I found myself immersed in an interesting twitter discussion yesterday with a number of pension experts regarding annuities, and more specifically whether or not annuities represent value for money.
I had a bit of a busy afternoon/evening but when I got up this morning I did some quick research.
Firstly I pretended I was 22 years older than I actually am (making me a male aged 65) and then assumed I had a pension fund of £100,000. There are many ways in which one could derive a retirement income from this money and they come with various combinations of guarantees, lock-ins, flexibility etc.
However, because it was early in the morning and I frankly couldn’t be bothered considering all of the alternatives (and in the interests of keeping this simple) I looked at just two scenarios:
1. Purchase an annuity from Aviva (chosen simply because one of the twitter-ers works for them – a couple of experts advise me that other company’s rates are similar enough to make this post valid)
Aviva’s (quite cool) online quick quote tool advised that I could receive an income of £5534.88 per annum for life and that if I pre-deceased my darling, magical wife, she would receive 50 per cent of this amount until she died (she was assumed to be two years younger, which isn’t true but nor does it really matter here). In the event that we both die, the retirement income would cease.
2. Purchase the Aviva 6.125 per cent 2036 corporate bond
The LSE website confirmed that I could invest £100,000 in the Aviva 6.125 per cent 2036 corporate bond at a price of around 99.28. To keep the arithmetic simple, let’s pretend that the price was actually higher and was 100.00, which should also allow me to ignore the dealing charge.
In this scenario and providing Aviva doesn’t default I can receive £6,125 for each of the next 23 years and then have my £100,000 returned to me. If I die in the meantime my investment will have a market value which could be nil (if Aviva is in default) or might more likely be a lot, lot more.
So, it’s decision time. Would you choose (1) or (2)?
As stated in the intro there are a lot of factors to consider but I can’t help thinking most people would rather receive 10.6 per cent more each year, run the risk of Aviva defaulting and in all probability ensure a far higher sum passes to their estate on death.
In any event, in the extremely unlikely event that Aviva was to default, what are the chances of the annuitants continuing to receive their income?
This is obviously not a true ‘apples for apples’ comparison but somewhere in these numbers lies the true value of an annuity and it gives some clues to how the market functions. I wonder how many fully informed people are (a) truly able to quantify this value and (b) would choose to buy an annuity from Aviva over the Aviva corporate bond?
Finally, some small print:
1. Holding the bond on the Nucleus wrap would mean paying around £350 per annum in platform charges. If this was the only asset in someone’s Sipp there is probably a cheaper way to hold the bond.
2. I know that annuities are backed by assets other than corporate bonds (eg gilts).
3. I also know that if I was 65 and unhealthy, a smoker etc I could secure a better annuity rate but that is not because annuity providers are charitable, it is because they expect to pay me less before I die. If I pay more for life assurance, the converse is only reasonable.
4. I am also aware that this scenario might not be possible due to drawdown constraints. These technical points don’t however amount to a credible defence of annuity pricing. At least not to me.
David Ferguson is chief executive at Nucleus