Annuities

At the moment you have to buy an annuity with your pension fund by the time you are 75.

I have had the feeling they are poor value for a long time but recently I worked out how I thought the fund would be diminished with age after you bought an annuity and the insurance company had to manage the fund to pay you an income.

So I looked up the life expectancy of a 65 year old male on the Government Actuarial Stastistical Table. It says that a 65 year old male could expect to live another 16 years.

Then I looked up some annuity rates and found that a 65 year old male could get an annuity rate of 7.2%.

Suppose you have a fund of £100,000. This buys you an annuity of £7,200 a year.

The insurance company now has your £100,000 and it can invest that money. It should be able to manage an income of 4.5% by investing in long term gilts.

So in the first year it should be able to earn £4,500 on your money and pay you £7,000. At the end of one year there is £97,300 left.

The question is, how much money is left after 16 years when, on average, all the males who bought a pension at age 65 are dead. OK some will live longer but some will die sooner. 16 years is the average.

The answer I get is nearly £39,000. That's nearly 40% of the original fund! So basically, on average, the insurance company gets to trouser 40% of the pension fund of a man who buys an annuity at age 65.

Well I'm stunned by that. So stunned I wonder if I've made a mistake. How can it be that so much of the fund remains for the insurance company. I know they have costs but it can't cost that much to maintain a pension fund. Once it's set up all they have to do is pay a monthly pension by standing order and bank the interest cheques they get. I bet that is paid electronically as well. The only other thing I can think of is to check up you are still alive so they know when they can trouser your money.

In brief...