managing money is more profitable. This I put put down to recency bias myself. Ultimately everything moves in cycles. 

TheGreenFrog

OldScientist said:

If you mean the more complex approach, yes the duration of the gilt and annuity 'constantly' have to be matched so that at purchase, the gilt would have a maturity date in the future (in other words, every so often, the gilt would have to be sold and a new one purchased). UK mortality stats (both general and those used by insurance companies) are available although annuity durations can also be tracked by measuring how payout rates change with changes in yields.

I agree, that mortality assumptions can change (although this will usually be gradual) and that low coupons would make life easier.

This is the bit I don't understand.  If I am 55 and mortality on annuity is at 88, why not just buy now a gilt maturing in 2058?