Income drawdown vs annuity purchase at retirement

jamesd

Yes, the spread on PIBS is often high. Be sure that you know about the increased risk to capital from PIBs based on the developments over the last few years.

smiler2

PIBS risk to capital is there, but for me it is better than an annuity as that will lose me all my capital for sure and the two products look pretty similar then, just the risk of the PIBS issuer default. With annuity rates so low now then I can see no other choice to get a decent return of 7-8% and keep the capital intact..

Right now a roll your own Annuity at age 56 using Benchmark 10 year gilts at 2% and a level withdrawal rate at 5% of the principal takes 25 years to run out taking me to a lofty age of 81...So for Anuuity providers making money out of annuities is easier than shooting fish in a barrel.

Linton

smiler2 wrote: »

Right now a roll your own Annuity at age 56 using Benchmark 10 year gilts at 2% and a level withdrawal rate at 5% of the principal takes 25 years to run out taking me to a lofty age of 81...So for Anuuity providers making money out of annuities is easier than shooting fish in a barrel.

The life expectancy for someone aged 56 in 2011 is about 82.
http://www.ons.gov.uk/ons/publications/re-reference-tables.html?edition=tcm%3A77-227587

What would happen if you were one of the lucky 50% who exceeded the average?

Paul_Herring

Linton wrote: »

What would happen if you were one of the lucky 50% who exceeded the average?

For some reason I'm uncomfortable with that '50%' figure. Not sure why... It just doesn't feel right. DH/James?

To answer your (no doubt) rhetorical question: They'd end up being reliant on the state.

jamesd

Paul_Herring wrote: »

For some reason I'm uncomfortable with that '50%' figure. Not sure why... It just doesn't feel right. DH/James?[

50% living longer than the live expectancy is right but the figure doesn't match the plain text description of what it is.

Paul_Herring wrote: »

They'd end up being reliant on the state.

Highly unlikely, except for the state pensions part, see below.

Linton wrote: »

The life expectancy for someone aged 56 in 2011 is about 82. http://www.ons.gov.uk/ons/publications/re-reference-tables.html?edition=tcm%3A77-227587

No, it isn't. For a male it's 29.4 more years, total age 85.4 and for a female 32.5 more years, total age 88.5 years.

You may have used the wrong life expectancy table, period rather than cohort, a common mistake. The figures I give are from the 2010 cohort principal projection for the UK. That's the correct one to use for retirement planning if you don't know where someone lives.

Linton wrote: »

What would happen if you were one of the lucky 50% who exceeded the average?

Depends.

Under flexible drawdown considered in this case it is possible to take out 100% of the money so the income would drop. But you have to start out with a guaranteed pension of at least £20,000 a year so it's unlikely that you'd end up reliant on the state unless the income was level and there was a period of high inflation. This particular case has a workplace scheme that has some inflation protection included so it's even more unlikely than with a level annuity. And then there are the state pensions that have plans to set them at a level above benefit level anyway.

In the more normal capped drawdown, the maximum amount of income that can be taken is reviewed regularly and set as a percentage of the pension pot value a the time of the review so it's impossible for just withdrawing money to get the value to zero. That has to be combined with poor investment performance between the two review dates that causes the value of the investments to become zero. That's entirely possible. But the plans for the state pensions would still mean that income didn't fall to benefit levels even if the work pension somehow vanished in spite of the PPF backup.

Linton

Thanks James.

My note was really a reply to smiler2 who suggested that as a simple 2% assumed growth would last someone until the great age of 82, then the annuity companies must be making a massive profit. Your life expectancy figures show the error of his thinking even better than mine.

jamesd

He's basically right about the principle, though, even if the number happens not to work at 4% income level. Biggest flaw was perhaps not allowing for inflation, which would reduce the effective yield to roughly zero if the 2% inflation target is hit every year.

The gilt yields are generally at record lows so it's a pretty pessimistic test to use today's yields. Around the last auction date they were 1.8% for 5 year and 2.1% for ten year (mixture or market and auction prices). The November 2011 15 year gilt benchmark yield was 2.58%.

The fifteen year yield is the most important one for drawdown because it's what's used in the GAD calculation for how much you're allowed to take out in capped drawdown, though it's not the actual amount, that depends on your age. It's ridiculously below the sustainable yields available from investments and mainly illustrates just how poor a choice of benchmark rate it is. 4.5% is more normal so the current level is artificially halving income levels even though what it's based on isn't what sensible consumers would be using. To give some idea of how bad it is, some retail bonds from insurance companies with terms to around 2032 have redemption yields over 10% and running yields in the 4-6% range.

Consumers simply shouldn't be buying gilts at those prices. You can get higher rates for five year term deposit accounts within a pension and you have an FSCS guarantee along with them.

The previous possible record was ten year consols (consolidated government bonds) at 2.21% sometime in 1897 between monthly reporting dates. Which means that gilt prices are now implying that the UK is more reliable as a payer than it was at the peak of the British Empire. Or more accurately, that we're the best of a bad bunch.

smiler2

Great responses, thx..

I take the point I cannot profit individually from the mortality boost a real Annuity shop would have, but level annuities do make sense if you have a reasonable £20k+ 'base' pension with some inflation linkage as it effectively gives most 'real' income in early retirement, where needed. In reality 80 year olds generally spend less that 65 year olds, lower bar bills etc !.
I agree a roll your own annuity is a bad idea if you do not have a decent base pension and I am lucky to be comfortably over the £20k pa limit to do unlimited draw down..

My take was really looking at PIBS as a draw down pension income stream until gilts shuffle back to 4% and annuity rates recover to make them a worthwhile option and I will be older as well so that would help.

A small question on PIBS, as they are not traded so much, how would you value a PIBS holding to work out your tax free 25% cash amount say in a SIPP before comencing drawdown. Would you value it at 100p, the real call value or a guesstimate of its current bid/offer price?. ie if you bought PIBS at 80p in your SIPP with the ultimate fixed call value at 100p you could boost your 25% tax free cash lump sum before atarting draw down from your SIPP by using the 100p valuation..

jamesd

You'd use the current selling price or the best you can get to that. Call price won't matter because the market should already have adjusted the price to allow for it if it's close enough to matter.

Linton

smiler2 wrote: »

Great responses, thx..

I take the point I cannot profit individually from the mortality boost a real Annuity shop would have, but level annuities do make sense if you have a reasonable £20k+ 'base' pension with some inflation linkage as it effectively gives most 'real' income in early retirement, where needed. In reality 80 year olds generally spend less that 65 year olds, lower bar bills etc !.
.........

I would question the wisdom of basing retirement planning on expenses decreasing when one is over 80:

1) Many people are perfectly healthy to a surprisingly old age and for example would not want to stop taking expensive holidays if that's what they were used to. Fewer bar bills maybe, but perhaps a greater appreciation of fine wine.

2) Some things become more expensive when you become less mobile. Transport is a good example. Heating another.

3) When you become infirm would you rather pay to receive the type of care you want and be able to look elsewhere if it didnt come up to scratch or would you be perfectly happy being reliant on what the state or local council could afford? Assuming you were lucky (or prudent) enough to have the choice.