Annuities as part of pension planning

username12345678

Hi, with 18 months to go before I can start accessing my SIPP I have started to consider using an RPI linked annuity with part of the available money to cover annual spending.

I should probably say I would be the more conservative end of the investing spectrum with loss avoidance and minimising volatility as a priority. There are no legacy requirements so depleting the pot over c35 years is fine.



Having gone back through the last ten years of spending the situation in 18 months will be something in the ballpark of the following:

SIPP+ISA+GIA

Average annual spending: 1.5% of total

Highest year: 2% of total

Whilst this is below the historical SWR's I'm still aware of longevity and inflation risks given my unwillingness to carry anything more than the bare minimum of equity exposure.




Current PF:

Equities: 20% (global index)

STMMF:  25%

Gilt ladder: 55% (nominal shorter end, IL's longer duration)



Having run the numbers through simulations it does seem that this current allocation will suffice for what I need. There is of course the re-investment risk of the STMMF and maturing gilts in a falling rate environment.

Which brings me to the question of an RPI linked annuity at age 55.

The rates at the moment seem to be between 3.8% and 4% so to cover the highest annual spend would require approximately 50% of the total available.




I asked AI to list some of the downsides to an early RPI annuity:

Forgoes a higher starting income than otherwise would be available.

Having input family health it has calculated I am slightly below average life expectancy. This could mean I don't get past breakeven against a level annuity.

The SP should be factored in as an inflation protected income later in life.

Inflation expectations long-term may not justify the financial penalties.

The final conclusion was that an RPI linked annuity was a 'sub-optimal' choice.



I'd be interested in more human views on the above and whether there is a justifiable place for annuities, be they level or escalating, with younger retirees.

Thanks.

dunstonh

Average annual spending: 1.5% of total
Highest year: 2% of total
Whilst this is below the historical SWR's I'm still aware of longevity and inflation risks given my unwillingness to carry anything more than the bare minimum of equity exposure.

That is not well below the historical SWR relative to assets.  The often quoted 3.5% is where there is 60% equities.   The lower the equities, the lower the SWR.

The final conclusion was that an RPI linked annuity was a 'sub-optimal' choice.

Bizarre but not unexpected.  AI shouldn't be relied on for things like that

An RPI annuity gives you certainty.   UK inflation tends to be stable for a period and then spikes.    It is those spikes that do the damage.  

It would be very strange for someone not looking to provide a legacy and is as cautious as your post suggests to not proceed, at least in part, with an indexed annuity.  Especially given the current rates, which are just off their best since 2008.

DRS1

If you have health issues then these can be reflected in the annuity rates you get quoted.

If you want to factor state pension into the mix then get a mix of fixed term and lifetime annuities.  So the fixed term one would expire when your SP kicks in and would mirror the amount of SP you would get.  The triple lock may mess up the calculations because you won't get those increases from an annuity. but if you just get a fixed term annuity paying today's state pension amount that should be OK.  You might get a nice bump in income when the state pension starts.

But if you already have a ladder of gilts why are you looking at an annuity?  You could just live off the gilt ladder as each step matures.

MyRealNameToo

username12345678 said:
I asked AI to list some of the downsides to an early RPI annuity:

Forgoes a higher starting income than otherwise would be available.

Having input family health it has calculated I am slightly below average life expectancy. This could mean I don't get past breakeven against a level annuity.

What is your personal medical and lifestyle (eg BMI, Smoker etc)? 

Family history isnt a great indicator of what your experience will be. Even doctors diagnoses arent always great. The idea of annuities is that it gives you protection from longevity risk, if you outlive expectations you continue to get paid in full. Enhanced Annuities are available for those with higher mortality risk which compensate for the anticipated earlier death. Alcoholic aunt was given 2-3 years to live if she stopped drinking, she couldn't, her annuity when it vested had a material uplift as a consequence. She survived almost 18 years 

Even with no health considitions you could die early, hit by the proverbial bus, and thats the downside of annuities. You could put a guarantee period in to mitigate but then you'll erode the benefit of an enhanced annuity if you qualify for one. 

username12345678

DRS1 said:

If you have health issues then these can be reflected in the annuity rates you get quoted.

If you want to factor state pension into the mix then get a mix of fixed term and lifetime annuities.  So the fixed term one would expire when your SP kicks in and would mirror the amount of SP you would get.  The triple lock may mess up the calculations because you won't get those increases from an annuity. but if you just get a fixed term annuity paying today's state pension amount that should be OK.  You might get a nice bump in income when the state pension starts.

But if you already have a ladder of gilts why are you looking at an annuity?  You could just live off the gilt ladder as each step matures.

I would be comfortable sticking with my gilt ladder plan as it is.

An RPI linked annuity does have a couple of possible benefits (for me anyway). The certainty and simplicity mainly; but also in the unlikely event that my longevity is a family outlier.

The flip side of course is losing the flexibility around drawing income which like most retirees is unlikely to be a constant, along with the question of whether the total income is likely to be as much with an annuity as a gilt ladder.

username12345678

MyRealNameToo said:

username12345678 said:
I asked AI to list some of the downsides to an early RPI annuity:

Forgoes a higher starting income than otherwise would be available.

Having input family health it has calculated I am slightly below average life expectancy. This could mean I don't get past breakeven against a level annuity.

What is your personal medical and lifestyle (eg BMI, Smoker etc)? 

Family history isnt a great indicator of what your experience will be. Even doctors diagnoses arent always great. The idea of annuities is that it gives you protection from longevity risk, if you outlive expectations you continue to get paid in full. Enhanced Annuities are available for those with higher mortality risk which compensate for the anticipated earlier death. Alcoholic aunt was given 2-3 years to live if she stopped drinking, she couldn't, her annuity when it vested had a material uplift as a consequence. She survived almost 18 years 

Even with no health considitions you could die early, hit by the proverbial bus, and thats the downside of annuities. You could put a guarantee period in to mitigate but then you'll erode the benefit of an enhanced annuity if you qualify for one. 

I have annual medical and they’re fine bar a slightly elevated bp. Probably cursed myself now lol.

OldScientist

While you have no legacy requirements, do you have a spouse (I note that the annuity rates you've quoted are for single life)?

One approach is to consider the long term first, i.e., post-67 when SP is in payment and buy sufficient annuity income to achieve your long term income requirements.

Then consider the bridging period to SP,  i.e., the period from 55-67 in your case, and construct a gilt ladder to provide a proportion or all of the required income.

For example, if '2%' was £20k (implying a pot of £1m), then in the long-term you'd need to add about £8k annuity income in addition to the state pension (with a cost of £200k, assuming a payout rate of 4%).

To construct a a 12 year gilt ladder providing £20k per year to start in 2 years time would currently cost about £220k.

For this example, about 40% of the pot is required to provide sufficient income for life. The rest can be left invested to provide ad-hoc income.

Obviously, if the '2%' is more than £20k, then the relative cost of the annuity will increase since the SP is a fixed amount.

IMV, in a comparison of an RPI annuity with a level one, for the cautious retiree it is the downside of the level annuity that is problematic. If high inflation shows up, then the initial advantage the level annuity has will soon disappear (e.g., the 1970s saw annualised inflation of just over 12% and slightly more than a threefold increase in prices during that decade - many 'crossover' calculations assume inflation is constant with relatively low values of 2%, 3%, 5% or so).

DRS1

username12345678 said:

DRS1 said:

If you have health issues then these can be reflected in the annuity rates you get quoted.

If you want to factor state pension into the mix then get a mix of fixed term and lifetime annuities.  So the fixed term one would expire when your SP kicks in and would mirror the amount of SP you would get.  The triple lock may mess up the calculations because you won't get those increases from an annuity. but if you just get a fixed term annuity paying today's state pension amount that should be OK.  You might get a nice bump in income when the state pension starts.

But if you already have a ladder of gilts why are you looking at an annuity?  You could just live off the gilt ladder as each step matures.

I would be comfortable sticking with my gilt ladder plan as it is.

An RPI linked annuity does have a couple of possible benefits (for me anyway). The certainty and simplicity mainly; but also in the unlikely event that my longevity is a family outlier.

The flip side of course is losing the flexibility around drawing income which like most retirees is unlikely to be a constant, along with the question of whether the total income is likely to be as much with an annuity as a gilt ladder.

As you and other people have pointed out the benefit of the annuity is the longevity issue.  If you set up a 30 year gilt ladder and live off that what do you do if you make it to year 31?  With the annuity you're fine.  On the other hand if you don't make it past year 2 your heirs still have the rest of the gilt ladder but with the annuity that is gone (assuming it is a single life annuity with no guarantee period or protected amount).

But you seem to be sensibly looking at only spending part of the pot on an annuity and having the rest available for drawdown as and when needed.  If you followed my mix and match suggestion with a fixed term annuity you would probably have a fair bit more left in the drawdown pot.

kempiejon

A perennial question round our way.
It looks like you'll have enough, not enough equity and other assets for my taste but you will know your reaction to market volatility.
How has the pot been growing so far?
Moving from accumulating to spending many find hard. An annuity removes a decision of what to sell and how much. Many like the idea of an inflation linked pension, it gives a certainty about some of the income. Current thinking is I can get a better return and leave a pot by going alone but I temper that with I can't always be lucky. In a year or two I'll look again at annuitising some of the pot for a base income to cover costs but not full spend.
What is the yield on the gilt ladder? 

Bostonerimus1

I've been retired for 10 years and have an index linked DB pension and one of the great benefits is that I get a monthly check without having to think about anything (particularly the markets). That goes a long way to control my BP. Of course you can do something similar with a gilt ladder. 

The size of your annuity/gilt ladder is going to be determined by your other sources of income and spending, but once you have that covered from reliable sources you might consider being aggressive with your remaining money, safe in the knowledge that the ups and downs of the markets won't affect your lifestyle.

username12345678

OldScientist said:

While you have no legacy requirements, do you have a spouse (I note that the annuity rates you've quoted are for single life)?

One approach is to consider the long term first, i.e., post-67 when SP is in payment and buy sufficient annuity income to achieve your long term income requirements.

Then consider the bridging period to SP,  i.e., the period from 55-67 in your case, and construct a gilt ladder to provide a proportion or all of the required income.

For example, if '2%' was £20k (implying a pot of £1m), then in the long-term you'd need to add about £8k annuity income in addition to the state pension (with a cost of £200k, assuming a payout rate of 4%).

To construct a a 12 year gilt ladder providing £20k per year to start in 2 years time would currently cost about £220k.

For this example, about 40% of the pot is required to provide sufficient income for life. The rest can be left invested to provide ad-hoc income.

Obviously, if the '2%' is more than £20k, then the relative cost of the annuity will increase since the SP is a fixed amount.

IMV, in a comparison of an RPI annuity with a level one, for the cautious retiree it is the downside of the level annuity that is problematic. If high inflation shows up, then the initial advantage the level annuity has will soon disappear (e.g., the 1970s saw annualised inflation of just over 12% and slightly more than a threefold increase in prices during that decade - many 'crossover' calculations assume inflation is constant with relatively low values of 2%, 3%, 5% or so).

No spouse and no children so no need for a joint life annuity or inheritance consideration.

The gilt ladder as it stands is more heavily weighted to longer duration ILG’s with the last redemption at age 75 at which point my plan originally was to buy an annuity with whatever was in my SIPP.

My thinking with an RPI annuity is that it protects from the worst case inflation scenarios albeit at some front loaded cost. I value certainty but not to the point that it is unreasonable, it’s finding the balance.