Annuity 5% increase per year or RPI

OldScientist

aldershot said:

The problem with RPI annuities is they backload your returns. By definition, you'll get the highest nominal payment in the month (year) you die. Yes, they provide longevity insurance, but anecdotal experience is that cash is more fun in your 60s and 70s and tails off in your 80s and beyond. Be careful not to have too little whilst you can enjoy the benefit and end up with too much when it's too late. 

I'd agree that nominal level annuity will provide higher nominal income at the start of retirement than either an RPI or a 5% escalation annuity. However, in the absence of deflation, it is possible that the real income from the RPI annuity will be higher than that of the level annuity even quite early on in retirement if inflation is high.

IMV, the strength of the RPI annuity is that it provides a floor of real income that, combined with SP and DB pension) can be set to whatever level is desired (e.g., covering essential expenditure or even more) for a lifetime. The residual portfolio can then be used to cover enhanced early expenditure (e.g., by using a constant percentage of portfolio variable withdrawal strategy, purchasing a term annuity, or by constructing an x year gilt ladder).

MK62

aldershot said:

The problem with RPI annuities is they backload your returns. By definition, you'll get the highest nominal payment in the month (year) you die. Yes, they provide longevity insurance, but anecdotal experience is that cash is more fun in your 60s and 70s and tails off in your 80s and beyond. Be careful not to have too little whilst you can enjoy the benefit and end up with too much when it's too late. 

In reality this is an issue every DC pension holder faces.......and unfortunately, without the benefit of hindsight, there is no way of knowing for sure what the right levels will be. I understand the desire for more when younger, but there is a real danger that in doing so, you might leave yourself short in later years.....with no way of correcting the situation.

The chances of getting your finances to click to zero or near zero on the day you check out are themselves next to zero........so, you are either going to check out with some left over, or you'll run out before the end (or more likely be forced to reduce your income in the later years).....personally, I'd rather be in the former situation, but each to their own as they say.......

Albermarle

MK62 said:

aldershot said:

The problem with RPI annuities is they backload your returns. By definition, you'll get the highest nominal payment in the month (year) you die. Yes, they provide longevity insurance, but anecdotal experience is that cash is more fun in your 60s and 70s and tails off in your 80s and beyond. Be careful not to have too little whilst you can enjoy the benefit and end up with too much when it's too late. 

In reality this is an issue every DC pension holder faces.......and unfortunately, without the benefit of hindsight, there is no way of knowing for sure what the right levels will be. I understand the desire for more when younger, but there is a real danger that in doing so, you might leave yourself short in later years.....with no way of correcting the situation.

The chances of getting your finances to click to zero or near zero on the day you check out are themselves next to zero........so, you are either going to check out with some left over, or you'll run out before the end (or more likely be forced to reduce your income in the later years).....personally, I'd rather be in the former situation, but each to their own as they say.......

I would also rather be in this situation, as long as it was not so much that my estate was liable for too much IHT !

MK62

Albermarle said:

MK62 said:

aldershot said:

The problem with RPI annuities is they backload your returns. By definition, you'll get the highest nominal payment in the month (year) you die. Yes, they provide longevity insurance, but anecdotal experience is that cash is more fun in your 60s and 70s and tails off in your 80s and beyond. Be careful not to have too little whilst you can enjoy the benefit and end up with too much when it's too late. 

In reality this is an issue every DC pension holder faces.......and unfortunately, without the benefit of hindsight, there is no way of knowing for sure what the right levels will be. I understand the desire for more when younger, but there is a real danger that in doing so, you might leave yourself short in later years.....with no way of correcting the situation.

The chances of getting your finances to click to zero or near zero on the day you check out are themselves next to zero........so, you are either going to check out with some left over, or you'll run out before the end (or more likely be forced to reduce your income in the later years).....personally, I'd rather be in the former situation, but each to their own as they say.......

I would also rather be in this situation, as long as it was not so much that my estate was liable for too much IHT !

I get that, but at the start of retirement we can only guess (even if an educated guess) at the highest level of annual income we can take to ensure that happens......assuming one of the main aims is the avoidance of large changes in annual income. The higher you push the dial in the early years of retirement, the bigger the risk of plan failure, should you live to a ripe old age......not knowing your expiry date is very inconvenient for pension planning...

ukdw

Comparing like for like between RPI and 5% or Level is tricky - because you don't know what inflation is going to be like - hopefully less than 5%.

But I did compare 5% vs Level - both with 30 year guarantee - I expected level to come out better overall - but surprisingly it didn't -    

Level is ahead of 5% for the first 13 years, but after that 5% catches up and exceeds level.  

At the end of the 30 year guarantee 5% is over double level - and the total income for the 30 years is about 201% of the purchase amount for level, vs 237% for 5% - so guaranteed to be an additional 36%

Then if the recipient outlives the 30 yr guarantee the 5% escalating gets steadily further ahead.

I think I might consider 5% for my next purchase.

Might go for RPI too - but I am expecting most of my RPI protection to come from the state pension plus investment growth of funds not used to purchase annuities.

NB/ My quotes were on HL for a £200k purchase

5% 30	£7262
Level 30	£13385

aroominyork

@ukdw, would you be happy to share your calcs/spreadsheet for the level vs. 5% comparison?

ukdw

aroominyork said:

@ukdw, would you be happy to share your calcs/spreadsheet for the level vs. 5% comparison?

For these figures I simply created a 31 column spreadsheet - with the 5% starting figure compounding by 5% each year ( x 1.05) then added up each year to get an overall figure.  I did find on issue with my calculations which ends up making 5% look even better against Level - at a total of 40% more.

The attached screenshot is for £200k.

To be strictly fair with the comparison I also added in a calculation for for notional compound interest on the excess that the level annuity receives in the early years at a rate of 4% compound - and this I think covers about half of the difference - but I am still surprised that 5% comes out better than level overall.

Break even in terms of total received funds comes after about 24 years, plus if you take into account some growth of the excess this pushes the break even point back to 28 years.

I have done these sort of calculations in the past for RPI too - but a lot depends on the RPI rate and sequence of rates you choose.

A bit hard to read - so split into two

westv

I would have done it slightly simpler than that.
4 columns
1 column with 30 rows numbered 1 to 30
1 column for the 5% increasing % figure
1 column for the 5% increasing % running total
1 column for the level annuity running total.

saajan_12

This isn't about what makes the most money - even with a great forecast, its just that and the reality could be higher or lower. Its about matching your costs so you don't run out of money. 

Eg if the crystal balls all say that with 70% certainty, RPI is expected to be less than 5% over your lifetime. So 70% of the time, you're better off with the 5% fixed. But lets your main costs are food, clothes. energy, holidays, which all rise with inflation. Then in 30% of  the time, inflation is high and you're short of money. Vs if you stick with an RPI linked annuity, then in 100% of cases you can live comfortably, even though you've given up some profits in 70% of cases. 

If you have well more than you need to live comfortably, THAT is what I would consider investing to maximise returns. 

leosayer

saajan_12 said:

This isn't about what makes the most money - even with a great forecast, its just that and the reality could be higher or lower. Its about matching your costs so you don't run out of money. 

Eg if the crystal balls all say that with 70% certainty, RPI is expected to be less than 5% over your lifetime. So 70% of the time, you're better off with the 5% fixed. But lets your main costs are food, clothes. energy, holidays, which all rise with inflation. Then in 30% of  the time, inflation is high and you're short of money. Vs if you stick with an RPI linked annuity, then in 100% of cases you can live comfortably, even though you've given up some profits in 70% of cases. 

If you have well more than you need to live comfortably, THAT is what I would consider investing to maximise returns. 

I fully agree.

The ability to meet basic living costs is too important to be left to chance.