Since pension freedoms came to the fore in the UK a couple of years ago there have been numerous articles regarding what is a Safe Withdrawal Rate (SWR) from your pension. The most recent article was published in Mail Money on the 23rd September. The interest in this topic is not surprising, because since the pension withdrawal limit was removed, from age 55 pension savers can now take as much or little from their pension plans as they like.
Previously the Government set rules about the maximum withdrawal limits, known as capped drawdown. But with the shackles now removed, what is a Safe Withdrawal Rate (SWR)?
This blog explores some of the research undertaken by experts and looks at the factors you should consider when determining a SWR.
The concept of a SWR started in America and has grown in prominence in Australia too. In 1994 a Financial Adviser hailing from New York by the name of Bill Bengen published an article in the Journal of Financial Planning. His article was based on empirical simulations of historical market behaviour over a 75-year period. Bill Bengen’s research concluded that a person could ‘draw down’ (withdraw), up to 4% annually from their pension portfolio without fear of outliving their money. The 4% rule also assumed that income would increase in line with inflation.
So, if you have a pension pot of £100,000 then the most you should withdraw is £4,000 p.a. (increasing each year in line with inflation).
More recently, Morning Star have undertaken research which also looks at historic stock market returns. They say you’d have a 8/10 chance of still having some money in your pot when you die if you withdrew 3.2% p.a.
Morning Star go onto suggest if you want to have virtually no chance of running out of money, annual withdrawals should be cut to no more than 2.5% p.a.
The impact of investment returns
A key consideration when selecting a SWR is the investment returns generated, particularly in the early years. From age 65, if your pension portfolio of £100,000 has consistent growth of 4% p.a. the pot is likely to last beyond age 101.
If your pension portfolio achieves growth of 5% p.a. but suffers a 25% fall in year 10, the fund is likely to be depleted at age 98. On the other hand, if your pension portfolio achieves growth of 5% p.a. but suffers a 25% fall in year 2, the fund is likely to be depleted at age 92. This is known as sequencing risk. Source: CII AF7 Pension Transfers.
Other factors to consider
Other factors which should be considered include how much of your pension pot you want to leave on death (if any). If you are happy for your pension to be fully depleted after 30 years, then an annual withdrawal rate of 4% p.a. might be appropriate. If you want to leave the original capital value intact for a beneficiary, then a withdrawal rate closer to 2% p.a. is needed.
You should also consider your personal circumstances, such as your tax rate and health. How reliant your family is on your pension savings when you die? How much of your pension pot you are prepared to, and can you afford to risk? Do you have any cash savings which you can fall back on if your pension is depleted early? Can you afford to stop withdrawals for a period, allowing time for your pension fund to recover following a stock market fall?
Addressing these considerations and keeping your pension withdrawals under review is critical to your long term financial security in retirement. If you would like to discuss your pension plans and how best to structure your retirement income contact us today to book your free initial consultation.
Tax treatment depends on individual circumstances. Tax treatment, rates and allowances are subject to change.
The value of pensions and the income they produce can fall as well as rise. You may get back less than you invested.