By Alex White, Head of ALM Research at Redington
Given how uncertain individual longevity is, this is huge. A typical retiree could have about 20 years of life expectancy remaining (slightly more for women, slightly less for men). But they will also have around a 10% chance of living half again as long as expected.
Guaranteeing a real income is hugely valuable compared to the risks of relying on a drawdown strategy. Moreover, a drawdown strategy is more likely to be unsuccessful in difficult economic conditions than easy ones, so if you rely on a drawdown approach and it fails, it’s likely to be in a wider context where everything else has gone wrong, and there’s less support to be had. For example, if you own a house and run out of retirement funds, you may have to sell it in a recession.
Real annuity rates of around 5% are now attainable . To put this into context, the Bengen rule suggests that, for real withdrawals from a pot to be sustainable, they should be no more than 4% . Our independent analysis found this held up in current market conditions with a 60-40 portfolio. So annuities may be offering better value.
There is, of course, a catch. Or to be precise, there are two catches. The first is that your money is locked up, and an unexpected cashflow could derail your plans as you lose liquidity. The second is that when you die, you can’t keep the money in your estate, to leave as an inheritance.
This second point is really where the value comes from, and it’s sizeable. Twenty-year real rates are around 1.5%, so the return for writing off the pot after death is worth around 3.5% pa. That’s around the long-term risk premium available on a typical 60-40 portfolio, so you get all that return with “complete” risk to your pot but almost no risk to your income .
This is perhaps the most helpful framing. Cash poses no risk to the pot, but a huge risk to the level of income affordable. Equities and other investment assets pose risk to both, but with an expectation that both the pot and income level will be larger through investment returns.
Annuities (broadly) incur a guaranteed loss of the pot, but with a guaranteed income. As many retirees will want some balance between these goals, having tools at the extreme ends is likely to be useful. For example, instead of a balanced pot with fixed outgoings, a member could take annuities for their minimum requirements, then invest in much higher risk/higher return assets on the residual pot, knowing they could spend less from it in tougher years (since their minimum needs are covered by the annuity).
When real rates were strongly negative annuities weren’t very attractive. That’s changed rapidly, and for a lot of retirees they’re a useful option to have in the toolkit.
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