Annuities

JohnWinder said:

It may be worth not buying the annuity until 70-75 to take advantage of the higher rates, or splitting between 65 and 75.

I’d like to understand this better. Buying at 75 means I lose out on all the payments I would have received if bought at 65. Why would the higher rate at 75 years more than compensate for this?
If such an ‘over’- compensation was to be gained, it would suggest the insurance company is incentivising people to take annuities later rather than earlier. Why would they turn away the business of younger people?
Surely the insurance companies want the business of as many people as possible, and therefore would incentivise younger annuitants with better overall returns? No they wouldn’t, as they’d be shooting themselves in the foot; so one would imagine there’d be no actuarial benefit on offer to taking early or late. Why do so many people suggest delaying?

The advantage of delaying taking an annuity until later, say your mid 70s, is that you get much better rates paid for by those who die young.  Below one's 70's, not enough people die relatively young to make much of a difference.  This of course assumes you yourself dont die early.  However if you do, you will be dead and so wont care.

It is also advantageous to you in that the money you would have put into an annuity at 65 can be left to grow for a further 10 years.

It makes no difference to the insurance companies - they set the annuity rates such that the annuities paid out match the cost at an age slightly above life expectancy.  So on average the insurance companies win out.  Market forces ensure that they cannot make more profit from one age group of people vs another - if people buying later were over-charged by one insurance company another one could take the business by paying fairer yet still profitable rates.

People have to run the numbers for their personal circumstances, but there are undoubted psychological benefits to having an income that doesn’t rely on the stock market and will last a lifetime. The biggest issue is probably inflation and the comparatively low level of initial payouts from an index linked annuity.

Just before I retired I used $270k to buy into my employers DB plan - essentially I used some of my DC pot to buy an index linked annuity and right now I’m so glad I did that as the falling value of my remaining DC pension pot has no impact on my retirement income or ability to sleep at night.

Previous pension regimes where you had to buy an annuity were restrictive, but the preeminence of the DC solution today is being shown to have its own issues when growth stalls, inflation kicks up and stock markets fall. A hybrid solution is probably the best for most people.

Linton said:

It is also advantageous to you in that the money you would have put into an annuity at 65 can be left to grow for a further 10 years.

Less, of course, any money you've used to provide income in the meantime.

Thanks for the link. It’s dead but the paper is findable.
As to method critique, the chart and the text don’t align well; the text says 6% and the chart 9%. Beyond that I’m out of my depth.
Its argument is that an 80 year old is (something less than) 6% more likely to live another 18 years (twice his average remaining years), than a 60 year old is to live another 52 years (twice his average remaining years). Which they conclude means that being older gives a bigger chance of living longer than average (for your age). I’ll accept that, but this seems to contradict, or at least distract from the notion (is it true?) that there’s more uncertainty about when the 60 yr old will die than the 80 year old, so I don't see how their characterisation of risk (6% of living twice your average years remaining) is sensible.
Anything that paper says must be known by the insurance actuaries, and I can’t believe they’d offer annuity rates that preference one age over another in terms of how much money they have to pay out.

Certainly for a nominal annuity later is better because the damage inflation can do is less, so I ignore those as I wouldn’t want one under any realistic circumstances. Retirement investing carries three risks: market, longevity and inflation. When I export those risks to an insurance company they’re all getting exported, thanks.
Younger, you have more assets, so won’t run out soon, with the chance to get as good or better returns than you need; but older, if you haven’t saved well or had good returns you could face running out with a few bad years. That makes the certainty of an annuity more appealing when you’re older, but it doesn’t say it’s worth waiting in terms of the money you get back.

If you can assume a safe withdrawal rate eg 3.5%, and your needed withdrawal rate (WR) is less than that, you don’t need an annuity but buying one with some or all of your money will lessen the fear of portfolio volatility and can be justified.
At the other extreme, if your desired WR is more than a SWR, then you’re taking the risks of market, longevity and inflation. You can get rid of those risks with an indexed annuity, and should as long as the annuity rate is high enough to provide for your WR. But if it’s not you need to work more or belt tighten but you might still not escape the ‘don’t have enough, annuitizing or not’ condition.
Reading Young's paper raises the complexity of risk aversion and expected utility, and choosing the figures they do they can show that waiting can be better. That's their conclusion, but I can't appraise their method.
The Young paper consider two conditions: the opportunity to annuitise only once (no longer the case in UK), or doing/not doing it on many occasions.
For ‘once only’ it seems to indicate that by waiting you get to obtain the benefit of market returns which they assume are 12%/year with volatility. Makes sense, and using those assumptions they get age of as late as 78 years.

Optimal age is dependent on risk aversion, health status, and how well other investments will do in your time horizon. But if you can annuitise any time, many times, and as much as you like, they suggest doing one early, and then repeatedly as wealth/existing income ratio gets to predetermined levels, not waiting until a late age.

One aspect not brought up is "what is an annuity for?"

I see it as primarily insurance against living too long.  So you should not look for the best average return but rather the most effective insurance.  As with all insurance the best return on average is to self-insure.  However to do that fully for retirement it would be prudent to plan on living to at least one's mid 90s.

From the insurance point of view buying anything other than an index linked annuity early in retirement is pointless since by the time you need the insurance inflation would have seriously devalued its benefit.  The later you start the less the effect of inflation. Perhaps the most efficient approach  is to plan to support yourself from drawdown until your then life expectancy with sufficient left over to buy an annuity.

 HL gives the fixed annuity rate at 75 as 8% and an RPI annuity at 5.5% when male life expectancy is 12 years.  On the same basis the fixed annuity rate at 85 with a life expectancy of 6 years would be 16% with an index linked annuity at perhaps 13-14%%.  These figures are much better than the cost of self-insuring for death at 95, never mind 100.