Potential downsides of an Index-Linked bond ladder?

[GeoffF100]

A big issue here is a change in the tax treatment. If gilts were no longer capital gains tax free that would be a problem. The government has already changed the basis of indexation from 2030. Annuities are guaranteed up to any amount, and the provider takes to hit if the rules relating to index linked gilts change. It would be politically very difficult to plunder people's pensions in payment, but plundering their investments is another matter. On the other hand, annuities appear to have substantial mark ups over the cost of providing them. (I found a mortality table and did a calculation about ten years ago.)

For me, all money is in tax free shelters, so CGT is not an issue.

Do you have any rough memory of a rough figure of the "substantial mark up" of annuities. I probably could pay 30% extra for the peace of mind.

I think it was less than 30%, and I do cannot claim any great accuracy. Annuities are a competitive market, so the mark up should not be too big.

[MikeT]

First rung purchased today (T27), took a little while on the phone with II but whoever I was talking to seemed very knowledgeable.

[1nvest]

Hello, I've read a few of the (excellent) threads on here about nominal and IL gilts and I've learned a lot from them, along with the links to other discussions (Monevator, etc). With IL gilts having positive yields across all maturities they seem (to me) a virtually risk-free way of ensuring the value of today's money in to the future.

Whilst I can see many benefits, I'd like to try and make sure I understand as many of the risks/downsides as possible.


From what I've read it seems some of the main considerations are:

Somebody outliving their ladder

Expenses not matching the income

RPI/CPI not being relevant to personal circumstances



I'm reasonably comfortable with these in as much that:

I'd look to extend the bond ladder out to around age 80 at which point I would use the remainder of my SIPP to buy an annuity

I've gone back through my total annual spending over the last few years and the plan would be to buy each gilt to be slightly in excess of this

I'm not sure there is much I can do about CPI/RPI not exactly matching spending in retirement



Are there other issues I should be thinking about?

Thanks.

CPI/RPI is a slowed measure. Buy and hold is no different to the cost-less lumping in each and every day, so for tomorrow many will 'spend' much of their total wealth on a house/stocks/other assets and spend relatively little on consumer products/services/items. viewtopic.php?p=660928#p660928

Bonds are you lending to someone who gets to set the terms and conditions, and can direct the figures (CPI, interest rates, taxation rates). In past cases of high stress (multi-year high inflation/interest rates) tax rates even for the average investor where increased to near 50% levels, in effect a non-coincidental partial default. Some cast that as being like buying fire insurance from a arsonist. If a stressful period is endured at some point during your 30/whatever year retirement period and that insurance payout is halved or maybe more! And given the state of government nowadays a stressful period at some point over the next few decades perhaps has a relatively high probability. The appearance of tax efficient/exempt can at any time be washed away with the stroke of a pen and as such is no guarantee either. Annuities bear the same risk, may very well be using the exact same Gilts at their foundation, but where unlike the state they're LTD. (could simply opt to declare bankruptcy).

[Hariseldon58]

Have you thought about US dollar TIPs ?

Real yields are 2% plus, I would hold unhedged, you get diversity of currency and supplier if UK goes down the pan, the exchange rate will probably tend to be a wash over time, the trend over the years has not been favourable for the pound.

A wide variety of index ETFs with different durations , under 5 years, under 10 years, over 10 years, total market.

My personal solution to this issue is to finance 10 + years of income with a mix of £ and US$, government bonds , a mix of inflation protected and nominals. The balance of the portfolio is global equity index funds to provide growth and over time inflation protection . Split 30% bonds and 70% equity.


Highly likely to provide a secure and rising income over the long run.

Worth noting if you have a positive yield that duration is always shorter than the maturity of a bond, higher the interest rate the higher the difference, longer the maturity of the bond , the difference gets bigger.

[JohnW]

Does the yield have to be positive? The coupon has to be >zero, but can't the yield be negative and you still get some of your money back before maturity if the coupon is >0, making the duration less than the maturity?

[Binno64]

I too have started building an index linked ladder so very interested in this thread.

My 1st purchase was T33 again using Interactive Investor. One of the reasons I chose T33 was that it is a relatively new gilt so the dirty price is only slightly above the clean price (doesn’t show as instant “loss” in portfolio)

I found an excellent tool to help build a gilt ladder (both nominal & index linked) but being a new member of lemonfool cast post links.

Maybe someone else could post the link:

lategenxer dot streamlit dot app slash gilt_ladder

Hopefully others will find this useful (just experiment with the parameters & be sure to view the cashflow tab - very informative)

[air04]

My 1st purchase was T33 again using Interactive Investor. One of the reasons I chose T33 was that it is a relatively new gilt so the dirty price is only slightly above the clean price (doesn’t show as instant “loss” in portfolio)

First rung purchased today (T27), took a little while on the phone with II but whoever I was talking to seemed very knowledgeable.

Based on my experience, buying older Index-Linked Gilts (ILGs) first is advantageous. I aimed to secure a certain level of index-linked income for a specific year. For instance, an older ILG like T68 pays interest in 2027, which means I could purchase fewer T27s. However, as I bought a ladder of 10-20 ILG bonds, their cumulative effect resulted in a reasonable amount of index linked (interest) income in the upcoming years.

[MikeT]

After taking a look at adjusting purchase amounts downwards the further along the yield curve I decided it was just simpler to invest the same amount in each gilt.

I’ve limited the purchases to 2 per phone call so I’m not sat for inordinate lengths of time.

[AshleyW]

It’s well worth comparing the cost of a conventional or IL gilt ladder with an annuity. There is a useful gilt builder application that lets you see the total initial investment for a specific annual income, for a defined time https://lategenxer.streamlit.app/Gilt_Ladder.
Tax is an important consideration as a gilt ladder will normally be lower taxed than an annuity but the annuity does provide protection against outliving your investments.

[tjh290633]

It’s well worth comparing the cost of a conventional or IL gilt ladder with an annuity. There is a useful gilt builder application that lets you see the total initial investment for a specific annual income, for a defined time https://lategenxer.streamlit.app/Gilt_Ladder.
Tax is an important consideration as a gilt ladder will normally be lower taxed than an annuity but the annuity does provide protection against outliving your investments.

Will it be lower taxed? I understand that annuities used to assume that some of your capital was returned with each payment. Hence only part was taxable. No longer the case as it is taxable as income. Presumably your gilt ladder is doing what an annuity provider would do, by arranging a future cash flow as the gilts mature.

This implies a combination of capital redemption and coupon payments, only the latter being taxable. Of course the annuity provider is working on average life expectancy and takes advantage that some will die earlier to provide the funds who live longer. What plans do you have for being longer lived? I suspect that there are better ways than drawing on the capital.

TJH

[NeilW]

Treasury default,

HM Treasury cannot default on Gilts. It is quite literally illegal for them to do so (as in you could go to court and force HM Treasury to order the Bank of England to make the exchange into Sterling - something the Bank of England has no power to refuse).

s12(4) of the National Loans Act 1968 makes Gilt repayment a Consolidated Fund standing service.

Parliament would have to pass primary legislation before Gilts could default.

[1nvest]

Treasury default,

HM Treasury cannot default on Gilts. It is quite literally illegal for them to do so (as in you could go to court and force HM Treasury to order the Bank of England to make the exchange into Sterling - something the Bank of England has no power to refuse).

s12(4) of the National Loans Act 1968 makes Gilt repayment a Consolidated Fund standing service.

Parliament would have to pass primary legislation before Gilts could default.

Or budget. 1968 and Roy Jenkings (Labour) introduced a retrospective top rate tax of 130%. During the 1960's the Beatles were singing 'Taxman' "19 for you 1 for me" .... in reflection of 95% taxation rates.

Open/full confiscations are a thing of the past, nowadays confiscations are gradual/partial via taxation and inflation (debasement of currency i.e. one prints spends new Pounds (to their benefit) that devalues all other Pounds in circulation)

[1nvest]

Tax is an important consideration as a gilt ladder will normally be lower taxed than an annuity but the annuity does provide protection against outliving your investments.

Buy a annuity and die next year and you wont care that you 'missed out'. Live to 100 and then find that they can extend your life by another 10 years, get to 110 and find they can add another 10 years ...etc. and you'll be glad you'd bought a annuity. Conceptually should pay out less each year than a index linked ladder. But a annuity will also typically involve a third party - who likely hedges their exposure by buying Index Linked Gilts. If a breakthrough suddenly added 50 years to typical lifetimes, many of those third parties might very well throw in the towel (declare bankruptcy).

Index linked gilts are point to point, guaranteed (fixed) known return between those two dates. Build a ladder spanning many years and that's more aligned with where you average into and out of stocks over many years, has a overall broad average total reward, but where stocks are inclined to provide the higher return of the two.

Typically stock, house, gold ...etc prices advance at a 2% higher rate that CPI (that is slowed by productivity), stocks additionally pay dividends - historically at around a 4.5% yield rate. On average a combined 6.5% more than CPI. Even if you secure inflation + 2% real rates from ILG that's still 4.5% less than stocks. Averaging into and out of stocks over many years is inclined to average the broader average, some purchase/sales at lows, and highs. Yet another form of averaging in addition to time averaging is a stock/bond (or stock/gold) blend and periodic rebalancing that tends to 'trade' in a add-low/reduce-high manner form of 'averaging'. The 'average' is 'good'. Many investors don't even achieve the 'average' (after costs/taxes and poor decisions). Some end up worse than had they just maintained a cash deposit account.

67/33 stock/gold foregoes 1/3rd of the dividends that might otherwise have been achieved, but lowers the volatility. Two thirds of 6.5% (all-stock expected real) = 4.4%. Still more than ILG's whilst being more consistent/certain (less volatile). Worst case will be better (higher than 4% SWR historic general measure), average case will leave less than if you'd been all in stocks - but still typically a very decent amount, and where during interim high volatility periods the portfolio volatility will be lower. Whatever might drive 67 in stocks halve might equally see 33 in gold double. No loss, and where rebalancing back to 67/33 has you holding twice as many shares after stock prices had halved (Martingale/d'Alembert betting sequence style, but with conceptual unlimited bank-roll (iterations)).