How much can you drawdown from your pension and when?
Wouldn’t it be nice to know exactly how much you can drawdown from your pension whilst being confident that your funds won’t run out? Or to be able to make those once in a life time purchasing decisions with confidence, whether it’s for a trip around the world or a much coveted car.
Back in the 1990s an American financial planner came up with the idea of a safe withdrawal rule. It allowed for 4% withdrawal from the initial fund at retirement for a period of 30 years (and with adjustments for inflation). It remains a popular rule and we often hear the 4% rule quoted as the go to retirement strategy. But is it reliable?
Recent research was conducted across 17 developed countries including the UK and using data from 1900 to 2008. Allowing for a 30-year retirement period, the results in respect of a perfectly (and unrealistically) balanced fund of equity and bonds only permitted a withdrawal rate of 3.77%.
That percentage dropped as account was taken of more realistically structured portfolios and fund charges and adviser fees (which hadn’t been factored in). A withdrawal rate of 4.01% demonstrated a 10% risk of running out of funds and with withdrawal rates of 5%, that risk increased to over 55%.
With changes to pension laws permitting you to take your pension from 55 or even earlier in some cases, and life expectancy getting longer, the other gaping hole left by these statistics is consideration of whether 30 years is enough provision. If you retire at 55, 40 years of retirement is not an unrealistic prospect.
Alternative withdrawal formulas
Of course, the accuracy of the 4% rule will very much depend on when you retire and the state of the market at that time. In periods of low return, the 4% rule presents even more of a risk. An alternative strategy is to take the natural yield from your funds, such as dividends or interest but on a portfolio equally made up of bonds and shares the natural yield is currently likely to be below the 4% benchmark.
There are other alternatives to consider too. Splitting your funds so that the majority remains invested and producing natural yield, while a smaller sum releases funds in the short term is another such option.
Do the withdrawal rules really help and if not, what is the answer?
The trouble with any general rule is that it isn’t going to meet the needs and demands of everyone. It’s ok to treat it as a yardstick or a starting point but you should also treat it with caution. At Juno Wealth, we firmly believe that carefully planning is key to identifying how much you can drawdown from your pension, by which we mean life planning as well as financial planning.
Life planning and cash flow planning
If you haven’t retired yet, one of the first things we do at Juno Wealth is to help you identify the retirement you want. That means identifying when you want to retire but also what you may want to do when retired and what big purchases might be part of your retirement – a conservatory, a holiday home in the sun, helping your children with a house deposit? We can factor in various different events so that your finances provide for different circumstances as they unfold.
We also use very easy to understand cash flow planning tools to help clarify how much you’ll need to fund your retirement, whether and where savings can be made or sometimes, just to confirm that you’re on track.
It’s this level of detail that helps brings rules like the 4% rule into context and means we can advise you with accuracy about suitable retirement strategies, how to invest your funds and appropriate withdrawal rates for you. The result is you don’t have to rely on a generic formula, hoping that the odds will work out in your favour. And, it means you can be confident about those retirement decisions and living the retirement you envisaged, knowing that your funds won’t run out.