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Annuities

Including Financial Independence and Retiring Early (FIRE)
1nvest
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Annuities

#484538

Postby 1nvest » March 5th, 2022, 3:28 pm

Moderator Message:
The following posts about annuities were split off from this thread about HYP1. - Chris

Dod101 wrote:HYP1 shows resilience until it doesn't. But you really ought to define 'resilience'. Remember the whole idea of a HYP is that it is an income strategy, Capital appreciation is very much secondary. So resilience in this context presumably means 'able to maintain and hopefully increase income'.

In the context of real terms, after RPI inflation, that has long since failed. A retiree would have had to take some other action in earlier years in order to maintain the inflation adjusted purchase power of the initial income provided at the start. As I recall it the HYP was proposed as a alternative to a annuity and annuity options include inflation adjustment of provided income.

Concentration wise and HYP1 is no different to what might be expected. LEXCX for instance operates on a similar model/method and from its 1930's start date of 30 stocks is down to around 20 stocks with the largest around 50% of the total portfolio value. Fundamentally runs winners rather than reducing out of them to add to other stocks - which does lead to concentration risk.

Yes mathematically the inflation adjusted income subsequently recovered, on paper, ignoring the shortfalls that would have had to be endured in earlier years that otherwise involve either spending less (taking a 'pension' cut), or selling shares to fill the hole, or not spending all of the income and reinvesting some, akin to taking a lower SWR.

Unnecessary/uncompensated (income and concentration) risks that can be easily addressed.

Bubblesofearth
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Re: HYP1 is 21 - thread discussing income and capital diversification

#484543

Postby Bubblesofearth » March 5th, 2022, 3:50 pm

1nvest wrote:In the context of real terms, after RPI inflation, that has long since failed. A retiree would have had to take some other action in earlier years in order to maintain the inflation adjusted purchase power of the initial income provided at the start. As I recall it the HYP was proposed as a alternative to a annuity and annuity options include inflation adjustment of provided income.



I don't know what annuity rates were back then but currently at age 60 you would be looking at around £2730 per £100,000 per year if you want an annual increase of 3%. If inflation is higher than that then you are going to see a decrease in purchasing power.

The FTSE100 is projected to yield 4.1% in 2022, a HYP presumably a bit more. So if you took the annuity equivalent of £2730 from your HYP in year 1 you would have a dividend excess of at least £1370 (£4100-£2730) to either reinvest or keep for lean years.

So it's important to look at annuity rates vs dividend yield before making a comparison and determining whether or not income would have kept up with inflation.

BoE

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Re: HYP1 is 21 - thread discussing income and capital diversification

#484597

Postby NotSure » March 5th, 2022, 8:35 pm

Bubblesofearth wrote:....I don't know what annuity rates were back then....


A quick Google suggests around 5% - they'd already dropped long way from previous decades. So 5k/year to begin which would have risen (smoothly and without risk, skill, luck or effort) to about £9k/year by now (assuming 3%/year uplift), and to about £12k/year over the next 10 years.

A lot of assumptions in the figures above, and I've no idea how this compares to HYP1, and even less regarding the next 10 years!

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Re: HYP1 is 21 - thread discussing income and capital diversification

#484616

Postby tjh290633 » March 5th, 2022, 11:35 pm

Bubblesofearth wrote:
1nvest wrote:In the context of real terms, after RPI inflation, that has long since failed. A retiree would have had to take some other action in earlier years in order to maintain the inflation adjusted purchase power of the initial income provided at the start. As I recall it the HYP was proposed as a alternative to a annuity and annuity options include inflation adjustment of provided income.



I don't know what annuity rates were back then but currently at age 60 you would be looking at around £2730 per £100,000 per year if you want an annual increase of 3%. If inflation is higher than that then you are going to see a decrease in purchasing power.

The FTSE100 is projected to yield 4.1% in 2022, a HYP presumably a bit more. So if you took the annuity equivalent of £2730 from your HYP in year 1 you would have a dividend excess of at least £1370 (£4100-£2730) to either reinvest or keep for lean years.

So it's important to look at annuity rates vs dividend yield before making a comparison and determining whether or not income would have kept up with inflation.

BoE

I can't give you the rates for 2001, but in 1997 when I retired, they were:

.               Single Life   Joint Lives
Level 909.00 797.86
5% escalating 646.00 448.00
Index-linked 740.00 570.76

I took the index-linked joint lives option (Limited to 5% inflation).

TJH

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Re: HYP1 is 21 - thread discussing income and capital diversification

#484650

Postby 1nvest » March 6th, 2022, 10:12 am

tjh290633 wrote:I can't give you the rates for 2001, but in 1997 when I retired, they were:

.               Single Life   Joint Lives
Level 909.00 797.86
5% escalating 646.00 448.00
Index-linked 740.00 570.76

Level Single Life 909 x 12 = £10,908/year for each £100,000, compared to recent (April 2021) £4,703 (from Scottish Widows) indicates just how much low yields are hurting newer/recent retirees. You need over twice as much to retire with the same income. End of March 1997 and 20 year conventional Gilts were priced to a 7.7% yield. April 2021 they were priced to a 1.4% yield.
Quick/dirty estimates of 14 versus 24 year break-even timings, difference between a 65 year old retiree living to 80 vs 90. With hindsight your timing was fortuitous Terry.

At the time of HYP 20 year Gilt yields were down to 4.5%, 5.5% for shorter dated. Assuming a 5% annuity rate and splitting the break-even difference to use a 85 years old (20 years) and I'd approximate a £7,500/year Single/Level annuity rate as the comparison to HYP1.

Rebasing £75,000 capital as per HYP1 and = £5625/year which for 21 years (HYP is 21) = £118,125 total income 'to date', compared to HYP1 reported

Code: Select all

2001 3,451
2002 3,474
2003 3,197
2004 3,205
2005 3,546
2006 4,131
2007 4,452
2008 5,040
2009 3,187
2010 3,297
2011 3,843
2012 4,289
2013 5,828
2014 5,601
2015 6,093
2016 6,124
2017 7,327
2018 8,882
2019 10,557
2020 5,533
2021 11,338

Total to date £ 112,395

£112,395. Annuity on that measure paid 62% more income in the earlier years than HYP1. After around 14 years (65 year old retiree approaching 80) saw around the same amount of income. As they've aged further HYP1 paying more income, and of course has the capital value still available for heirs.

Many might prefer more income when they're younger and better able/fit to spend. As a aside there's a old interesting example here (by Peter Ponzo (Gummy)) of a method to potentially achieve that higher earlier year income using a SWR approach, around a third of the way down that web page starting after the first horizontal bar line

In fact we reduce the withdrawal rate to 3% but withdraw 50% of the excess gains, over and above the 4% inflation. As it turns out, there's still a 92% survival rate, over the thousand Monte Carlo simulations

Image
that starts with a 6% type yield that declines down in subsequent years/later life.

Given a number of choices a good choice is to spread across those choices, diversification. Wont be fully loaded into what turns out to be the best choice, but neither will you have been fully loaded into what might prove to have been the worst choice. Thirds each HYP, annuity, Sensible Withdrawal Rate ... or however wide you might like (Investment Trust income funds/whatever).

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Re: HYP1 is 21 - thread discussing income and capital diversification

#484666

Postby tjh290633 » March 6th, 2022, 11:06 am

1nvest wrote: With hindsight your timing was fortuitous Terry.

Not my timing, more likely my parent's' timing in 1933.
1nvest wrote: Annuity on that measure paid 62% more income in the earlier years than HYP1.

That of course is for a single life level annuity. My choice was for a joint life index-linked annuity, which does make a difference.

As you say,
1nvest wrote:Many might prefer more income when they're younger and better able/fit to spend.
but the more prudent might have later years in mind, when care costs might have an impact. Also spending does not reduce appreciably when you get older. Cruises, for example, rise in cost with inflation. Remember the many widows who had been left with a level annuity, reducing in value each year? That term "Fixed Income" doesn't often appear much these days, because people are wise to the effect, and it is why relying on fixed interest securities became unpopular.

TJH

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Re: HYP1 is 21 - thread discussing income and capital diversification

#484677

Postby NotSure » March 6th, 2022, 11:39 am

tjh290633 wrote:
1nvest wrote: With hindsight your timing was fortuitous Terry.

Not my timing, more likely my parent's' timing in 1933.


While I would agree that annuities are a no-no at the present price, there are two or three other aspects (aside from price) that need to be considered IMHO (not by most here, but by some transient lurkers perhaps).

One, though annuities are unusually expensive, due to recent share price performance, pots are unusually big. Two, for the same reason, near to midterm future prospects for the pot are probably rather poor after such a long period of over-performance (for someone retiring today, sequence of return risks look to be rather elevated at the moment). Finally, an increasing or index-linked annuity means you income will definitely be reasonable as you approach very old age, when your skills at looking after a portfolio may be impaired. Barring hyper-inflation, an annuity allows you live as you have become used to right into your nineties or even beyond, with no stress, hassle or skill. E.g. HYP1. It looks like an accident about to happen with the bulk of the income from cyclical sectors. Very easy to notice and address this, if you have the skills and are paying attention, but maybe not so much in your eighties or nineties (or for your surviving partner, if they are less knowledgeable).

So while, annuities look like money down the drain at the moment, the 'tipping point' may be closer than it appears, and the alternatives are better suited to those (like on here) that have at least a little knowledge - others may panic sell at the first sign of trouble (after news of the ''crash" reaches the front pages) and end up in a lot of trouble, especially if they are lucky enough to enjoy a long and healthy retirement.

(Edited to add, most people cannot afford to live off the natural yield - they have to use an SWR approach to have enough income, hence the 'leaving it for descendants' is less of a factor)

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Re: HYP1 is 21 - thread discussing income and capital diversification

#484698

Postby 1nvest » March 6th, 2022, 1:00 pm

tjh290633 wrote:
1nvest wrote: With hindsight your timing was fortuitous Terry.

Not my timing, more likely my parent's' timing in 1933.
:lol:
As you say,
1nvest wrote:Many might prefer more income when they're younger and better able/fit to spend.
but the more prudent might have later years in mind, when care costs might have an impact. Also spending does not reduce appreciably when you get older. Cruises, for example, rise in cost with inflation. Remember the many widows who had been left with a level annuity, reducing in value each year? That term "Fixed Income" doesn't often appear much these days, because people are wise to the effect, and it is why relying on fixed interest securities became unpopular.

In the US inflation bonds are still available, however annuities are more commonly forced into fixed rate (so the tendency is more towards adding additional annuities as you age). Like with UK inflation bonds (NS index linked savings accounts that were closed to new investors) I guess we may very well see inflation linked annuities becoming a thing of the past. States generally seem more inclined to remove safety, induce volatility/uncertainty, even raid those that strove towards safety (pension funds raids). Uncertainty induces having to save/accumulate more and is a negative IMO, if retirees could accumulate £300K with a degree of certainty that would over £10K/year of inflation linked spending for 30 years that's far better than having to accumulate perhaps twice as much in order to cover the uncertainties/volatility of income/spending. As HYP1 income shows the volatility of income can be considerable in some years, whilst that might broadly wash in practice when its down your spending may still have been the same/risen. That risk is greater in earlier years as having to sell/spend shares to fill the hole can have a significant effect on overall/subsequent portfolio compounding/outcome.


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