November 23, 2020
One of the most common questions we hear is “will I run out of money in retirement?” With people living longer than ever, and more choices than ever when it comes to transitioning into retirement, your pension fund could have to last you 20, 30 or even 40 years.
When it comes to determining whether you have ‘enough’, a lot of the focus is often placed on the accumulation stage of your retirement. Are you saving enough? Is your pension invested correctly? Are you saving tax-efficiently?
However, when it comes to ensuring your money lasts your whole life, it’s important also to regularly monitor your pension drawdown in the decumulation stage.
Why it’s important to take sustainable withdrawals
It may sound obvious but one of the sure-fire ways to deplete your pension pot is to take unsustainable withdrawals from your fund.
Since the mid-1990s, experts have considered that 4% is a sustainable level of withdrawals. This comes from research American financial adviser Bill Bengen, published in 1994.
Bengen used historical data from the US to establish that an initial withdrawal of $40,000 from a $1,000,000 portfolio invested in 50% US equities and 50% US Intermediate Bonds, and then 4% annual withdrawals, would have seen the fund last for 30 years, even taking the most volatile periods into consideration.
This 4% ‘sustainable withdrawal rate’ has been used for 25 years as a rule of thumb for retirees when it comes to drawing down their retirement income. It also explains why retirees taking more than 4% a year from their fund are at risk of running out of money.
However, recent research has revealed that even this withdrawal rate may be too high to avoid exhausting your pension pot.
Why ‘3% is the new 4%’
A recent report from pensions consultancy LCP has found that even using the long-standing 4% rule of thumb could lead you to deplete your fund in retirement.
Dan Mikulskis, the author of the report, says that ‘3% is the new 4%’ because pension pots are no longer growing as quickly as when interest rates were higher. He says that sticking to 4% withdrawals is now three times more likely to lead to failure (i.e. running out of money) than a decade ago. The two main reasons for this are:
- Market conditions have changed in the last decade
- Increased longevity.
Interestingly, as well as recommending that retirees consider a lower withdrawal rate, LCP also suggest that retirees plan their retirement spending in more flexible ways than a constant real terms withdrawal.
For example, you may want to take more income in the early years as you are fit and healthy, and less in later years. Or you may take less in the early years as you are still working, and more when you give up work for good.
Bear in mind that even withdrawing 3% of your pension fund each year might still not ensure you have enough money in your retirement. This is because:
- Your portfolio will be different to the one used to establish the 3% rate. The mix of asset classes you’re invested in makes a difference to how sustainable your withdrawals are
- You may live less or longer than the 30 years used in the research
- You have to consider the investment fees and taxes you’ll pay.
An example of how income drawdown can work well
Here’s an example of how a sustainable withdrawal strategy was devised, specific to the client circumstances, objectives and risk tolerance resulting in a plan which assisted the client to live the life they wanted in retirement.
A company director became a client of Andrew’s in 2000, prior to his retirement at age 65 in 2002. When he retired his fund was worth £878,247.
The client took a tax-free lump sum from his fund and moved the remaining sum of £717,455 to Income Drawdown.
We put together an investment strategy for the client, based on the knowledge that initially he’d be continuing to work and therefore needed to draw down less income from his fund initially, but would ultimately stop work and look to increase income in retirement.
In the last 18 years, the income the client has withdrawn from his fund has fluctuated markedly, driven by his changing personal circumstances and unforeseen events.
Since 2002, a total of £715,512 has been paid in income from the fund – almost the exact value of the fund originally moved to Income Drawdown.
However, the investment strategy we put in place, and have regularly reviewed, has been effective enough to mean that £613,095 remains in the fund.
This amount will be enough to meet the client’s remaining income needs, and the investment strategy remains in place. Eventually, the client will pass the remaining fund to his wife, if he predeceases her, or his children.
Important note: when putting a plan such as this in place, it’s important to conduct regular reviews. The plan may need to be adapted in changing market or economic conditions – for example, income may need to be reduced or switched off completely in times of extreme volatility. Other resources may also need to be used to avoid depletion of the fund.
Get in touch
If you want to make sure you don’t run out of money in retirement, we can help. Please get in touch by email at firstname.lastname@example.org or call (0161) 8080200.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.