Annuities - Money Saving Value?

edited 30 November -1 at 1:00AM in Pensions, Annuities & Retirement Planning
9 replies 918 views
ReportInvestorReportInvestor Forumite
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Do the economies of scale enjoyed by the big insurers actually translate into value for money when pension investors purchase their annuities?

Let's take a specific example.

The average male aged 60 is expected to live to 80 & gets a flat rate annuity of 6% pa based on a £100K pension with no fancy trimmings like minimum five year guarantee or partner benefits.

But what about an individual DIY solution if we didn't have to go to an insurer.

If that same male invested his £100K in Treasury 2055 paying 4.25% (currently yielding 4.23%) at 1% purchase costs, and cancelled some each year, he could provide a 6% income for himself until age 84 by taking the gilt edged income and selling some of the Treasury stock each year. But the insurer only has to look after him until age 80, yielding a tidy profit (in spite of the insurers' economies of scale).

Obviously there is a risk that the Treasury stock could fall in value if interest rates were to rise. [It could also rise in value.] But against that, if there was a big rise in inflation, our man with his own Treasury stock might be able to react in time, whereas our man with a flat rate annuity could not.

Should we be mutually pooling resources with our old classmates and other friends of a similar age to outdo the insurers and save money?

After all, you could get to 76 by keeping your £100K under the mattress and taking £500 cash out each month :D

And you could also get to 84 by using a building society account if it consistently yielded 4% pa [versus the current 5.55% at Portman BS] (which obviously carries more risk than my example using Treasury stock).

Replies

  • oceanblue_3oceanblue_3 Forumite
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    Reportinvestor, you raise some interesting points; however, when you write.."The average male aged 60 is expected to live to 80", you need to check the accuracy of this at the GAD website - annuity providers use the Cohort Life Expectancy tables, where life expectancy for our 60-year-old man is to age 83.2 years. In addition, annuity rates have improved recently - the best rate at the moment is 6.4%, not 6.0%.

    Furthermore, competent DIY is always less costly than work carried out by professionals. The question to ask is "how often is DIY fit for purpose?"

    In the context of what really happens in the world of annuities, we need to be stressing to all Moneysavers the need for them to use their Open Market Options and, where relevant, to make sure they receive quotations for enhanced/impaired life annuities.
    oceanblue is a Chartered Financial Planner.
    Anything posted is for discussion only. It should not be taken to represent financial advice. Different people have different needs, and what is right for one person may not be right for another. If you feel an area discussed may be relevant to you, then please seek advice from an Independent Financial Adviser; he or she will be able to advise you after having found out more about your own circumstances.
  • ReportInvestorReportInvestor Forumite
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    Thanks for the info about Life Expectancy Cohorts :beer:.

    Who currently offers the 6.4% ob? I was using an average of the top few rates on the FSA website for my 6%.

    In the "real world of annuities", most people still don't shop around :eek:, never mind get the best rate or anything close to it. Are most people getting an awful deal from their insurer?

    As you know, I do recommend people always shop around and enquire about impaired annuities.

    I suspect that moneysavers will be depressed that insurers are unable to beat the performance level of Joe Public using a very modest building society account.
  • DiggingOutDiggingOut Forumite
    770 Posts
    With an annuity from an insurance company, if you live to 90 you still have an income. With DIY, things get rough at 84. They take the risk, and are compensated for doing so by paying a lower income on the annuity.
    I have five stars! This doesn't mean that I know anything about any of the things I post. I could be a raving lunatic, or a brilliant genius, or just some guy on the internet. In fact, I could be all three at the same time.

    If anything I say makes sense, then do it. If not, don't. Don't blame me or my stars if you do something stupid because I suggested it. I'm responsible for my own stupidity only. You are responsible for yours.

    Why, I don't even have five stars anymore! Aren't you glad you aren't responsible for my stupidity?
  • EdInvestorEdInvestor
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    Hi Digging Out

    The problem with the ordinary annuity is inflation.Even at current low levels, after 20 years the spending power of your income is halved.Add on another ten years and what's it going to buy then? It's all very well having an income until you die, but if it won't buy anything....

    And the really big risk is that the low levels of inflation we've got used to won't last.The funeral of Ted Heath this week reminded me of one of the downsides of his premiership - for most of that period in the 1970s (which upcoming retirees will remeber well) inflation was over 20% a year. :eek:

    After only 4 or 5 years like that, your annuity would be worthless.At least if you still had your capital you might be able to do something about it, but of course you've given it up :(.

    It really is a difficult problem now that people live so long.
    Trying to keep it simple...;)
  • dunstonhdunstonh Forumite
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    Index linked annuities forgotten again ed?
    I am an Independent Financial Adviser (IFA). The comments I make are just my opinion and are for discussion purposes only. They are not financial advice and you should not treat them as such. If you feel an area discussed may be relevant to you, then please seek advice from an Independent Financial Adviser local to you.
  • MarkyMarkDMarkyMarkD Forumite
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    ReportInvestor

    Your original comparison is just nonsense.

    Insurance companies have to generate a profit. There are no economies of scale in operating an annuity business - the insurers buy the same gilts that you or I could purchase. Then, out of the gilt interest, they have to run their company and provide a return to their shareholders or equivalent.

    Life expectancy is constantly improving. Insurers have to accept that risk out of their gilt return.

    Those who have compulsory purchase annuity funds have a life expectancy significantly higher than the average for the population as a whole.

    Loss making savings rates are not sustainable in the short term. 5.55% is a loss making rate for Portman. And it's a variable rate - whereas the annuity return is fixed and guaranteed for life.

    I agree with oceanblue - given that annuity purchase is compulsory, comparing it to other (riskier) returns is meaningless. And the reason annuity purchase IS compulsory, is because other options always involve accepting risk in exchange for return.

    It's more useful to encourage the exercise of Open Market Options and hence to maximise the annuity return pensioners are able to achieve.
  • ReportInvestorReportInvestor Forumite
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    MarkyMarkD wrote:
    It's more useful to encourage the exercise of Open Market Options and hence to maximise the annuity return pensioners are able to achieve.
    I certainly hope that all MSErs purchasing an annuity do take that basic step.

    But as more people seek the best deal, and more people follow press advice to apply for impaired annuities, this will be a further downward pressure on future annuity rates for the ordinary pensioner - assuming you are correct that there is little room for manoeuvre for the big insurers in this field because of their need for profit and the risk they have undertaken.

    The other important message is that MoneySavers who are not in a defined benefit final salary pension scheme can expect less and less retirement income from their final pension pot :( .

    That's a drum that the IFA section of the site needs to beat more loudly so that MSE site members have a proper, realistic low expectation of their retirement prospects :(.

    Unless the stock market [and consequently income drawdown] performs, of course ;).
  • EdInvestorEdInvestor
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    dunstonh wrote:
    Index linked annuities forgotten again ed?


    Unfortunately they're a luxury product.Their starting income is comparatively so low that few people buy them - the better off have smarter ways of financing their retirement than losing their capital by buying annuities, and the less well-off can't afford them.Even IFAs see them as poor value.

    Comparative income, level and index linked annuities
    Trying to keep it simple...;)
  • dunstonhdunstonh Forumite
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    Unfortunately they're a luxury product.Their starting income is comparatively so low that few people buy them

    You need to make your mind up whether covering inflation is a requirement or a luxury. A annually increasing income starting at 5.1% in year is hardly a luxury. Most people are not getting that in their building society account.
    the better off have smarter ways of financing their retirement than losing their capital by buying annuities

    Actually, you will be surprised at how many well off individuals purchase annuities to get rid of the capital. However, most individuals save for retirement to give them a retirement income. Not so they can have a reduced income but pass greater assets on when they are dead.
    Even IFAs see them as poor value.

    Another unqualified quote. How can a product providing 5.1% but increases annually be considered poor value alongside a savings account which you yourself have suggested many a time?
    I am an Independent Financial Adviser (IFA). The comments I make are just my opinion and are for discussion purposes only. They are not financial advice and you should not treat them as such. If you feel an area discussed may be relevant to you, then please seek advice from an Independent Financial Adviser local to you.
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