Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?

General discussions about equity high-yield income strategies
Wasron
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Re: Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?

Postby Wasron » December 9th, 2016, 6:31 pm

I should point out that the scheme in question is essentially closed, so the choice is between a preserved DB pension increasing by CPI until retirement or transferring away.

The view of the actuaries was that a lot of cash was on offer, due to low interest rates and low annuity rates. If in future annuity rates rise, on the back of rising inflation and/or lower bond prices then there's always the option of buying an annuity after all.

Wasron

flyer61
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Re: Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?

Postby flyer61 » December 11th, 2016, 11:22 am

What an interesting thread! The comment concerning the actuaries transferring their DB benefits into SIPPS/PP's had me in stitches. Just like the MP's all having their London pads paid off.....

The UK pension system in a nut shell. State pension....anybody hear of anybody not being paid it.....No, thought not, generally simple and works. The pension industry attached to retirement income, anybody hear of high fees, poor performance, opaque charging, constantly changing rules and for the money parted with not worth the cake.....Lots...thought so. In short it is buyer beware, tax relief etc should not wag your retirement planning.

I could go on but better not as may run out of BP tablets. The DB scheme I was a member of was significantly underfunded and the owners of the business decided they would cut their losses and run. This they did this with an RAA. Another word for legalised theft. Many people were buried by this after decades of service. They did the right thing and have been royally shafted. The business carried on as if nothing had happened.
So why bring this up. Well I transferred out just before it began the PPF assessment period.

The PPF is designed to protect the pension industry not you.

My transfer figure was terrible given what i gave up even on what the PPF would give me. However a couple of things come to mind. After two years I had turned my 500K into 593K of which I took 25% at the first opportunity. The rest remains invested and I continue to work. My wife gets the lot if anything happens to me. My kids might end up not having to do pension when they are older ( a huge plus in my eyes) The PPF only gives a widows benefit of 50% of what you are in receipt of at the time of your demise. My old dear will get the lot this way.

So if there is any chance of your scheme ending up in the PPF and for many this can come out of the blue consider transferring out at the earliest opportunity.

Sorry if a little thread drift...

1nv35t
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Re: Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?

Postby 1nv35t » December 11th, 2016, 1:28 pm

flyer61 wrote:So if there is any chance of your scheme ending up in the PPF and for many this can come out of the blue consider transferring out at the earliest opportunity.

Quick and dirty calculation, I estimate that I could achieve similar inflation adjusted pension by transferring and depositing into a index linked gilt ladder spanning up to age 85. Such that the cost/benefit boils down to longevity/heirs and a de-risking of single 'stock' risk (BT in my case is the pension provider) compared to the state (index linked gilts) - who can always print more money or take some other action to avoid default. 85+ in my case is optimistic, so on the longevity front transfer has the edge. As does moving from single stock risk over to state based risk. Accordingly at 34 times valuation levels I'm sorely tempted and will be requesting a transfer valuation soon.

Not so sure about a HYP choice as a alternative to index linked gilts however. Yes in effect with gilts at negative yields you forego some of the capital to secure the same level of purchase power, but that washes to provide the same level of pension compared to not having transferred. As such HYP would be a bet on possibly more, maybe less in reflection of the additional risk being taken. Easy to assume it would be more, but by no means guaranteed.

Wasron
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Re: Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?

Postby Wasron » December 12th, 2016, 8:36 am

flyer61 wrote:What an interesting thread! The comment concerning the actuaries transferring their DB benefits into SIPPS/PP's had me in stitches. Just like the MP's all having their London pads paid off.....

...I could go on but better not as may run out of BP tablets. The DB scheme I was a member of was significantly underfunded and the owners of the business decided they would cut their losses and run...


In my particular case the scheme funding isn't an issue and the actuaries who have transferred had no oversight of our scheme, but I accept the general sentiment of your post...

Wasron

taken2often
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Re: Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?

Postby taken2often » December 13th, 2016, 11:08 pm

A simple question but as usual complicated. I am no expert but I will try a few answers. To the question yes and no. The annuity starts immediatley
the HYPE takes time for the income to flow in. After one year you should know what your income is.

I invest for income and not a HYPE, so my average buying yield will be much higher than the Ftse. If you wish to buy, and hands off then a Vanguard
60% equity 40% bond type income or 80/20%. would work. The down side of this is if it is a accumulation fund then you have to sell units for income. Usually bad news when the markets are down.

Some consider their State pension the Bond element and have 100% equity fund. If so I would only buy income and forget the capital and total return. I would also try to spend 80% of income if needed and reinvest 20% for indexing.

For an annuity to work you would need to live to a 100, especially if it is indexed.

A Sipp income should be superior to an annuity. Wife or Partner can continue the same income after you die. You should always have capital available
to increase your income say after 85 as you can run down the capital, or not and the residue can be handed on and on and on.

Hope some of this is helpful

Bob

OLTB
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Re: Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?

Postby OLTB » December 14th, 2016, 1:31 pm

taken2often wrote:
Hope some of this is helpful

Bob


Many thanks Bob (and other contributors) - the responses have all been very informative and useful in gathering others thoughts.

Thanks, OLTB

bionichamster
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Re: Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?

Postby bionichamster » January 3rd, 2017, 1:30 pm

I think it's possible that those that bought an all in HYP a la pyad as an annuity alternative have nothing more to say or do, probably hardly frequented or at least contributed to the TMF boards and similarly don't need to waste their days over here chatting about triming, top ups or weightings, diversification or minimum number of pick.



A few years ago I made some comparisons with the performance of PYAD's HYP1 demonstartion potfolio and an annuity that could have been purchased at the same time with the same money. I repeated the comparison a couple of times (here's a link to year 11: http://boards.fool.co.uk/hyp1-benchmark-comparison-12407288.aspx)

A good annuity rate at the time for a flat rate annuity was £5662 and £5212 (60 YO male and female respectively)

As you can see after 11 years the income from HYP1 still didn't match the flat rate annuity. However one could argue that occasionally pruning and reallocating investments in the HYP and it might have done better income wise; also perhaps HYP1 just happens to have existed in a particularly bad time span (aren't they all) but it still has the advantage of being available for all manner of other uses (kid's house deposit, passing on when you pass on etc..) Also the HYP could be in an ISA where withdrawl could be tax free or presumably drawdown from a SIPP could be managed to be more tax efficient in comparison to an annuity? However the HYP seems to be increasing reliant on a few dominant shares that make up the majority of the dividend payments and thus could be vulnerable to a shock in the future if one of those companies flies into a flock of black swans.

It's worth noting that now 16 years on from its inception HYP1 has finally outstripped the flat rate annuity but it took 13 years to do so (2013 it produce £5828) although it fell back below the male annuity in 2014 by a few pounds (£5601) before hitting £6093 in 2015, not sure about the 2016 figures but looking foward to seeing them, I expect it will be accelerating away from the annuity now.

What does that say about HYP as an "immediate replacement" for an annuity? Well it certainly indicates that it's more complicated than one might think and you must seriously consider a range of factors other than the headline income rate when comparing. For me the HYP wins on most counts, but for a short life expectancy retiree with no heirs and who wants a simple life then perhaps the annuity has some serious merit? Mind you I think annuity rates are not as good now so maybe not....

taken2often
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Re: Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?

Postby taken2often » January 3rd, 2017, 5:51 pm

An indexed annuity would have started at around 3k plus and would take a very long time to catch up. Make it a joint life, even longer.

You also have to keep in mind the 2008/2009 market crash. I bought a lot of cheap income then and still have it. The problem with Hype is that they
tend to have about 15/20 shares so when they take a hit it can be substantial.

Over a 20/30 year period a DIY portfolio with modest charges should out perform an annuity. Especially if you reinvest 20% of the yield per year.

Bob

tjh290633
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Re: Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?

Postby tjh290633 » January 3rd, 2017, 6:13 pm

I retired in 1998 and took an LPI Annuity as part of my pensions. I have kept records of the progress of that and alternatives.

These data refer to 50% spouse's pension, calculated out to 2031.

Level annuity: £787.96 per £10k, IRR 7.16%

5% escalating: £448 per £10k, IRR 7.26%

LPI annuity: £570.76 per £10k, IRR 6.54% (assuming RPI remains at current level until end date.

My HYP: IRR 8.20% from December 1998 to date.

Of course I also retain the capital in the HYP and reinvest some of the dividends.

The IRR of the HYP since it was started in 1987 is 10.5%.

TJH

OLTB
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Re: Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?

Postby OLTB » January 3rd, 2017, 8:03 pm

taken2often wrote:An indexed annuity would have started at around 3k plus and would take a very long time to catch up. Make it a joint life, even longer.


Thanks Bob and TJH - I think that an index linked annuity is a fairer comparison given that the idea of the HYP is for an increasing income rather than a level income.

It also seems to me (reading many other comments on other topics) that a 15 share HYP is too restrictive and that diversifying to perhaps the 25 share level is more prudent (the sector diversification being key).

How many sectors are there by the way and do all have HYP candidates in them or are some sectors not HYP-friendly?

Cheers, OLTB.

Gengulphus
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Re: Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?

Postby Gengulphus » January 3rd, 2017, 10:20 pm

bionichamster wrote:
I think it's possible that those that bought an all in HYP a la pyad as an annuity alternative have nothing more to say or do, probably hardly frequented or at least contributed to the TMF boards and similarly don't need to waste their days over here chatting about triming, top ups or weightings, diversification or minimum number of pick.

A few years ago I made some comparisons with the performance of PYAD's HYP1 demonstartion potfolio and an annuity that could have been purchased at the same time with the same money. I repeated the comparison a couple of times (here's a link to year 11: http://boards.fool.co.uk/hyp1-benchmark-comparison-12407288.aspx)

As that link probably won't survive much more than another month or so, here's an archived version of the full thread: http://web.archive.org/web/20170103135311/http://boards.fool.co.uk/hyp1-benchmark-comparison-12407288.aspx?sort=whole

But I would comment on both this thread's subject question and an early quote from that link:

"But before we get too pleased shouldn't we compare it with the real benchmark? The product that the HYP was originally conceived as a replacement for?
The Annuity.
"

A HYP is very clearly not a plug-in replacement for an annuity, because they have quite different investment characteristics. In particular, the income available from a HYP does not depend on the age of the investor, while that available from an annuity does. And related to that, the HYP leaves the capital accessible - only as an alternative to continuing to get the income, not in addition to it, but that's an alternative that isn't there with an annuity. So basically, an annuity provides an income bonus that depends on the age of the investor when it is bought, while a HYP instead provides flexibility about what the investor can do after it is bought.

In addition, a HYP is a very equity-based investment, while an annuity is generally much more gilts/bonds-based, so they have very different risk vs reward characteristics - and the comparison between the two varies over time. For instance, the link quotes a level annuity rate of £725 per £10k invested (averaged for men and women) at age 60, but the figure I've found in a quick search just now is £444, barely above 60% of £725. But the forecast yield available from a HYP bought now is reasonably close to the 4.8% forecast for HYP1 when it was bought (http://news.fool.co.uk//news/foolseyeview/2000/fev001113c.htm), and certainly way above 60% of that figure, which would be under a 3% yield.

Furthermore, a HYP requires a certain amount of maintenance effort from its investor - effort that an annuity doesn't require. It's not a huge amount - but for some investors (especially those whose ability to do it themselves has gne or is going) there is a large qualitative difference between requiring zero and non-zero maintenance effort.

So the only sensible answer to the question "Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?" is in my view that which is better depends a great deal on all sorts of things about the investor - on their age, how badly they need immediate income, how much they value future flexibility, market conditions when they happen to be facing the investment decision, how much they're willing/able to do to maintain their own investments, etc. And therefore that no, the phrase "annuity replacement" is not a good description of a HYP: it grossly over-simplifies the comparison, encouraging one-dimensional thinking about the issue.

So why was the HYP "originally conceived as a replacement" for an annuity? The answer is simple: it wasn't! Read the original HYP article http://news.fool.co.uk//news/foolseyevi ... 01106c.htm and you'll find the alternatives that it actually does mention (with my bold to point them out):

"Conventional wisdom on this topic from IFAs will tend to propel you in the direction of some kind of insurance company product such as guaranteed income bonds or the like. A lot of literature on the subject of retirement investing for income suggests that, even if you have been saving through equity vehicles of some kind up until now, there should be some switch away from equities just because you have retired.

Advisers make such comments because of the perceived risk of keeping money in shares, it being felt by them that at the age of, say, 60, one should be taking less risk than before with savings. From what I have seen, the great majority of retirement lump sums end up either in insurance company investments, or simply in National Savings and bank and building society deposits.
"

Now yes, an annuity is an insurance company product, so it is included in that - but if one is looking for what HYPs were originally conceived as replacements for, guaranteed income bonds, National Savings products, bank deposits and building society deposits are all actually mentioned. And they all have much more similar characteristics to HYPs in terms of providing an income that does not depend on the investor's age, retaining access to capital and requiring some maintenance effort. It's still a multi-dimensional issue and I wouldn't regard describing a HYP as a replacement for any of them as a terribly accurate description - but it's a lot closer than regarding it as an "annuity replacement"!

To sum up, the phrase "annuity replacement" seems to me to be a 'sound bite' description of a HYP that has emerged since the original concept rather than being that original concept. And like so many 'sound bites', it's memorable and not totally divorced from reality - but sufficiently so to make it highly misleading!

As for what the original concept was, it seems clear to me from re-reading that original link that it was that equities could sensibly be used as a reasonably reliable (though not totally risk-free) source of retirement income, and that it was within the abilities of the average retirement investor to do so for themselves rather than needing to employ any sort of fund manager to do it for them.

Finally, I should add that I'm only trying to avoid what appears to me to be a myth about that original article, not to say that it was correct on all counts. On the contrary, I think it is flawed in at least two ways: it didn't look at the issue of maintaining the portfolio in the face of corporate activity and weighting imbalances developing, and related to that, its comment that "no more than about 15 shares are necessary to take strip out the excessive risk of too few shares" misses a significant point: yes, there are academic studies that say that 15 equally-weighted shareholdings are enough to diversify away most such risk, and yes, 15 roughly equally-weighted holdings should do almost as good a job. But 15 very unequally-weighted holdings won't - and in particular, the academic studies should IMHO be taken as implying that holdings which are significantly more than 1/15th of the portfolio do produce excessive lack-of-diversification risk. HYP1 has had a demonstration of this, in the form of BT's major contribution to its income fall between year 8 and year 9 (about 10% of its total year 8 dividend income disappeared in that one cut alone), and it's at risk of a bigger demonstration should anything nasty happen to BATS...

There are ways those flaws could have been mitigated that wouldn't have involved turning HYP1 into a tinkered HYP. For instance, HYP1 could have had a "maintenance aim", say that no one holding should exceed 10% (*) of either the portfolio's capital value or of its income. That's an aim, not a requirement, so it doesn't require the portfolio to tinker: it just means that when reinvesting the proceeds of takeovers and other corporate actions, decisions that create or increase a breach of the aim should not be made. Had HYP1 had such an aim and been run in accordance with it, it would still currently be in breach of that aim, as BATS's long run of superior performance would have pushed it well over 10% - but equally, it wouldn't be up at the 25%ish level!

(*) I'd prefer a somewhat lower figure, but 10% is a convenient round number and also means that HYP1 did initially satisfy the aim: its initial highest-yielding share was responsible for just under 10% of its forecast income when it was purchased.

Gengulphus

Gengulphus
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Re: Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?

Postby Gengulphus » January 3rd, 2017, 10:39 pm

OLTB wrote:How many sectors are there by the way ...

Depends what you count as a sector! If you use the ICB classification's sectors totally unchanged, 41 according to https://en.wikipedia.org/wiki/Industry_Classification_Benchmark. Many HYPers will modify it in some way or use their own 'home-brew' classification, though...

OLTB wrote:... and do all have HYP candidates in them or are some sectors not HYP-friendly?

Some don't - but which they are varies over time, so it's not really a question of the sector being HYP-unfriendly, just of it being in fashion, and therefore not cheap / high-yield. For example, when HYP1 was constructed, it was probably just about impossible to find a tech / telecoms / media HYP candidate - but some have certainly appeared since.

Gengulphus

dspp
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Re: Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?

Postby dspp » January 4th, 2017, 10:14 am

I run a couple of HYPs for myself and a friend. Both were bought in essentially one go although actual purchasing was spread over several months for practical reasons and there have been some additional top ups when extra funds came into range. With mine I am non-HYP in some significant respects, but the other is very plain vanilla. Both consist of about 30-35 HYP shares and dividends are generally rolled over into some Vanguard trackers.

We are at the two year mark on the other and last year I decided to switch the reporting date to the tax year rather than the New Year to ease admin. However prompted by this I have just taken a look at it and it remains very balanced. No substantive tinkering has gone on and I just mop up the dividends quarterly into the trackers. Capital wise only 2-3 shares are down to about 50-60 and a corresponding amount are up so the total capital is up much in line with FTSE. Dividend yield is at about 4.5% across the portfolio but I am not set up the way many of you are with spreadsheets for everything to immediately run those numbers - we both have day jobs and plenty of other things to be going on with (very Dorisean). I'll post numbers at tax year point by the way.

Over a longer period, and with fewer shares (7 or 15) rather than the 30-35 we selected, and I would worry a lot more about accidental over-concentration evolving, but that is partly why we made the decisions we did. So back to the original query I reckon that approached this way it is not a bad alternative to an annuity, with some advantages and disadvantages, but of course it is not identical. In my mind a better comparison for an annuity would be a low cost tracker (e.g. VWRL) and with the understanding that capital would be sold as time went on (or spending reduced) if returns were insufficient / the starting pot too small - but that is really getting over to the FIRE board considerations and things like firecalc pathways.

regards, dspp

sausages
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Re: Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?

Postby sausages » January 4th, 2017, 8:57 pm

I'm in the fortunate position of having a preserved DB pension that will deliver a very comfortable £2500 pm (and the scheme is in surplus too...). Behind the curve on property but have a plan to deal with that in 12 years. So for me HYP is about generating a second income stream that will pay for the nicer things in life and as such the higher risk of equity is acceptable for the potentially higher rewards, and also as a possible income bridge between an earlish retirement from the first career before drawing the full DB pension.

taken2often
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Re: Is an Immediately Purchased HYP really a Replacement for an Immediate Annuity?

Postby taken2often » January 5th, 2017, 11:01 pm

A Hype running for 30/40 years should do very well. The problem is that most of us tend to start later in life. That why I invest for income
over a wide range of items. PIBS, Preference Shares, ordinary shares and Investment trusts. I have just completed the year end.

Yield on cost 6.3% Yield on current value 6.8% income increased by 4.75%. There are cut and stopped dividends due to the oil prices. This has caused
capital loss that I ignore. As I have not sold any of these items I have hopes of recovery, so only dividend loss unless sold. The bulk of the income is reinvested but I only buy stock at 5% yield or more. You also have distortion, by buying throughout the year and it takes time for the income to flow. Four out of my five portfolio's are tax free, although I have to pay US tax on my ISA, will have to see how that works this year.

I do trim out profits to buy higher yield. To me a Capital Gain is Capital at Risk I have 126 items.

Bob


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