UK Gilts (eg TR32) vs Bond Funds for Retirement Portfolio Balance (7-Year Horizon, Retiring at 57)

QrizB

Peter_F said:

 30 year gilts have recently been offering yields of 5.6%. Given that a 60 year old could secure a level annuity of 6% pa ...

Just over 7%, per the current table at https://www.hl.co.uk/retirement/annuities/best-buy-rates

Or almost 4.6% increasing by RPI.

MK62

QrizB said:

Peter_F said:

 30 year gilts have recently been offering yields of 5.6%. Given that a 60 year old could secure a level annuity of 6% pa ...

Just over 7%, per the current table at https://www.hl.co.uk/retirement/annuities/best-buy-rates

Or almost 4.6% increasing by RPI.

Hardly apples to apples though......

OldScientist

JamTomorrow said:

OldScientist said:

Yes, your understanding is correct. If the duration of the annuity and the fixed income holdings are perfectly matched then the rise in price of the gilt should exactly compensate for the fall in payout rate of the annuity. In practice, matching the duration exactly is unlikely to be achieved, but the tracking error (in terms of income purchased) will be smaller than with no matching (so it is a matter of reducing interest rate risk rather than eliminating it).

While it does seem like alchemy, what this method tries to do is to hold a collection of fixed income that has similar properties to that held by the insurance company (their actual underlying holdings are unknown and will vary from company to company). In order to achieve a better match it is usual to hold two or three gilts at a range of maturities (rather than just one) since these will then capture changes across the yield curve (e.g., as we have seen recently, yields of longer gilts have risen far more than those of shorter gilts).

It is unfortunate that deferred income annuities are not currently available in the UK (they are available in the US where they are sometimes used as longevity insurance) since this would remove the need to mess about with matching!

Thanks again, your insight is brilliant and feels like an "aha" moment! It reminds me of when I realised that concentrating my workplace pension contributions into fewer months, rather than spreading them evenly over 12 months, significantly reduced my National Insurance (NI) contributions for the same pension outcome.  Something that is straightforward to do but never seems to make mainstream financial guidance.

It also resonates with a past strategy where I used a Contract for Difference (CFD) to hedge a 3-year Save As You Earn (SAYE) scheme. I was confident the share price had more downside risk by the time my SAYE matured in a year, so the CFD effectively locked in the current price for a small cost.

Similarly, I’m surprised no financial institutions are offering a product to lock in today’s record-high annuity rates for a modest fee, especially for those nearing retirement. After reading your post, I’m keen to explore this approach further and allocate part of my pension portfolio to UK Gilts that align with my investment horizon.  Sorry, but a few questions:

1. Is a single Gilt too simplistic or directionally fit for purpose? I assume your suggestion to use 2–3 funds is to hedge against changes in the yield curve, which could make a single Gilt less effective. Is that the risk?
2. Resources for further research? Are there any recommended books, articles, or websites where I can dive deeper into using Gilts to lock in annuity rates?  
3. Tools for Gilt selection? Are there any existing tools that take inputs like age, years to retirement, and desired annuity investment (e.g., £300k) to recommend specific UK Gilts? If not, I’ll consider building something like this using Google’s Gemini Canvas or similar platforms?

1)Yes, a single gilt (or fund) will not track changes across the yield curve, multiple ones (two or three) will do a better job.
2) There are quite a lot of threads on duration matching and liability matching at bogleheads (e.g., see bobcat2's posts in https://www.bogleheads.org/forum/viewtopic.php?t=445348 ) which is a similar effect
3) AFAIK, no.

This idea is not new, lifestyle retirement plans that were going to purchase a nominal annuity would include a mix long (over 15 year) gilt funds and 'cash' (STMMFs) to achieve something similar.

Bostonerimus1

OldScientist said:

JamTomorrow said:

OldScientist said:

A couple of comments - the horizon of 7 years takes you to retirement, but not beyond. With an individual bond held to maturity you run interest rate risk at maturity if it is to be reinvested.

In retirement, for many people income is the most important consideration (legacy may also be important). Guaranteed income (i.e., not dependent on market conditions) can come from SP, DB pensions, annuities, and collapsing gilt ladders.

The last of these can be built before retirement. For example, using the gilt ladder tool at https://lategenxer.streamlit.app/Gilt_Ladder it would appear that a 40 year ladder (i.e., taking you to 97) with a 7 year delay in starting that will provide an inflation adjusted £10k per year can currently be built for about £250k. While this is complex to construct, it is relatively easy to use in retirement (coupons and maturing bonds end up in your pension account).

An alternative, as already mentioned, is to purchase an annuity at retirement. Since, AFAIK, deferred annuities are not currently available in the UK, in order to lock in the current good rates, inflation linked gilt funds or individual gilts that match the duration of the annuity (roughly half the life expectancy at purchase) plus the delay until purchase will ensure the income at purchase is roughly the same as now (yields and payout rates going down will lead to price rises in the gilts held and vice versa).

Yes, on the first point I will need to decide what to do with the 40% bond allocation that has matured.  If Annuity rates are similar or better to now then a large chunk of this could be allocated to an annuity.  If the economy is under control and interest rates have fallen I agree I will be in a dilemma if only low rate return available.  I don't really know what my strategy should then be in that scenario in 7 years time.  Maybe hold in low rate money market fonds or recycle in to short duration IL GILTS so that my capital keeps pace with inflation as I don't feel I need to chase return, just preserve it in real terms.

I'm not sure I understand your insights on locking in good rates.  Let's say I expect to live to 90 so if I buy say £300k of an individual GILT with 23 year duration ((90-57)/2)+7 that would lock in current yield rates? 

Using TG49 as an example with current YTM of 5.4% and lets say the rate drops by 1% in one years time (and then hold for the next 6 years), then the price of that bond should increase by ~22% (22 years left x 1% movement), so my TG49 bond holding would increase to ~£360k.  Therefore when I come to buy an annuity in 7 years time I now have £360k, rather than £300k, and that additional £60k of capital should directionally be suifficient to offset the reduction in annuities from a ~1% reduction in the yield curve?  I think I now see what you are saying but can you confirm if I have got that right.

That does feel like some kind of financial alchemy but I can see how that could be a strategy to largely lock in todays annuity rates if you are certain you are going to buy an annuity in 7 years time.  It's when you learn things like this that I love this site   Thank you.

Yes, your understanding is correct. If the duration of the annuity and the fixed income holdings are perfectly matched then the rise in price of the gilt should exactly compensate for the fall in payout rate of the annuity. In practice, matching the duration exactly is unlikely to be achieved, but the tracking error (in terms of income purchased) will be smaller than with no matching (so it is a matter of reducing interest rate risk rather than eliminating it).

While it does seem like alchemy, what this method tries to do is to hold a collection of fixed income that has similar properties to that held by the insurance company (their actual underlying holdings are unknown and will vary from company to company). In order to achieve a better match it is usual to hold two or three gilts at a range of maturities (rather than just one) since these will then capture changes across the yield curve (e.g., as we have seen recently, yields of longer gilts have risen far more than those of shorter gilts).

It is unfortunate that deferred income annuities are not currently available in the UK (they are available in the US where they are sometimes used as longevity insurance) since this would remove the need to mess about with matching!

The USA has plenty of things wrong with it, but it does have some interesting fixed income products. You can buy a deferred annuity, but watch out for fees and the often poor internal rate of return. I own one of the deferred annuities with a good reputation and new deposits get an interest rate of 4.4% which is better than the 10 Year Treasury Bill and the interest rate is guaranteed never to fall below 3%. At retirement I can do things like take it out over 10 years or turn it into a lifetime annuity. It's been a useful part of my conservative fixed income allocation.

More interesting for this conversation are target maturity bond funds. These funds hold bonds that all mature within the same year. They pay out regular interest and distribute the principal at maturity so it's easy to construct a bond ladder.

Bostonerimus1

Peter_F said:

Without wishing to derail the discussion I would suggest that perhaps you are focusing on the wrong issue.
I am assuming that retiring at age 57 it is your intention to use income drawdown at least initially to fund your retirement income. Let's assume that you do this for at least 10 years until age 67 that gives you a 17 year investment period from today
On that basis most people would opt for a portfolio that is weighted towards equities but with a significant bond portfolio to dampen volatility and provide regular income. Historically many people would adopt a 60:40 portfolio. Whether you use gilt/bond funds or individual gilts/bonds really won't make that much difference. The most important aspect of your portfolio is the overall weighting towards equities and bonds. 

Equity markets can always suffer corrections of 30% or more. Generally they are short lived but not always. A 60:40 portfolio might limit the fall to 20%. If so this should not overly impact your retirement plans providing you take sensible short term steps.
Reduce your withdrawals in the early years and perhaps supplement your income with some part time work.
If you are going to use income withdrawal over a long time period, you need to be comfortable with your portfolio fluctuating significantly in value. If you aren't then an annuity provides a sensible reliable income stream.

For a successful retirement, I would encourage you to focus more on longer term planning rather than just the next 7 years.

Historically there was a rule of thumb to hold "your age in bonds" when thinking about retirement allocations and to emphasize dividends over growth in your equities. One of the most venerable such income oriented funds in the USA has been around since 1970 and is called the Wellesley fund. It is 60% bonds with an average maturity of about 10 years, and 40% dividend oriented companies like Unilever and JP Morgan. I like an approach that uses bond interest and stock dividends along with SP to provide retirement income. Wellesley has a sister fund called Wellington that is 60% dividend stocks and 40% bonds founded in 1929 - what a year to start an investment fund!

Bostonerimus1

This might be of interest to some people. It's a presentation given by Zvi Bodie to Boston University staff about retirement income. It's obviously American, but where you see TIPs think Index Linked Gilts and for I-bonds think NS&I saving bonds. It presents a contrarian low risk approach to retirement investment and income generation. It's part of a series of lectures done by BU Human Resources and was widely shared between academic institutions and gives you an idea of the sort of effort that went into benefits education.

https://www.youtube.com/watch?v=gj0oGwOJ2K8