Government Bonds V Annuity

grumpsthegit

Hi, I have been looking at Annuities a little more as I get closer to pulling the pin and retiring. Probably as I am relatively young (will be 58 by the time I retire) the annuity quotes I have been getting are ok but not great. So I thought I would look at an alternative angle. The Coupon on the longer term government Bonds seems to range from 4.25% to 4.75%. So although its not a like for like comparison the return I can get seems pretty comparable. But with the bonus that I get the capital back at the maturity of the bond and if I purchase the bond within my SIPP wrapper it will still be in a tax free wrapper at the end.

To make it a fairer comparison I got a quote for a fixed term Annuity where the capital is paid back at the end - and the Bond had a better return with the compromise of the term being less flexible.

So am I missing anything here - is there a hidden risk I am not seeing when comparing say a fixed term annuity with a Government bond? The price on TR43 is £0.9452 so I would also get a 5 % return at maturity if I understand correct? Not a lot but as they say every little helps.

Thanks 

phlebas192

Are the annuities you are looking at fixed rate or do they have some form of annual increase? Ordinary gilts do not and the amount you receive will constantly reduce in real terms. If you read classic literature you will come across plenty of examples of genteel characters who are living on a fixed income and the penury they ended up in because their income had been reduced by inflation!
You can look at index linked gilts where the coupon payment does increase with inflation, but they typically pay very small coupons so aren't suitable for income purposes other than as a structured gilt ladder where most of the income comes from capital repayments when they mature (ie you don't end up with the capital returned at the end of the ladder period).

Linton

An annuity is designed to give you a steady income until you die. A fixed duration annuity rather defeats the reason for buying an annuity in the first place.

If you buy an annuity at say 55 a fixed rate annuity should give you much the same income as a bond, Longevity becomes an increasingly important consideration as you get older.  If you purchased an annuity  at say 75 it would provide a much higher ongoing income than a bond. The people who die early pay for those who don’t.

You seem to be somewhat confused as to the returns from a normal gilt. What you get is a fixed rate of interest paid out 6-monthly until maturity at which point you get £100 back. There isn’t an additional lump sum.

DRS1

"There isn’t an additional lump sum."

I think he was thinking of the gain on maturity.  If he bought 10000 nominal of TR43 he'd pay 9452 for it (well a bit more) and get back 10000 so a gain of c548.

Of course 10k in 2043 will be worth less than it is today.

grumpsthegit

DRS1 said:

"There isn’t an additional lump sum."

I think he was thinking of the gain on maturity.  If he bought 10000 nominal of TR43 he'd pay 9452 for it (well a bit more) and get back 10000 so a gain of c548.

Of course 10k in 2043 will be worth less than it is today.

Correct and yes it would be worth less but a fixed term annuity that returns the principal would be less and outside the tax free wrapper.

OldScientist

According to https://www.williamburrows.com/calculators/annuity-tables/
A single life level annuity taken at 58 currently has a payout rate of  about 6.8%
A joint life level annuity (100% beneficiary) at 58yo has a payout rate of about 6.2%

To cover a long enough period, you would need a 40 year nominal gilt (taking you to 98yo), so TR63, TG65, or TR68 might be suitable. £100 would buy you about £5, £4.60, and £5 of income per year, respectively and would return capital (£126, £184, and £142 when they matured).

Because of the return of capital this is not a like-with-like comparison, but it is clear that the annuity will deliver more income, but no legacy.

A better comparison is with a 40 year collapsing gilt ladder (e.g., see https://lategenxer.streamlit.app/Gilt_Ladder ) which currently has a payout rate of about 5.9%.

Again, the annuity, whether single life or joint, pays out more but at the cost of leaving no legacy (although the ladder would leave a diminishing legacy and none in the event of living beyond 40 years, at which point the income also falls to zero).

edit: If my understanding is correct, income from the annuity will be taxed, but so will income from the gilt/gilt ladder if it comes from the 75% taxable element.

zagfles

phlebas192 said:

Are the annuities you are looking at fixed rate or do they have some form of annual increase? Ordinary gilts do not and the amount you receive will constantly reduce in real terms. If you read classic literature you will come across plenty of examples of genteel characters who are living on a fixed income and the penury they ended up in because their income had been reduced by inflation!
You can look at index linked gilts where the coupon payment does increase with inflation, but they typically pay very small coupons so aren't suitable for income purposes other than as a structured gilt ladder where most of the income comes from capital repayments when they mature (ie you don't end up with the capital returned at the end of the ladder period).

Yup - average inflation (RPI) over the last 10 years was 4.6%, that's pretty similar to the returns from flat gilts so basically flat gilts don't provide any real return at all at the moment (obviously the future might be better or worse than the last 10 years). Index linked gilts can provide a small but guaranteed real return. 

grumpsthegit

A better comparison is with a 40 year collapsing gilt ladder (e.g., see https://lategenxer.streamlit.app/Gilt_Ladder ) which currently has a payout rate of about 5.9%.

Many thanks for this link - very useful!

Lowtrawler

OldScientist said:

According to https://www.williamburrows.com/calculators/annuity-tables/
A single life level annuity taken at 58 currently has a payout rate of  about 6.8%
A joint life level annuity (100% beneficiary) at 58yo has a payout rate of about 6.2%

To cover a long enough period, you would need a 40 year nominal gilt (taking you to 98yo), so TR63, TG65, or TR68 might be suitable. £100 would buy you about £5, £4.60, and £5 of income per year, respectively and would return capital (£126, £184, and £142 when they matured).

Because of the return of capital this is not a like-with-like comparison, but it is clear that the annuity will deliver more income, but no legacy.

A better comparison is with a 40 year collapsing gilt ladder (e.g., see https://lategenxer.streamlit.app/Gilt_Ladder ) which currently has a payout rate of about 5.9%.

Again, the annuity, whether single life or joint, pays out more but at the cost of leaving no legacy (although the ladder would leave a diminishing legacy and none in the event of living beyond 40 years, at which point the income also falls to zero).

edit: If my understanding is correct, income from the annuity will be taxed, but so will income from the gilt/gilt ladder if it comes from the 75% taxable element.

I have looked into this quite a bit and any comparison between annuities / gilt ladders needs to be based on average life expectancy.. For a male aged 58, their average life expectancy is 82 and, for a woman, 85. Annuity pricing will be based on these values and a gilt ladder should be based on this comparison.

If the poster were to seek an RPI linked 100% joint income to age 85, he would be able to purchase a gilt ladder for roughly 10% less than the cost of an equivalent annuity. If he were to use the same money buying the gilt ladder, it would permit a ladder to be built expiring in his early 90's.

Through looking at a 40 year nominal gilt, you are effectively saying his life expectancy is 98 and so annuities are always going to be better.

For the average person, a gilt ladder provides better value than an annuity because the average person will only live to 82/85. Purchasing an annuity rather than a gilt ladder is always a gamble on how long you will live. If you live to average life expectancy or less, a gilt ladder is the best choice. If you live up to 5 years longer than average life expectancy, the gilt ladder is still best. If you live more than 5 years longer than the average, the annuity becomes your best choice.

Albermarle

grumpsthegit said:

DRS1 said:

"There isn’t an additional lump sum."

I think he was thinking of the gain on maturity.  If he bought 10000 nominal of TR43 he'd pay 9452 for it (well a bit more) and get back 10000 so a gain of c548.

Of course 10k in 2043 will be worth less than it is today.

Correct and yes it would be worth less but a fixed term annuity that returns the principal would be less and outside the tax free wrapper.

I am not 100% sure about this.
I thought ( but could well be wrong) that I had read somewhere that when a fixed term annuity matures, one option is that the capital sum can go  back into a drawdown pension.

grumpsthegit

For the average person, a gilt ladder provides better value than an annuity because the average person will only live to 82/85. Purchasing an annuity rather than a gilt ladder is always a gamble on how long you will live. If you live to average life expectancy or less, a gilt ladder is the best choice. If you live up to 5 years longer than average life expectancy, the gilt ladder is still best. If you live more than 5 years longer than the average, the annuity becomes your best choice.

Thanks Lowtrawler this is useful. If I even live to the Average life expectancy I will be amazed based on family history and the fact I drink more than I should!

So maybe a bond ladder sufficient to cover my baseline level of expenses and keep the rest in equities plus a cash buffer for discretionary spending - oh decisions decisions.