How much can I take from my Pension Fund each year and be sure I do not run out of money in retirement is a common question we are asked. With the introduction of flexi-pension drawdown, increases in life expectancy and ongoing uncertainty in financial markets many are concerned the long established ‘rules of thumb’ are no longer valid.
Individuals may wish to take a tax-free lump sum from their pension fund, they may wish to take more in the early years of retirement with the intention of compensating with a lower amount in later life or they may wish to work part-time (or full time) later in life than originally planned. A wide variety of personal circumstances can make the Safe Withdrawal Rate much more difficult to calculate than was once the case.
The ‘safe withdrawal rate’ is the safe initial (increased by inflation rate each year) level of income that can be withdrawn from a pension fund over a 30 year period to ensure the pension holder continues to receive an income in line with inflation, without running out of capital. The long established ‘rule of thumb’ SWR was set at 4% by USA based financial planner William Bengen over 20 years ago.
The 4% SWR has been widely discussed and criticised over the years. A report by Morningstar in early 2016 suggested that the SWR for the UK should not be 4% but actually 2.5%. Bengen’s original research was based on historical data on USA markets. It is important to remember any research based on historical performance is not necessarily an indicator of future performance. Bengen’s 4% should not be blindly applied without understanding his assumptions. For example, his research ignored the impact of fees.
The SWR should only be used as a starting point and no more than a guide. What really matters is an individual’s personal circumstances and aspirations. Factors to consider include:
- Attitude to risk.
- Required income guarantees (if any).
- Investment strategy, including diversification.
- Any desire to leave any remaining pension fund to beneficiaries on death.
- Planned withdrawal profile.
- The impact of fees and taxes.
- Planned changes in spending habits in retirement.
- Planning for long term care in later life.
For many, there is one great unknown – how long they may live. According to the Office For National Statistics (2014), the average lifespan for Male Baby Boomers (those born between 1946 and 1965) is 79 years old but those reaching 65 years old can expect to live (on average) to 87 years. It is important to note the difference between Male and Female life expectancies has closed with fewer men in hazardous occupations. A baby boomer female reaching 65 years of age can expect to live on average to 89 years. This has implications for a married couple where both could be reasonably expected to live for 22 years from the traditional retirement age of 65.
Brexit, a new (and potentially volatile) USA president, escalation of conflicts in the Middle East and Far East, and key upcoming elections in the Eurozone all have the potential to cause market volatility in the short to medium term. The 4% rule (or any other rule) may not apply if funds are withdrawn from pension funds when the markets are significantly down as this can have a disproportionate effect on the remaining fund.
In conclusion an SWR of 4% (or any other number) would be a convenient guide for those approaching retirement. This is probably why Bengen’s 4% number has persisted so long. The unfortunate reality, in many cases, is there is no general number that may be applied and the actual safe withdrawal rate is entirely dependent on personal circumstances, aspirations and (as noted in the previous paragraph) the performance of the markets at the point withdrawals are made.
The information in this article does not constitute financial or other professional advice. You should not take action on the basis of this article without seeking regulated independent financial advice that addresses your specific circumstances.
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