Consider these two numbers.
At a cost of £100,000 a 60 year old male can buy an annuity that will pay him £4,822 a year for the rest of his life and then fall to half of that for his surviving partner until she dies.
Alternatively, the same amount of money invested across the FT All-Share Index would currently offer an annual income of £3,670. Some passive funds invested in UK equities, but with a value bias, offer an income of £4,900 for the same money.
These figures sum up the conundrum in the capital markets right now. The low level of income from a conventional annuity demonstrates the high valuations currently ascribed to fixed income stocks. Bonds, that return capital in a specified number of years, are expensive for two reasons. One is a degree of certainty over the return of capital more or less whatever happens and the second is a preservation of spending power in an economic environment that has low inflation or is slightly deflationary.
The downside is that you don’t get much income for your capital. Bond bulls can argue that isn’t too much to suffer if you think prices for goods and services will be lower in the future. Even so, it still means you need a lot of capital to generate a reasonable income. Perhaps the biggest drawback is that the income is fixed. Even if inflation does not re-emerge it is likely that a pensioner’s cost will rise anyway over time from increasing health and care expenses.
Rising dividends and lacklustre equity markets have resulted in the unusual situation that the yield from equities now virtually matches that from annuities. There are no guarantees that dividends will be maintained and indeed the stress from many industries, not least in commodities and retailing, has already forced some companies to cut dividends.
Taken in the round forecasts for dividends in 2016 from UK companies has already fallen 5% from £92 billion to £87 billion. It would have been more if sterling had not weakened against the dollar. Only a brave man would declare that there are no more cuts to come.
Even if dividends are cut a new pensioner could still be better off investing in equities than buying an annuity because he retains the ability, depending on…
Would you really want to invest all your retirement funds in a UK tracker though ? If you take EU or US tracker funds the yield is much lower - 1.5 to 2%.
