Fixed Term Annuities - good option for low risk retirees with interest rate rises?
parawhat
Member
Anybody given any consideration to using FTAs for lower risk drawdown clients as an alternative to invested FAD?
I've just been playing around with some quotes on Assureweb and for a £100,000 purchase price (nil PCLS) over a 5 year term you can get an level income of £3,857 plus a guaranteed lump sum at the end of £80,715.
If I've got my sums right, that's an IRR of c.5.12%. When I'd done similar exercises in the past the IRRs were c.1%.
No brainer?
Jonny (paraflex)
Comments
Certainly an option for the right Client in the current climate.
Am I missing something here? £100,000 annuity purchased...you get back £3,857 per annum for 5 years level which is £19,285. Then you get back £80,715. That is an IRR of 0% in my book. It would be the same if it was in a bank and just drawing on cash. Sorry if I have totally missed something?
I think the figures might be a typo. Just ran one myself....65 year old, 63 year old wife. 100% joint annuity and the 2 options as follows:
£7920.60 for 5 years with a guaranteed maturity value of £83,135.
Or
£4,736 for 5 years with a guaranteed maturity value of £104,515.
Top options is 5.24% IRR and bottom option 5.54% IRR. As you say definitely worth considering for lower risk retirees.
I had a look into the Novia-Just annuity in a SIPP. Limited annuity options.
Had anyone else looked deeper into the other available products?
@Nath are you using a tool to work out the IRR? If so, which one? I get a slightly different return <5%.
Paraplanner. F1, Apple, Nutella, ice cream. No trite motivational quotes. Turning a bit northern.
@richallum yeah, I was rushing and did £85,135 as the maturity value not £83,135. 4.86% on my top option, but still 5.54% on the option below. Did that match yours?....I just used the XIRR function in excel.
(((7920.6*5)+83135)/100,000)^(1/5) = 1.0418 = 4.2%
(((4736*5)+104515)/100000)^(1/5) = 1.0509 = 5.1%
I just chucked together a basic XIRR function on excel to look at it...what have I done wrong Ben ha ha!! Attached for you to tear apart
No fancy template just quickly chucked in the figures and XIRR
I'm guessing as I'm using the XIRR which takes the cashflow dates into account vs IRR which doesn't?
IRR is a time weighted return and would give the same result as my calculation.
XIRR allows for the timing of cashflows and is a money weighted return.
With a fixed-term annuity you don't get any ongoing return on the premium paid. As soon as you buy the annuity you're committed to a guaranteed, fixed return, spread out over a fixed period. As you're going to spend it, the cashflows have no additional investment value to you. Everything else (gains or losses) belongs to the insurance company. I'd say the IRR is the more appropriate of the two methods for this scenario.
If you compare it with leaving your £100k invested and taking £7,920.60 each year, what return would you need to give you £83,135 at the end of the period? That would be the 4.86%. In other words, your invested money needs to yield more over the period to give you the same outcome. You can test this with the PV formula in excel. The present value of the cashflows you get from the annuity will be £100k when you use 4.86% as the rate in that formula. The difference between that and the 4.18% from the IRR is part of the profit the insurance company is making.
Insurance company invests £100,000 at 4.86% for five years. Let's say it does this in a way that provides it with near certainty that it can achieve this return (which it probably can). It gets £126,779 over the period.
Its liability on that investment is to pay you £39,603 in regular payments and then £83,135 at the end of five years. A total of £122,738.
It makes a gross £4,041 on the deal.
Hopefully that makes sense?
Total sense yep. I shouldn't have just jumped into a spreadsheet that I had used for the alternative scenario you mentioned and should have thought it through more
Cheers Benjamin, have a good weekend!