The DIY Annuity

An annuity is a death pact with your money. You both exit at the same time. With a  DIY annuity..

DIY  ... I didn't know there was such a thing.

Stick around, you may learn something. Stan is 60, he has saved £100000 in cash under his bed and decides on a DIY annuity. He's got a life expectancy of 25 years, so every year

Wait...

Every year he takes out 1/25th of his money.  4%. That makes £4000 a year.

But surely...

But surely he could put it in a bank for all those years, even as he is withdrawing it? True. And guess what - at 2.5% interest that money now lasts 38 years. Half as long again.

No no - suppose he lives longer than that... then his money runs out.

Yup - at age 99 he is in big trouble.

So that's not a proper annuity.... a proper annuity goes on until you die.

Ah, for that you have to go to a proper insurance company. And they do the same kind of sums. They will return  your money to you over your expected lifetime with interest, less a bit for their expenses. But the interest ain't great, because they invest the money in government bonds (gilts).

But it's better..

It's a better deal if you live longer than average. It's not if you die earlier than  your average life expectancy. Because your money is gone.

I get it... and it's an average deal if you live to exactly your life expectancy.

Nope - it's a poor deal, cos the insurance chops maybe 10% off for their expenses, commission to independent financial advisors and profit.

Hey - that's my money - can't I get that back.

Some of it. Try searching 'annuity, commission, rebate' on the internet. My search came up with Cavendishonline who will rebate around 1.5% of your annuity payment. 

About the DIY annuity...

It's useful to help you understand  why

• delaying buying an annuity increases your pension - because your life expectancy drops
  
• why income from an annuity seems poor - because it is invested in government bonds
  

It means a 55 year old woman in good health who wants to buy an index-linked pension is going to find it expensive: in October 2008  a payment of £100000 delivered her an annual pension of £3200. 

Isn't index-linked what we all  have to buy?

Not necessarily, certainty is expensive. If she bought a level pension [not index linked] her pension would  double. Or she could wait another 5-10 years. Or she could split the purchase, half now and half later.

Can't I do something else with my pension money?

You could have a self-invested pension plan, but that's another story.