OverviewUS financial planner, William P Bengen, is credited with developing the 4% rule. This states that withdrawing 4% initially from a pension pot and increasing this each year by the rate of inflation means there is little likelihood of running out of money during a 30-year period.
Subsequent analysis by Morningstar suggested that the rate should be nearer 3%, though its latest report concludes that the safe withdrawal rate is 4%. This is more by coincidence than design. Bengen’s analysis was based on historic data, while the Morningstar study is underpinned by its view of future returns.
Reliance on a single figure may be overly simplistic
The recent FCA thematic review of retirement advice questioned whether a single rate, that doesn’t reflect individual circumstances, is appropriate. There are various factors that can impact how much money can be taken safely. Some of these are individual to the person. For example, age and health. Others are extraneous influences like inflation and investment returns.
The cost of a comfortable retirement
The Retirement Living Standards study suggests that the gross income for a comfortable retirement is £50,887 for a single person1. Allowing for a full State Pension of £11,502, this would still leave a shortfall of £39,385. Withdrawing 4% would require a pension pot of nearly £1 million (assuming no defined benefits or other savings and investments).
Gross and net figures for a comfortable retirement
| Net (£) | Gross (£) | |
|---|---|---|
| Single | 43,100 | 50,887 |
| Couple | 59,000 | 67,474 |
Source: Retirement Living Standards, Pensions and Lifetime Savings Association, 2023
A 2022 ONS report suggests that the average pension pot for men in their 60s is £228,200 and for women in their 60s is £152,6002. This presents a challenge.
Squaring the circle
A US study, looking over a 140-year period, revealed that retirees withdrawing at the rate of 4%, would have only a 10% likelihood of ending up with less than their initial capital after 30 years and a 10% chance they would have 6 times their original capital intact3. Simple adherence to a fixed 4% withdrawal rate ignores the individual factors that govern the calculation of an appropriate withdrawal rate. In many cases, as the US data suggests, 4% could be overly conservative.
So what circumstances determine how much someone can safely take?
- Age
Age is important. If the objective is for money to last until 95 with a 90% probability of success, a 65 year old could take 4.0% and a 70 year old 4.5% (see chart below).
- Longevity
If, through lifestyle choices or health issues, someone’s life expectancy is likely to be compromised, a higher rate could be taken. Choosing a 20 year term with a 90% probability of success means 5.5% could be withdrawn (see chart below).
- Access to other assets
A 90% probability of success years may be too conservative, particularly where there are other assets that can be used, like property equity. A 65 year old could withdraw up to 5%, if they accept a 70% probability of success over 30 years. - Inherited wealth
Anyone likely to receive a significant inheritance in the future could also accept a lower probability of success or select a shorter term.
Safe withdrawal rates based on term and equity rating
There are also other factors that should be taken into account. These include:
- Level of charges
Morningstar analysis suggests a 1% charge should reduce the safe withdrawal rate by 0.4% . - Equity weighting
While projected returns from equities are higher than other asset classes, the safe withdrawal rate is often lower, the higher the equity weighting. This is caused by the volatility of equities when a 90% probability of success is chosen. - Legacy
If leaving a legacy isn’t a consideration, this could increase withdrawal rates. - Inflation
In its 2022 report, Morningstar modelled partial inflation-linking by assuming income was inflation linked by 1% less than the actual rate of inflation. This increased the initial safe withdrawal rate by 0.5%. Given there is evidence that spending reduces over the course of retirement, it may make sense not to fully inflation link income.
What’s more, this is a moving target. The withdrawal rate at outset may not be the most appropriate rate several years into retirement. The client’s circumstances may have changed. Health issues could emerge, for example.
Advisers do need to monitor withdrawal rates throughout retirement. Cash flow models are increasingly used which can be used to run alternative assumptions and stress test different scenarios.
Check out our report Sustainable withdrawal rates for drawdown clients for more on this subject.
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