Guest Spot: Exploding retirement income myths #5
- Author : Just
- Date : 1 Sep 2021
Myth #5: ‘Retirees shouldn’t buy an annuity until they’re at least age 75’
We live in an era dominated by soundbites and snappy slogans. From the world of advertising “Just do it”, “every little helps”, and “I’m loving it”, are very memorable examples. They’re written by ad agency professionals whose job is to write copy in soundbites that connect emotionally with us in order to influence where we spend our hard earned cash. The reality is that as good as these slogans are, they lack detailed information and only work if the brands they represent live up to the promises they make to us.
One such soundbite that has penetrated the minds of many a retiree and their adviser, albeit it’s not quite that snappy, are those words spoken at The Dispatch Box by the then Chancellor of the Exchequer, George Osborne in March 2014… “No one will have to buy an annuity”.
Putting to one side the obvious inference of this statement, which is that guaranteed income for life provided by an annuity is in some way a bad thing. Having taken this message onboard emotionally, it falls to the adviser to find and document the necessary logic and evidence to support what they and their client now believe to be right.
The preference for some advisers is to take George at his word and ‘go it alone’ for the whole retirement journey when it comes to managing longevity, and effectively self-annuitise’. In other ‘exploding retirement income myths’ articles we’ve commented on what level of rigour and evidence may be needed going forwards to demonstrate that this is in fact, a suitable option for a client.
But where the belief is that guaranteeing income for life still has a role to play at some point and the emotional preference is one of deferral rather than avoidance, how can an adviser evidence that deferring the purchase of an annuity with some or all of a client’s pension funds to a later point in time, is a financially sound and logical thing to do?
A well known and well regarded financial academic, Moshe Milevsky published a paper in 2004 which introduced what he titled ‘the implied longevity yield’.
Milevsky was also one of the first academics to recognise, back in 2006, the impact the sequence of returns can have on a portfolio when it’s used to pay out regular income, so he knows his onions!
In simple terms, what Milevsky suggests is pretty straightforward and sounds a lot like a variation of a critical yield. Let’s assume an adviser has a 65 year old client and they are recommending that guaranteeing income for life in whole or in part should not be considered until at least age 75. To quantify the ‘cost’ of self-annuitising for 10 years the adviser should get two sets of annuity quotes to establish:
- the cost of securing the necessary income now, from age 65, with a 10 year guarantee included; and
- the current cost of buying the same level of income for a 75 year old, with no guarantee period (it will obviously be less than (1))
If we assume an income requirement of £10,000 pa level, as of the beginning of July the cost of buying the annuity for the 65 year old would be just over £208,000 and for a 75 year old it would be £145,500. Allowing for the same required withdrawals via flexi-access drawdown (FAD) over the 10 years, the portfolio return required to be able to buy the same level of income in 10 years time would be a shade under 4% per annum gross. Going beyond Milevsky’s paper now, in search of what future good practice may come to look like, after making a suitable allowance for fees this critical yield can then be modelled stochastically to identify the likelihood (probability) of it being achievable over the next 10 years. Modelling a 60/40 mature equity and bonds portfolio with fees of 1.75% per annum suggests there is around a 55% probability of having the necessary £145,500 available after 10 years of FAD.
This more rigorous stochastic modelling compared to the more simplistic deterministic variety used within FAD critical yield illustrations, will help to provide a client with a more realistic, robust and logical assessment as to what the true costs and risks may be when choosing to defer an annuity purchase, and provide a balance against the more emotional justifications borne out of soundbites and slogans.
Building elements of guaranteed income into FAD is easy with Secure Lifetime Income available within the Novia SIPP. If you’d like to know more please get in touch with your usual Novia contact.
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