The fallacy of "lifestyling"

[Marc]

Imagine I'm 65 today and for every 100k of pension fund my guaranteed annuity is €5,023pa for life with a 10 year guarantee. That's current annuity rates from Irish Life, I might be able to squeeze a little more out.

Now let's compare that with a middle of the road ARF strategy which is, by definition, what most people will hold and see how I am likely to do if I try to keep up with the guaranteed annuity



I expect to bomb out most of the time.

If I take less risk I will have much more confidence that I will almost certainly bomb out



Whereas if I take a lot of investment risk then it looks like this





From this I would conclude that many, if not most people should be considering an annuity in retirement for at least part of their pension fund and therefore a lifestyle approach is not inappropriate for many people.

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

 

[AJAM]

Most of the people on this forum will know my views on this. My proposal for AE (which I'll be presenting in person for the first time in Ireland tomorrow: https://www.tasc.ie/news/2023/03/07/assessing-the-proposed-auto-enrollment-pension-scheme-tasc-e/ ) recommends 100% in equities for everyone, always, pre- and post-retirement. Returns are smoothed to eliminate the risk of a new retiree suffering a massive fall in the value of their fund just as they're about to take their tax-free lump sum.
I view AE not as agglomeration of individual accounts but as a sovereign wealth fund, which will continue to grow for decades into the future, with no need to sell investments, so the right investment strategy is to invest everything in equities.

This is a brilliant yet sensible idea. So no chance it will be adopted by government.

But the main issue with it is, in the worst of times (read 2008 financial crisis), when you need government to step in and bankroll withdrawals for 1-5 years, is exactly the time when they can't afford to do it.

 

[AJAM]

For the last 20 years annuities did not make sense.
But with rates continuing to rise, annuities are much more attractive.
They should definitely be considered at retirement.

 

[JimmyB99]

That's really impressive looking, Marc........I'll need to get my specs out to have a better look at the detail of all this.

Can you answer the question that's been doing the rounds here please? If we forget about the lifestyle approach and someone is actively keeping an eye on their fund, where should someone invest as they approach retirement if they wish to secure a given level of pension/guaranteed income? I appreciate that you are busy so understand if you may need some time to respond.

Thanks in advance.

 

[JimmyB99]

But the main issue with it is, in the worst of times (read 2008 financial crisis), when you need government to step in and bankroll withdrawals for 1-5 years, is exactly the time when they can't afford to do it.

I think you are right, AJAM. The 2008 financial crisis is not actually the problem! It's only a portent of the problem! The real issues with these proposals (as recounted to me by someone who knows much more about these things than I'll ever know) is what happens when things are far, far worse than the financial crisis? It is possible, for example, that the world continues to not act quickly enough regarding the climate crisis and who knows the level of disruption this could cause? It is possible that things then get really, really ugly and stay that way for a long, long time. At that point, governments will have enough other challenges without adding this to the list.

 

[murphaph1]

Thanks Marc. Definitely worth keeping annuities on the radar. If a person keeps their DC pension fund invested in all equities until retirement date and the markets are down, can you take out an ARF and then (if the markets improve and annuity yields are attractive) later buy an annuity?

 

[JimmyB99]

Hi murph,

I actually know the simple answer to this one - to quote/misquote Barack - yes you can.

Where you'd need advice from Marc or some other person with advanced specialist knowledge is getting the full pros and cons of deferring an annuity purchase. There's concepts like annuity drags which are above my pay grade. At a simple level, however, deferring an annuity purchase (in whole or in part) may be an interesting planning tool for you as not alone will it give your equity fund time to rebound (if that's your goal) but presumably, all other things like interest rates being equal, the annuity should be somewhat higher if it is deferred for a period due to your residual life expectancy being lower at that point.

I hope that helps.

 

[David_Dublin]

If you don't take the additional €300k (taxable at 20%) but transfer it also into an ARF , the result -€1.8m- will simply generate a higher income drawdown each year which will possibly attract a marginal tax rate close to 50% (PAYE + USC+ PRSI). So not taking the additional €300k may not make sense.

I get that. I'm just wondering if you've no use for it then do u just end up investing it, in which case you incur capital gains when realising growth, whereas u don't incur that if you left it in ARF.
Admittedly I'm sure most people can find soemthing to do with 300k.

 

[AJAM]

what happens when things are far, far worse than the financial crisis? It is possible, for example, that the world continues to not act quickly enough regarding the climate crisis and who knows the level of disruption this could cause? It is possible that things then get really, really ugly and stay that way for a long, long time.

I wouldn't worry Jimmy. If it gets that bad, you won't need to worry about your pension.

 

[Conan]

I get that. I'm just wondering if you've no use for it then do u just end up investing it, in which case you incur capital gains when realising growth, whereas u don't incur that if you left it in ARF.
Admittedly I'm sure most people can find soemthing to do with 300k.

True but you only incur CGT on any growth not the original capital. If you invest the €300k into an ARF you possibly incur Income Tax + on the drawdown from the capital.

 

[Colm Fagan]

But the main issue with it is, in the worst of times (read 2008 financial crisis), when you need government to step in and bankroll withdrawals for 1-5 years, is exactly the time when they can't afford to do it.

Hi @AJAM. We're in danger of morphing into the quite separate discussion of my AE proposal, and if we continue, maybe would be best to continue the discussion on that thread, but a quick answer to your question is that the AE scheme enjoys positive cash flows for decades, so times like 2008 are in fact good news in that they allow the fund to load up with equities at rock bottom prices. The smoothed fund value exceeds market value at such a time, which is good news for members exiting, but what about new/ existing contributors who're buying from them at exorbitant prices, I hear you ask? The quick answer is that it's worth their while even if they have to pay well over market value on occasion (it's still worth it if they have to pay up to 170% at young ages the odd time) because smoothing means that they can remain invested in equities forever, earning higher (expected) returns. That's a very valuable option, not available without smoothing. This question is explored at the bottom of p9/27, top of p10/27 of https://actuaries.org.uk/media/q42dthzb/colm-fagan.pdf, if you're interested in exploring further. If you do wish to come back to me on it, I suggest it's best to to to the AE forum rather than discuss it on this forum, which is about the quite separate - but very important - question of lifestyle investing.

 

[AJAM]

Hi Colm, yes I only read your slides after I posted that.
Looks very good! Count me in as a supporter.

 

[ashambles]

From this I would conclude that many, if not most people should be considering an annuity in retirement for at least part of their pension fund and therefore a lifestyle approach is not inappropriate for many people.

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

While I largely agree, I could be wrong but I seem to remember the introduction of lifestyling was partially because people were being forced into annuities - prior to opening up ARFs to almost everyone.

These probably followed along from Target-Date funds introduced in the US in the 1990's.

Here it was a response to people who'd ended up in the early 2000's with pensions reduced by a crash but had to buy annuities, they couldn't wait for the market to recover and they couldn't switch to an ARF.

The Irish pension market learned from that and introduced a product which blew up in a different way in 2022 when a bond bubble burst.

According to this "pension for life" fund https://www.irishlifecorporatebusiness.ie/empower_pls, is designed to be entered 6 years from retirement, the fact sheet says

"Prior to 2018 the fund invested in indexed long dated AAA/AA Eurozone Government Bonds" (the idea of target date funds is they'd be near-dated bonds at that stage?)

That rethink in 2018 seems to have made it even worse - the fund last year was down 28%.

 

[JimmyB99]

I wouldn't worry Jimmy. If it gets that bad, you won't need to worry about your pension.

Your comment made me smile! Thanks!

As mentioned, it's a separate discussion. I was simply explaining why the risk you mentioned isn't the really the material risk in all of this. There are many possible occurences where potentially the world doesn't stop turning but normal economics as we know it are massively disturbed for multi-decades.

 

[JimmyB99]

That rethink in 2018 seems to have made it even worse - the fund last year was down 28%.

Interesting comments, Ashambles. I must admit I don't like it when people quote the decline in a long bond fund (in this context) without also acknowledging the "corresponding" increase in annuity rates over the same period. It just seems like presenting part of the picture? I don't know by exactly how much annuity rates increased in the period in question but I'd imagine they increased significantly?

 

[Duke of Marmalade]

Imagine I'm 65 today and for every 100k of pension fund my guaranteed annuity is €5,023pa for life with a 10 year guarantee. That's current annuity rates from Irish Life, I might be able to squeeze a little more out.

Now let's compare that with a middle of the road ARF strategy which is, by definition, what most people will hold and see how I am likely to do if I try to keep up with the guaranteed annuity

View attachment 7385

I expect to bomb out most of the time.

If I take less risk I will have much more confidence that I will almost certainly bomb out

View attachment 7386

Whereas if I take a lot of investment risk then it looks like this

View attachment 7387



From this I would conclude that many, if not most people should be considering an annuity in retirement for at least part of their pension fund and therefore a lifestyle approach is not inappropriate for many people.

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

Good stuff. Before I make a comment, what is the shaded skew parallelogram indicating?

 

[Marc]

Good stuff. Before I make a comment, what is the shaded skew parallelogram indicating?

It’s a predicted “comfort zone” from answers to a financial personality assessment- so a measure of risk tolerance which, of course, has very little to do with the required investment risk to meet an income objective.

What it really tells us is if the portfolio a client “needs” to hold in order to meet an objective, is inconsistent with their likely risk tolerance.

The financial services world generally does this the wrong way round and lets the client’s risk tolerance drive the portfolio selection process in order to tick a compliance box.

 

[Duke of Marmalade]

It’s a predicted “comfort zone” from answers to a financial personality assessment- so a measure of risk tolerance which, of course, has very little to do with the required investment risk to meet an income objective.

What it really tells us is if the portfolio a client “needs” to hold in order to meet an objective, is inconsistent with their likely risk tolerance.

The financial services world generally does this the wrong way round and let’s the client’s risk tolerance drive the portfolio selection process in order to tick a compliance box.

Okay, So my read is that only Exhibit A is in the comfort zone. I think this method of illustration is excellent. It does suggest that annuities are back on the radar. In terms of my OP of course the correct diagrams are those pertaining during the lifestyling phase when annuity rates would be much lower and these are what the blind application of the lifestyling concept were locking into.
Of course, what is missing is the absence of any estate on the annuity. But it points quite strongly towards the annuity option for those unconcerned with leaving an estate e.g. no dependents. I understand that the example in OP is in this situation.
The ARF option on the other hand may for some be leaving far too much in the estate and the choice to go up the risk reward spectrum would seem to imply that the pensioner is taking the risk and their dependents are taking the reward, if it transpires.
You have made a good case for taking financial advice on these matters but then again AAM doesn't do a bad job as I think we see in this thread.

I am presuming that G means gross and N means net in the graphics

 

[Steven Barrett]

For the last 20 years annuities did not make sense.
But with rates continuing to rise, annuities are much more attractive.
They should definitely be considered at retirement.

Annuities should always be considered at retirement, no matter what the annuity rate. Retirement is a huge milestone is someone's life and they should have all the options presented to them. Far too often, retirees are only presented with the ARF option. The cynical amongst us may look at the higher initial commission and ongoing annual fees versus the smaller initial commission and no ongoing fees as being a major factor in not offering the option of an annuity.

But as the first three general principles of the Consumer Protection code states below, surely that couldn't be the case.

2.1. acts honestly, fairly and professionally in the best interests of its customers and the integrity of the market;
2.2 acts with due skill, care and diligence in the best interests of its customers;
2.3 does not recklessly, negligently or deliberately mislead a customer as to the real or perceived advantages or disadvantages of any product or service;

 

[Robzig]

Interesting comments, Steven