Case study ARF v Annuity

[Kev1964]

I know this an old chestnut but maybe the landscape is changing.

I'm 59 and plan to begin drawing a pension from a pot forecasted to be worth €540,000, in just over 2 years time. I'll be 61 then and plan to withdraw the 25% TFLS which will leave me with c€400,000 to invest. Any time I've investigated which is the better option between an ARF and an annuity, the former seems always to be the favoured option.

I tend to take a negative view of risk and consider the possibility of serious melt down of stock markets while I'm invested and relying on my ARF for a significant part of my income. To me, its not unreasonable to think that there could be no growth in my fund (fees and successive world crises) and after 25 years or so of 4/5% annual drawdowns, the fund is gone. Not a nice prospect at age 86. Annuities therefore hold a certain appeal, especially as I have no children to inherit any unused ARF. My wife is as well if not better catered for pension pot wise. We also both have some index linked DB plans and (hopefully) two state pensions each and good liquidity so inflation is not such a worry.

I recently had some annuity quotes for my age, single life, no indexing and was surprised to see that I could have well over 4% for the rest of my life. See quotes below. They might even be higher when I'm 61. In my case I see this as a good option with the added benefit of being able to stop focusing on my pension pot value, stock markets, click bait newspaper articles, etc. I'd appreciate any views on this option, especially thoughts on whether annuities might continue to improve over the next 24 months. In the UK stg. market, even better annuity value is available ...and seems to be improving.

Quotations are based on:

Single life

No escalation

Standard Annuity

NEW IRELAND

5 year Guarantee – 4.52% €18141.22

10 Year Guarantee – 4.49% €18020.85

ZURICH

5 year guarantee – 4.43807% €17,807.76 per annum

10 year guarantee – 4.40790% €17,686.70 per annum

AVIVA

5 year guarantee – 4.2561% €17,077.60 per annum

10 year guarantee – 4.2274% €16,962.44 per annum

IRISH LIFE

5 year guarantee – 4.337% €17,347.20 per annum

10 year guarantee - 4.313% €17,245 per annum

 

[Marc]

Absolutely agree that an annuity is more relevant now than in recent years.

I did a detailed analysis here

The decision process for many people will be around how much of a lump sum to take, if any.

If you can get almost 4.5% fixed for life from an annuity what are you going to do with the lump sum?

If the answer is leave it in cash forever then arguably leave it in the pension.

By the same token if you do have some guaranteed pensions already, then what do you need a guarantee for? Although I would agree that for people without any close family, an annuity is a near perfect solution.

Break even for indexation including payback of lower initial pension is typically around 22 years. Given that typical expenditures decline by around 1 to 2%pa in retirement on average it’s not normally a good bet for most people .

Another option often overlooked is why not transfer into a PRSA and pursue a phased retirement plan. Split the PRSA in to several lumps and take some cash and some taxable income whilst leaving the rest alone.

It’s never a one size fits all problem and why working with a good adviser always makes sense.

Marc Westlake CFP, TEP, APFS, QFA, EFP
Chartered, Certified and European Financial Planner
Registered Trust & Estate Practitioner
Everlake

 

[Sarenco]

To me, its not unreasonable to think that there could be no growth in my fund (fees and successive world crises) and after 25 years or so of 4/5% annual drawdowns, the fund is gone.

If you draw down a fixed percentage (as opposed to a fixed amount) every year from your fund then it is mathematically impossible to ever completely exhaust the fund.

Now, the fund may well be a lot smaller after 25 years of withdrawals, in which case you would be drawing down a fixed percentage of a smaller fund.

No escalation

This is the bit I would find scary.

The purchasing power of €18k is very likely to be lower, perhaps very significantly lower, in 25 years time.

We also both have some index linked DB plans and (hopefully) two state pensions each and good liquidity so inflation is not such a worry.

That obviously helps but without knowing the value of the index linked DB plans, it's difficult to offer an opinion.

 

[Tomandgerry]

I think no escalation is very risky, can you get quotes with?

 

[Kev1964]

I think no escalation is very risky, can you get quotes with?

Yes I have in the past but the starting point is about 50/60% of what a non escalation start point is and takes 20+ years to catch up. From memory....maybe its different now.

 

[Sarenco]

If your annuity escalated in line with inflation, capped @5%pa, your annuity rate would drop below 3%.

It's still worth considering but it's a long way from an open and shut case, even if you have no need or desire to leave a legacy.

 

[fayf]

Yes I have in the past but the starting point is about 50/60% of what a non escalation start point is and takes 20+ years to catch up. From memory....maybe its different now.

Great thread, and much more relevant now, as annuities have risen steadily, and could increase more.

I did a few calcs with and without escalation, a few years back, and came to the same, 20 years + to catch up.

This thread has me thinking- after drawdown of TFLS, what about a 50 % annuity, and 50 % ARF, it might be a good trade off hedge.

 

[Kev1964]

If you draw down a fixed percentage (as opposed to a fixed amount) every year from your fund then it is mathematically impossible to ever completely exhaust the fund.

Now, the fund may well be a lot smaller after 25 years of withdrawals, in which case you would be drawing down a fixed percentage of a smaller fund.

This is the bit I would find scary.

The purchasing power of €18k is very likely to be lower, perhaps very significantly lower, in 25 years time.

That obviously helps but without knowing the value of the index linked DB plans, it's difficult to offer an opinion.

Thanks for your detailed response Sarenco. I doff my hat to your mathematical correction but I think you understand the point.
The starting point of an index linked annuity appears to be a lot less than a non escalation one. It can take 20 years to catch up. The payout levels may have changed since the last time I had a quote.
My question really is whether annuities might be making a comeback in general terms and might rates be increasing for now and the near future?

 

[Conan]

Another factor to consider is your state of health. If your health is poor (or bad family history) then an Annuity might not be a great idea. However if your health is good, then an Annuity (guaranteed income for life) is attractive.
As regards escalation versus non escalating, the level Annuity gives you a much higher starting income (when hopefully you have the health and retirement plans which might find a higher income helpful). And you will still have the lump sum, which might be dipped into over time to offset the impact of inflation.
If you are retiring at say age 61, the average life expectancy for a male is now c24 years. It’s likely that your spending over that 24 years will be more front loaded (travel, hobbies etc) than back loaded (other than possible nursing home care - which is really hard to plan for).
As you have demonstrated, Annuities are now back in play as a real option for retirees (based on higher interest rates). And they may improve further by the time you retire. But also worth remembering that you could initially invest into an ARF, with the intention of converting to an Annuity at a later stage.

 

[LDFerguson]

The starting point of an index linked annuity appears to be a lot less than a non escalation one. It can take 20 years to catch up. The payout levels may have changed since the last time I had a quote.

Just running a couple of Zurich Life annuity quotes as examples ... they might or might not be the best rates of the various annuity companies.

• Male aged 62, €100,000 fund, no escalation on pensions, 5 year guarantee: Annual pension €4,841
• Male aged 62, €100,000 fund, 3% escalation on pensions, 5 year guarantee: Annual pension €3,262

Putting the two above into a spreadsheet, it would take over 26 years for the total paid on the escalating pension to catch up with the total paid on the level. Age 88! Considering the point already mentioned above about the typical spending patterns of a retired person, it's hard to find reasons to recommend an escalating annuity.

Regards,

Liam
www.FergA.com

 

[fayf]

I know this an old chestnut but maybe the landscape is changing.

I'm 59 and plan to begin drawing a pension from a pot forecasted to be worth €540,000, in just over 2 years time. I'll be 61 then and plan to withdraw the 25% TFLS which will leave me with c€400,000 to invest. Any time I've investigated which is the better option between an ARF and an annuity, the former seems always to be the favoured option.

I tend to take a negative view of risk and consider the possibility of serious melt down of stock markets while I'm invested and relying on my ARF for a significant part of my income. To me, its not unreasonable to think that there could be no growth in my fund (fees and successive world crises) and after 25 years or so of 4/5% annual drawdowns, the fund is gone. Not a nice prospect at age 86. Annuities therefore hold a certain appeal, especially as I have no children to inherit any unused ARF. My wife is as well if not better catered for pension pot wise. We also both have some index linked DB plans and (hopefully) two state pensions each and good liquidity so inflation is not such a worry.

I recently had some annuity quotes for my age, single life, no indexing and was surprised to see that I could have well over 4% for the rest of my life. See quotes below. They might even be higher when I'm 61. In my case I see this as a good option with the added benefit of being able to stop focusing on my pension pot value, stock markets, click bait newspaper articles, etc. I'd appreciate any views on this option, especially thoughts on whether annuities might continue to improve over the next 24 months. In the UK stg. market, even better annuity value is available ...and seems to be improving.

Quotations are based on:

Single life

No escalation

Standard Annuity

NEW IRELAND

5 year Guarantee – 4.52% €18141.22

10 Year Guarantee – 4.49% €18020.85

ZURICH

5 year guarantee – 4.43807% €17,807.76 per annum

10 year guarantee – 4.40790% €17,686.70 per annum

AVIVA

5 year guarantee – 4.2561% €17,077.60 per annum

10 year guarantee – 4.2274% €16,962.44 per annum

IRISH LIFE

5 year guarantee – 4.337% €17,347.20 per annum

10 year guarantee - 4.313% €17,245 per annum

I was wondering, what fees are involved in setting these up.
As its an annuity, i assume its fees, front loaded and something of the order of 1.50 %to 2.00 %, as ongoing charges are not relevant, as amounts are guaranteed.

 

[Colm Fagan]

For what it's worth, my experience of a self-administered ARF/AMRF since starting at end 2010 is as follows:
Starting amount: Assume €1 million (not the real amount, but everything adjusted pro rata):
Yearly withdrawal: Started at €47k in 2011, increased to €53k in 2012, etc. Blip in 2016 because I transferred in an insurance company ARF. Small net positive cash flow that year as a result. Otherwise, withdrawal increased almost every year (the occasional reduction because of market value falls). Withdrawal in 2022 was €104k. Total amount withdrawn by end 2022: €914k (12 years)
Value at 31 March 2023: In excess of €1.7m
Needless to say, I'm glad I didn't buy an annuity. The ARF (all ARF now) is practically 100% in equities. Average (at best) performance. Probably under-average because it's mainly in UK companies, due to familiarity with the market. The UK market has not done well. Very passive investment strategy, e.g. I sold shares in two companies in 2022 and bought in one. No purchases or sales so far in 2023. Dividends from existing holdings cover most of income requirement. I have no intention of changing my investment strategy as I get (even) older.

 

[Kev1964]

If the answer is leave it in cash forever then arguably leave it in the pension.

Good point Marc. Unlikely to get 4.5% interest if left on deposit somewhere.

 

[Marc]

For what it's worth, my experience of a self-administered ARF/AMRF since starting at end 2010 is as follows:
Starting amount: Assume €1 million (not the real amount, but everything adjusted pro rata):
Yearly withdrawal: Started at €47k in 2011, increased to €53k in 2012, etc. Blip in 2016 because I transferred in an insurance company ARF. Small net positive cash flow that year as a result. Otherwise, withdrawal increased almost every year (the occasional reduction because of market value falls). Withdrawal in 2022 was €104k. Total amount withdrawn by end 2022: €914k (12 years)
Value at 31 March 2023: In excess of €1.7m
Needless to say, I'm glad I didn't buy an annuity. The ARF (all ARF now) is practically 100% in equities. Average (at best) performance. Probably under-average because it's mainly in UK companies, due to familiarity with the market. The UK market has not done well. Very passive investment strategy, e.g. I sold shares in two companies in 2022 and bought in one. No purchases or sales so far in 2023. Dividends from existing holdings cover most of income requirement. I have no intention of changing my investment strategy as I get (even) older.

I’ve called this out as madness before and am compelled to do so again lest anyone actually thinks it’s a sensible approach to take.

I’m trying to imagine how easy my job would be if I could restrict my view of the world to the lived experience of just one lucky investor who retired after the Global Financial crisis and bet the house on a highly concentrated stock portfolio.

I think my PI insurance, the regulator and indeed common sense would all have something to say on the subject.

 

[Colm Fagan]

I’ve called this out as madness before and am compelled to do so again

Just to be clear, I'm not advising anyone to do as I did. I'm just recounting my experience. And of course I was invested all through the GFC and suffered the consequences - but I survived.
I would be very careful indeed before advising anyone to buy an annuity.
I was a pension consultant once, many years ago. I recounted - on this forum, I think - being told in the early 1980's of pensioners from a company I was advising who had retired in 1967 on fixed annuities. They had lost around two-thirds of their value, probably more, by the time I started advising the company.
My pension is invested in real businesses whose earnings should keep pace with inflation in the long-run.

 

[Sarenco]

There really is no easy answer to this question.

It would be easy if we knew we were retiring at the start of, what turned out be be, the longest equity bull market in history.

Or if we knew we were heading into a decade + of unprecedented high inflation.

Of course, we only know these things with the benefit of hindsight.

So, the sensible thing is to hedge your bets.

Retiring with an ARF invested 100% in a concentrated equity portfolio is not sensible for most folk.

Equally, retiring at 55 with a fixed annuity is rarely, if ever, sensible.

But there is plenty of middle ground between these two extremes.

 

[GSheehy]

I was wondering, what fees are involved in setting these up.
As its an annuity, i assume its fees, front loaded and something of the order of 1.50 %to 2.00 %, as ongoing charges are not relevant, as amounts are guaranteed.

Commission is at the discretion of the intermediary/agent and can be between 0% and 3%.

But, you could pay a fee if the intermediary was waiving the commission.

Gerard

www.PensionAnnuity.ie

 

[CuriousCork]

A friend of mine who is a pension advisor is advising his clients to avoid annuities as he is concerned that if the life assurance company has a "Black Swan" event (for example, making investments the way Silicon Valley Bank did, that it would be unable to pay out. Better to have an ARF, where the funds are segregated.

 

[Colm Fagan]

A friend of mine who is a pension advisor is advising his clients to avoid annuities as he is concerned that if the life assurance company has a "Black Swan" event (for example, making investments the way Silicon Valley Bank did, that it would be unable to pay out. Better to have an ARF, where the funds are segregated.

I think your friend is mistaken. If the ARF is with an insurance company, your investment is probably in unit-linked funds, which form part of the company's assets, and are not specifically hypothecated to you. Therefore, if anything happens to the insurance company, you're in much the same boat as someone who took out an annuity.
I hasten to add, however, that EU Solvency rules are designed to ensure that, if the insurance company has a Black Swan event, your money should be safe irrespective of whether it's in an annuity or a unit-linked fund.
However, I still have my objections to annuities. @Marc ridiculed my ARF investment strategy as follows:

I’m trying to imagine how easy my job would be if I could restrict my view of the world to the lived experience of just one lucky investor who retired after the Global Financial crisis and bet the house on a highly concentrated stock portfolio.

I agree that I was lucky in the timing of when I took out my ARF (although I lost a fair amount in my first year, 2011). I earned an average return of something over 10% a year in the 12 years plus since end 2010. I might have earned, say, 3% a year less on average if times hadn't been so good - but that would still have been over 7% a year. And were times that good anyway, e.g., Brexit, Covid, etc.?
My worry about people who advocate annuities is that they seem to forget the terrible inflation we experienced in the past. They seem to blithely think there's little or no chance of it returning with anything like the same ferocity. That belief could be as mistaken as @Marc thinks my decision to invest entirely in equities was.
I do have a big problem with ARF's though. Some advisers see them as a nice source of a steady recurring income - at the client's expense. I did some sums recently and concluded that charges by advisers and insurance companies eat up more than a quarter of each year's income withdrawal for many, probably most, of their clients. It's far more than 25% in many cases. That level of fee extraction is unconscionable and partly explains where I'm coming from with my proposal for a smoothed approach to auto-enrolled pensions, an approach that encompasses post-retirement as well as pre-retirement.

 

[Marc]

A friend of mine who is a pension advisor is advising his clients to avoid annuities as he is concerned that if the life assurance company has a "Black Swan" event (for example, making investments the way Silicon Valley Bank did, that it would be unable to pay out. Better to have an ARF, where the funds are segregated.

This demonstrates a clear lack of understanding of the relative risk of an annuity vs an ARF where both are provided by an insurance company which is the dominant distribution model for retail advice in Ireland to such an extent that many people are blissfully unaware that there is an alternative.

Spurious arguments like this are sometimes put forward by salespeople in order to justify more lucrative alternatives. It’s therefore difficult to separate a lack of understanding from financial conflicts of interest sometimes.

The relative risks in default are the same where either option are purchased from a life assurance company.

Simply google Solvency II for any life co for a detailed report of their capital adequacy.

A different capital risk position of an annuity vs a ARF would exist if the ARF is arranged via a QFM that is not a life company and uses a custodian bank such as Pershing Securities.

This is typically how investors arrange an ARF where the advice is not entirely dependent on the dominant commission model.