Extraordinary value - not

[Alaric]

So I asked a well know UK insurer for an example quote for one hundred grand for me and the missus (we're both in our early 50's). 100% spouses annuity, level, and paid monthly.

The rate given was 2.1% annually and all of it is treated as 'capital element' (i.e. tax free). Lucky me.

Your benchmark comparison should be what income you would get if you put the money into the longest Gilt you could find. You wouldn't get 2.1% and it would be taxed.

I doubt there's much of a market in PLAs, so no great incentive for the insurer to take on higher risk by assuming potentially more lucrative investments than Gilts. If you had offered them a pension fund buy out in the hundreds of millions, they might have been a bit more competitive.

[thebarns]

I disagree that the benchmark comparison should be the longest dated gilt.

That does not take into account the fact that the initial £100k is completely lost and handed over to the life company.

So saying 2.1% is better than the rate on a long term gilt can’t be right as it does not take into account that you are being given back your own money and indeed if it was invested in a gilt, you would get all of your capital back at any point in time, assuming no changes in gilt valuations, positive or negative.

The benchmark is the 48 years it would take you to get your own money back, plus the 1-2% conservative that that money could generate, virtually risk free each year.

So the offered PLA of 2.1% is appalling and will have all insurer’s massive overheads and profit margins built into their calculations.

[richfool]

For interest/fun, I decided to look into what's called a Purchased Life Annuity. This differs from a pension annuity in that you still hand over your non pension cash to an insurer and in return they pay you an income for the rest of your (and spouses if required) days, but the 'income' is partly treated as a return of capital and therefore not taxed.

You might think it's mad freely handing over your cash to an insurer, but I had read somewhere that payments could be higher and guaranteed for life and, if you weren't planning passing it on to anyone, they might be worth a look. I had hoped to see something north of 5% interest along with a capital repayment element, but to be honest, I really didn't have a clue.

So I asked a well know UK insurer for an example quote for one hundred grand for me and the missus (we're both in our early 50's). 100% spouses annuity, level, and paid monthly.

The rate given was 2.1% annually and all of it is treated as 'capital element' (i.e. tax free). Lucky me.

The insurer's set up commission is 2% initially.

On death of the last annuitant, the plan will cease with no value. At no time will the plan have any cash in value.

At first I thought I must be missing something. Are they really just setting up a plan to return to me my own money on a gradual monthly basis? £100k/£2100 per annum = 47 years worth of 'income' and that's not including the small amount of interest I could get on deposit, or more (with risk) from, say, an investment trust, plus having at least some of your capital intact for emergencies and to pass on.

I guess we could be better off if one of us makes it to 150. If we both peg it in our 70's then it's party time at PondLife central office and the Rescue Cats go hungry.

I mean really?

I would suggest that an annuity for someone in their early 50's would offer a much less attractive return, than if one was age 70 upwards. The older you are when commencing an annuity, the better the rate of return. They are also going to have to pay out (longer) until the second party passes on.

[AleisterCrowley]

It does look a bit..odd. Is there any index linking, or is it a flat 2.1% of principal until you expire?
£2100 isn't going to buy much in (say) 30 years time
I must be missing something

[Alaric]

So saying 2.1% is better than the rate on a long term gilt can’t be right as it does not take into account that you are being given back your own money

They take the money, invest it in a gilt at say 1.5% and make up the difference to 2.1% by giving you back the initial purchase price over time. They might have to wait 40 years before they can take what's left of the original capital value for themselves.

[AleisterCrowley]

Quick back of an envelope calc (so probably wrong) suggests if you put £100k in an account paying 1% after tax and withdrew £2,100 pa, it would last approx 65 years

[AsleepInYorkshire]

I read somewhere that premium bonds pay out an average of 1.4% per annum in "winnings".

AiY

[argoal]

Age 55 Age 60 Age 65 Age 65(smoker*) Age 70 Age 75
Single life, level, no guarantee £3,825 £4,235 £5,022 £5,276 £5,808 £7,214
Single life, level, 5 year guarantee £3,819 £4,224 £4,995 £5,245 £5,743 £7,053
Single life, RPI, 5 year guarantee £1,707 £2,080 £2,740 £3,185 £3,556 £4,654
Single life, 3% escalation, 5 year guarantee £2,147 £2,678 £3,466 £3,599 £4,233 £5,261
Joint life 50%, level, no guarantee £3,436 £3,893 £4,520 £4,597 £5,262 £6,223

The figures above are from the Hargreaves Landsdown Best Buy annuity table. (Apologies for formatting).

According to them you get £3,436 for a joint-life 50% level annuity at 55.

Generally these things don’t become worth looking at until you are 70 and in good enough health to worry about living to 100+.

[SalvorHardin]

2.1% isn't outrageously low. It's a consequence of extremely low long dated gilt yields combined with being in your early 50s. Here's a rough calculation, remember it is better to be roughly right than precisely wrong

The insurer is going to use a gilt yield of a maturity date that is close to the joint life expectancy. Early 50s couple, 100% last survivor, say 35 years.

30 year gilts yield 1.2% (the true risk-free return)

Cost per £1 of level annuity = ( (1 + i ) ^ n) / i
Where i is the interest rate and n the term in years

So we have ( (1 + 0.012)^35 - 1) / 0.012 = £43.2 per £1
or an annual return of 2.3%

Or you can get about 4% on the FTSE100.

We live in interesting times

[Alaric]

Or you can get about 4% on the FTSE100.

Which could be 2% next year if every Company halved their dividend, or half of them suspended dividends.

That's one of the factors that destroyed private sector defined benefit pension provision. The sheer cost of doing so if you were confined to investing in Gilts because there was no room to manoeuvre by cutting or not increasing benefits and the accounting rules prohibited phantom or aspirational assets.

[EthicsGradient]

2.1% isn't outrageously low. It's a consequence of extremely low long dated gilt yields combined with being in your early 50s. Here's a rough calculation, remember it is better to be roughly right than precisely wrong

The insurer is going to use a gilt yield of a maturity date that is close to the joint life expectancy. Early 50s couple, 100% last survivor, say 35 years.

30 year gilts yield 1.2% (the true risk-free return)

Cost per £1 of level annuity = ( (1 + i ) ^ n) / i
Where i is the interest rate and n the term in years

So we have ( (1 + 0.012)^35 - 1) / 0.012 = £43.2 per £1
or an annual return of 2.3%

I don't think that's right - that's the calculation for how much periodic saving would build up - the ratio of the eventual value to a regular amount saved (ie, save £1 for 35 years at 1.2%, and you'll end up with £43.20). As a sanity check, put in a higher interest rate, eg 5%; you get 90.32 as the result of the calculation. If you said that was "£90.32 per £1 or an annual return of 1.1%", that'd make no sense - if they could get more interest from gilts, they wouldn't make the amount you get even smaller.

I think the spreadsheet PMT function ("Returns the periodic payment for an annuity with constant interest rates" - LibreOffice help) gives us the figure:
=PMT(1.2%,35,-100000) gives a result of £3515.88 (compare with argoal's HL figures above - for £100,000, I presume). What makes the figure the company quoted so pathetic is that a yield of 0% for 40 years (early 50s couple, level annuity, assume 2nd partner dies in their early 90s) would give 2.5%. The NPER function tells us how many years, with a return of 1.2%, an annuity should pay out at 2.1% of the principal: 71 years. So the survivor would need to break the world record for age.

[SalvorHardin]

I don't think that's right - that's the calculation for how much periodic saving would build up - the ratio of the eventual value to a regular amount saved (ie, save £1 for 35 years at 1.2%, and you'll end up with £43.20). As a sanity check, put in a higher interest rate, eg 5%; you get 90.32 as the result of the calculation. If you said that was "£90.32 per £1 or an annual return of 1.1%", that'd make no sense - if they could get more interest from gilts, they wouldn't make the amount you get even smaller.

You're right! I've mixed up the formulas! Oops

[Dod101]

For interest/fun, I decided to look into what's called a Purchased Life Annuity. This differs from a pension annuity in that you still hand over your non pension cash to an insurer and in return they pay you an income for the rest of your (and spouses if required) days, but the 'income' is partly treated as a return of capital and therefore not taxed.


The rate given was 2.1% annually and all of it is treated as 'capital element' (i.e. tax free). Lucky me.

The insurer's set up commission is 2% initially.

What is the difference between a Purchased Life Annuity and a Pension Annuity?

If you buy an annuity (usually for life and sometimes the benefits are index linked) the taxman usually treats some of the annuity payment as a return of your capital and some as a form of interest, so that the capital portion is not taxed but the interest part is. I have never heard of annuity payments being entirely untaxed. Is that correct? If so, it probably means that the provider is not counting an any investment return from your £100,000. You have heard of negative interest rates haven't you?

So they are going to pay you £2,100 per annum to you and your spouse so long as at least one of you remains alive. You say their expenses (commission) is 2% so from their point of view you are apparently receiving 2.1% on £98,000, not the full £100,000. Long term gilt rates are very low as has been mentioned and of course one of you could live to be 100! Furthermore, annuity rates vary widely and so you would need to do a full survey of the market to get a realistic handle on what is available.

Dod

[scrumpyjack]

I think it is a mistake to call a guaranteed fixed return as 'risk free' when it is only guaranteed in nominal terms and not real terms. Inflation is a very significant long term risk and what matters is how much the money you receive each year will buy. Losing purchasing power due to inflation, however guaranteed it is, is risky and it may be that after 10 or 20 years the 'guaranteed' income won't buy a can of beans!

Hence my view is that it is very misleading the way financial advisers tend to say that a fixed guaranteed nominal return is less risky than a return based on dividends from companies engaged in real economic activity. Both are risky in different ways.

[Alaric]

So they are going to pay you £2,100 per annum to you and your spouse so long as at least one of you remains alive. You say their expenses (commission) is 2% so from their point of view you are apparently receiving 2.1% on £98,000, not the full £100,000.

As well as the up front commission, the insurer also has to allow for the costs of paying the annuity every month/quarter/year and the costs of reporting. When these costs increase with inflation, they could take a sizeable bite out of the investment returns given the potential lifetime of the annuity contract.

If they are still using the traditional actuarial approach, the value of a last survivor annuity is the sum for each future year of

(annuity amount + expense amount) multiplied by (the probability the first life is living plus the probability the second life is living minus the probability the first life is living multiplied by the probability the second life is living) multiplied by the discount factor.

[AsleepInYorkshire]

For interest/fun, I decided to look into what's called a Purchased Life Annuity. This differs from a pension annuity in that you still hand over your non pension cash to an insurer and in return they pay you an income for the rest of your (and spouses if required) days, but the 'income' is partly treated as a return of capital and therefore not taxed.

You might think it's mad freely handing over your cash to an insurer, but I had read somewhere that payments could be higher and guaranteed for life and, if you weren't planning passing it on to anyone, they might be worth a look. I had hoped to see something north of 5% interest along with a capital repayment element, but to be honest, I really didn't have a clue.

So I asked a well know UK insurer for an example quote for one hundred grand for me and the missus (we're both in our early 50's). 100% spouses annuity, level, and paid monthly.

The rate given was 2.1% annually and all of it is treated as 'capital element' (i.e. tax free). Lucky me.

The insurer's set up commission is 2% initially.

On death of the last annuitant, the plan will cease with no value. At no time will the plan have any cash in value.

At first I thought I must be missing something. Are they really just setting up a plan to return to me my own money on a gradual monthly basis? £100k/£2100 per annum = 47 years worth of 'income' and that's not including the small amount of interest I could get on deposit, or more (with risk) from, say, an investment trust, plus having at least some of your capital intact for emergencies and to pass on.

I guess we could be better off if one of us makes it to 150. If we both peg it in our 70's then it's party time at PondLife central office and the Rescue Cats go hungry.

I mean really?

I don't live in an area of the country where house prices are stupidy. But 100K would buy you a decent 25 year old terraced home with a rental income of £600/month. That's a cool 7.2% income. And on top of that, in theory at least the house price is growing [compounded] by 8% pa.

With rough figures like that I can see why house prices remain resilient in the UK. It may also explain why PLA's aren't flavour of the day.

AiY

[dmukgr]

I don't live in an area of the country where house prices are stupidy. But 100K would buy you a decent 25 year old terraced home with a rental income of £600/month. That's a cool 7.2% income. And on top of that, in theory at least the house price is growing [compounded] by 8% pa.

With rough figures like that I can see why house prices remain resilient in the UK. It may also explain why PLA's aren't flavour of the day.

AiY

I come from Oldham which is always an eye opener when I return and see the prices - I never thought of looking at rent though. It's food for thought. Out of interest, where in Yorkshire are you refering to?

[Hariseldon58]

I was interested in the calculations and the use of a spreadsheet, I picked up my decades old Hewlett Packard 12C and a couple of button pushes later I had the answer.

They were very popular at one time for professionals doing financial calcs, bond payments etc, many years ago and still my first port of call for quick what ifs.

[AleisterCrowley]

Still available- I have the 12C on my Amazon wish list, but can't justify the outlay when I have Excel (and no need to do 'rapid' calculations on the fly)
https://www.amazon.co.uk/dp/B00009WNV9/ ... _lig_dp_it
They do look cool though...

[Wuffle]

North staffs resident here, another place where 100k buys an easily rentable house with decent returns.
I feel for the kids that I am shafting and don't have any of my own to offset the guilt.
The comparison with the financial product is logical to some extent in that you might (might) cop for some maintenance costs with the house, but you will cop for a bunch of financial services salaries (likely London based) with the financial product.
Let's face it, half of you on TLF are on the other end of this observation!