American financial planner William Bengen first suggested his 4% pension withdrawal rule in 1994. Over the last two decades, much has changed.
In the 1990s interest rates were high. Withdrawing 4% could allow for a comfortable retirement while still seeing growth. Only ever a rule of thumb, it now looks increasingly outdated. Studies suggest you are three times more likely to run out of money in retirement if you adopt this “rule”.
So how much can you afford to withdraw from your pension and what factors might influence how much you take?
The golden rule is that there is no golden rule
There are things the 4% rule does not consider.
How much you withdraw from your pension will depend on your circumstances and the wider economy. Speak to us and we can help you manage your retirement fund in a sustainable way that considers all the factors that are important to you.
Here are three reasons to ditch the 4% rule:
1. You might have investments elsewhere
The rule doesn’t consider other savings or investments. Not only will you need to factor these in, but you’ll need to consider the timing of them too.
If you have a regular income, from Buy-to-Let properties, for example, you might not need to take your pension at once. Just because you reach the minimum retirement age (55 currently, but rising to 57 in 2028) doesn’t mean you have to begin taking your pension.
In fact, there are many good reasons not to:
- The earlier you start withdrawing from your pension the longer your pot will need to last.
- You might trigger the Money Purchase Annual Allowance (MPAA), thereby limiting the pension contributions you can make while still receiving tax relief.
- Unused pension funds on death don’t form part of your estate for Inheritance Tax purposes so can be passed on to a beneficiary, tax-free in some circumstances.
If you do start to withdraw from your pension early, remember that the amount you need is unlikely to be static. You might have money earmarked for big-ticket items early in your retirement – travel or house renovations, for example – but you might spend less as your retirement goes on.
You might use your savings to supplement your retirement income in the early years. Remember too, that you will become eligible for the State Pension, currently at age 66. For the 2020/21 tax year the amount you could receive is £9,110.40, rising to £9,338.16 in 2021/22.
The exact amount of State Pension you receive will depend on your National Insurance record.
We can look at your finances as a whole and help you manage your different income streams in a sustainable and tax-efficient way.
2. You might end up withdrawing more than you need
A recent report by LCP suggests that cutting your withdrawals by 25% – from 4% to 3% – could make your pension more sustainable in retirement.
Calculating what you need, and taking only that amount, might allow your fund to last longer, but there might be other benefits too.
Taking more than you need will likely result in the excess amount being held in cash. Money held in this way is great for emergencies – you can access it quickly whenever you need it – but if you already have a sufficient “rainy day” fund in place, avoid holding additional cash.
Interest rates on savings have been low since the 2008 global financial crisis. Not only will your fund stand a better chance of growing if it is invested within your pension, but it is also more likely to counteract the effect of inflation.
Cash with a savings interest rate below the rate of inflation is effectively losing value in real terms so avoid withdrawing more than you need.
3. The 4% rule doesn’t factor in periods of short-term volatility
Sticking to a steadfast 4% rule is inflexible. Not only does it fail to consider your circumstances and non-pension income, it also ignores the markets.
In March 2020, the BBC reported that the market uncertainty around the coronavirus pandemic had caused the FTSE 100, the S&P 500, and the Dow Jones to suffer their worst drops in thirty years.
Periods of short-term volatility don’t need to affect your long-term financial plans, but they can impact your short-term withdrawals. When markets are low, you’ll need to sell more invested units to achieve the same level of income. This can deplete your fund faster than expected and make budgeting and managing your withdrawals even harder.
Get in touch
The days of William Bengen’s 4% withdrawal rule are over, if, in fact, those days ever existed. Managing pension withdrawals is difficult and highly personal, dependant on your financial position as well as external factors beyond your control.
This can make it difficult to decide the right amount to withdraw, but we are here to help. If you’d like to discuss the impact of your pension withdrawals on your retirement get in touch. Please email enquiries@hda-ifa.co.uk or call 012 4251 4563.
Please note
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of, and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
