Whatever rung of the so-called retirement ladder you are on, pre-retirement, just about to retire, just retired, well-retired, you must read this. (Although see here for “Why retirement no longer makes sense”)

 

An annuity is the most important financial product you have to get a quote for.

 

Not some form of variable annuity, or new age annuity with lots of bells and whistles. But a good old fashioned lifetime income with zero guarantees, except for inflation linking the income they provide you.

You must get this quote.

This is not the same as saying you must buy said annuity. That may or may not be a good idea.

The reason why you must get the quote is this (and this is the bit some “experts” don’t understand or won’t tell you):

That quote is probably the best bit of information you can lay your hands on to accurately tell you how much your retirement is priced at.

Your retirement costs – how much?


To explain further – we can crunch some numbers on an example individual. Let’s say the individual is age 65 and male.


The individual has a requirement to fund £1,000 per month on top of their state pension. The £1,000 per month has to be index linked to cater for inflationary indexes.


To buy an annuity to provide this will require approximately £355,000.


Please do not put any significance on this number, do not rely on it or relate it to your situation. You must get your own quote. This number was sourced on one day from what is described as a tool to find the best rates on any given day. The number is irrelevant to the point of this article.


What is relevant is what that number is for you.


So, assume it is £355,000 for this purpose of the rest of this article and you have that £1,000 per month plus indexing need.


The annuity figure prices up your retirement cost, more accurately than anything else.


That’s the point.


Therefore, if you have your state pension, your only reliable income source, and the only other thing you have is £200,000 in investible assets (for example your savings, such as ISAs and building society accounts) and nothing else, no other money or pensions, then that annuity quote identifies that you have a problem, because your retirement is “priced at £355,000”. And you have £200,000.


The reason the single life indexed annuity is so accurate is that it is based on two things, one prevailing income rates. Two, your mortality expectation, based on averages for you current age.


What it does, is tell you what it costs to fund that income AND PROVIDE LONGEVITY INSURANCE. We wouldn’t normally apply capital letters to anything but in this case it is vital to emphasise this as starkly as we can.

Let’s put it another way, you can say and ask “I want £1,000 per month for the rest of my life and it needs to keep pace with inflation and I have £200,000 – how shall I manage this, how should I invest it?

 

You may well find an expert who tells you that the market for shares has pretty much delivered around 6% per year in real terms over long periods. Real terms means 6% + inflation.

 

You check and find this is broadly right. Simplistically therefore you think:

I can invest my £200,000, withdraw 6% per year and that produces £12,000 in year one, or £1,000 per month. Voila. Then in year two I can take the same again, adjust it a bit higher to cater for inflation. 

And so on in years three, four, and five, all the way until I die.  All being well I can use the return to fund my income. 

If there are some down periods these should average out against the up periods, and even if they don’t my capital is sufficient to surely allow me to eat into it a bit and never run out of money however long I live”.

Yes, this may work.

 

But the annuity quote has provided you with a clue, that it may not.

 

Why would an insurance company need £355,000 to provide you with the certainty of that £1,000 per month inflation-linked? Because it has longevity insurance built in.

To understand this further, if you pursue the strategy of investing your £200,000 into shares and withdrawing 6% per year, you would need to calculate what happens if your retirement period actually provides 4.5% per year and/or has multi-year capital losses at some point (because the share values fall). 

 

You would need to overlay this calculation with different ages where you would run out of money and then try and work out how long you might live (which you can’t do accurately by the way).

 

You don’t need to do any of this because the annuity quote has in many ways done this for you. You can tell very quickly that the gap between your £200,000 and the £355,000 is way too big. 

 

Therefore, that investment strategy has serious risks of meaning you will run out of money and as a 65 year old how do you feel about running out of money, say, at 86? And then living to 98?

 

The ‘investment withdrawal strategy’ has no longevity insurance built in. None. It cannot compete with the ‘no risk, certain income for life’ annuity – in respect of the insurance angle.

 

This is not an article written to persuade you to use annuities or to put down alternative methods, it is not an article even about the way you should structure your income or go about your financial planning.

 

It is intended to highlight how important it is to get an annuity quote, to see the sort of price your retirement is going to cost. 

 

Doing so will focus the mind on certain realities, which may not otherwise be obvious.

 

We strongly suggest at various stages as you are looking at your income/expenditure position in retirement you max out on all possible methods of analysing the price of your retirement, this should include getting an annuity quote and having a cash flow forecast done.

 

Put the two together and you will get a compelling picture of what your retirement will cost. And that will give you the best chance of planning it successfully.

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