Annuities explained

What do a loaf and an annuity have in common?

The cockney rhyming slang for money is bread. It originates from bread and honey = money. When it comes to describing how you exchange your pension savings for an annuity, a loaf is the perfect analogy.{{1}} [[1]]An annuity is a financial contract which provides an income stream in return for an initial payment with specific parameters.[[1]] You hand over your life savings to an insurance company who promise to pay you an income in return for the rest of your life. You give them your loaf and they give you back a slice a year until you die.

Being based in Bolton, Warburtons is obviously my favourite sliced white bread. I do prefer Hovis brown bread, but that won’t work for this analogy.

How does the insurance company decide how much to give you each year?

Consider a 60 year old male who has reached retirement in average health. His live expectancy would be slightly longer than a Warburtons Medium sliced loaf. I hasten to add that I don’t mean the loaf’s sell by date, I’m referring to the fact it has 20 slices. One slice a year, so slightly longer than 20 years life expectancy.

What if the 60 year old isn’t average and has smoked?

If he had reached age 60 and is say a smoker, he could be expected to last as long as a Warburtons Toastie loaf which has only 17 slices, but crucially each slice is thicker.

What if the 60 year old was well below average in the good health department?

If he had suffered from a heart attack or had kidney failure, he may qualify for an impaired life annuity. This is the equivalent of the Warburtons outrageously thick Super Toastie loaf, which has only 14 slices. Each slice is unfeasibly thick at almost 2cm. My personal favourite kind of toast, thickly spread with Lurpack and Marmite. But the loaf never lasts very long.

What if the 60 year old was married?

If he wanted to ensure his annuity survived for both of their lives he will have to make do with the relatively hopeless, Warburtons Sandwich Loaf which has a full 28 ultra thin slices. A loaf which simply always sticks to the roof of your mouth in a place your tongue can’t reach. This loaf typically goes mouldy before you finish it unless you have a very large family or are
planning a kids party.

What if someone dies earlier then they should?

In this case the slices they don’t get to eat are passed around those who have managed to do better and survive beyond their average life expectancy. I have talked about life expectancy in the past, that blog is here.

Does the size of the loaf vary?

No. All the above examples assume the same size fund, or amount of “bread”, or if you like a normal 800g large loaf. It’s just that in the above examples the loaf will need to last for varying life-spans.

If you have two 60 year old males and one has only half the fund of the other. He would start off with a smaller loaf such as the 400g version, which more easily fits in a Dualit toaster. The slices of both loaves are the same thicknesses, but the smaller loaf’s slices are considerably smaller in area.