Key Post People should consider buying an annuity on retirement

Marc

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Why an Annuity matters to an ARF investor


How should one approach investing an ARF?

As we set out in our [broken link removed] for retirement planning in Ireland, an investor’s risk tolerance is only one of several factors that go into the decision to go into an ARF.

A far more appropriate way to approach this question is to ask; “what rate of return am I looking for?”

For most people this is the imputed distribution requirement of 4% or 5%pa of the fund required by the Government, but another very relevant comparison (as we set out in our guide) is the income forgone from the annuity that could have been purchased instead.

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In this example , we can see that based on the current fund value of €150,436, our client could purchase an annuity today (in 2020) at a fixed rate of 3.625%pa.

Their ARF with 4% distributions is currently paying €6017pa,
so we might conclude that the ARF is more suitable than an annuity purchased today.

But the real test is can the ARF support the level of income that could have been provided originally when the ARF was established? Since it is that annuity that the client gave up when making the decision to take the ARF in the first place.

Annuity Rates in 2016 for this client were 3.23%pa so we can conclude that, for this client at least, the decision not to purchase an annuity has worked out very well. They have received more income than the initial annuity would have provided and can now purchase a guaranteed income greater than the original annuity would have provided.

The annuity provides a Critical Yield

You can think of this as your personal benchmark, the average annual return your ARF needs to achieve every year in order to not be worse off.

So if your annuity rate is 3% the day you open your ARF you need to average a return of more than say 5%pa to account for charges every year to be no worse off.

don’t fall into the trap of saying I got my 4% and there is still some left.

4% of €1 is 4 cent in income with 96 cent left. It will never “run out”

can your ARF support the 3% of the ORIGINAL capital value - that’s the real test and for many it’s simply not possible to keep this up.

the second consideration is to compare your current fund value with current annuity rates as this takes account of changing fund values AND changing interest rates.

your fund might well have gone up in value but annuity rates might have gone down by more leaving you worse off of you were to convert the remaining fund to an annuity.

This is the real hurdle for any ARF to match - simply to continue to provide the guaranteed income that could have been purchased at outset.

How Does This Translate Into A Real Client’s Actual Investment Experience?



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We can see in the chart above that the client originally invested €145,035 on the 4th April 2016 and an additional investment was made of €17,163 on the 4th January 2018.

As at Friday 1st May 2020, the account was standing at €150,436 an annualised return (allowing for outflows) of 1.78%pa.

We can see from the time weighted performance analysis below, that aside from the first quarter of 2020, the account has performed extremely closely to the expected return.

1588520588309.png


This clearly illustrates the risk of market falls to an ARF strategy. We have to invest in risky assets in order to generate sufficient expected returns and in so doing, we are exposed to
the frequent gyrations of the markets.

The annuity always provides a relentless consistency against which to judge the success or otherwise of an ARF strategy whereas, in the short-term at least, markets are remarkably unpredictable.


Marc Westlake
Chartered Certified and European Financial Planner
www.globalwealth.ie
 
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Thanks Marc.

How would ARFs and annuities be treated when I die? Presumably that's a consideration.
 
So €1m gets me €22,000 adjusted for inflation for life?

What does the "capped at 7.5%" part mean?
It was the Irish Life calculator. There was no complete inflation protection, but you could chose "inflation capped" and they then asked what cap you wanted. I took the maximum available - 7.5%. I guess it means they will increase it by the lesser of inflation or 7.5% each year.
 
So €1m gets me €22,000 adjusted for inflation for life?

What does the "capped at 7.5%" part mean?
Inflation Linked Increases

The income from this type of annuity escalates in the course of payment as Consumer Price Index (CPI) varies. The rate of escalation is usually capped at a maximum rate e.g. CPI max 5% p.a.

 
So if inflation was to run at 7.5%pa or more over the next 30 years your annuity payment would be around €192,000pa at age 95.

As an alternative to the above annuity, would you be happy to bet that you can make a withdrawal from your ARF of almost 20% of your starting capital after 30 years of withdrawals?

This is the crux of longevity insurance.
There is no “best before date” on your birth certificate. If you live to be 100 during a period of high inflation then an inflation protected annuity can work out to be fantastic value.

yet the focus for many if not most people and their advisers is “what if you die after just a year”
 
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If inflation is running at 7.5%, I’d be confident enough taking a 30 year view on global equities, yes.
 
So if inflation was to run at 7.5%pa or more over the next 30 years your annuity payment would be around €192,000pa at age 95.

would you be happy to bet that you can make a withdrawal from your ARF of almost 20% of your starting capital after 30 years of withdrawals?
What point are you making Marc? Are you suggesting that they might not be able to deliver? They will have secured the liability with inflation linked (French) government debt. I think the implied inflation rate is about 2% p.a. If it turns out to be 7.5% p.a. the (French) government will stomp up the difference and since their tax base will have similarly inflated that would be no problem to them.
 
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