Ending the ‘golden rule’ of drawdown: Is 3% the new 4%?

Financial News

The so-called ‘golden rule’ when withdrawing from your pension pot used to be to take 4% each year. And yet a recent report suggests that doing just that will leave you three times more likely to run out of money in retirement.

The study by pensions consultancy firm LCP blames low interest rates – an issue exacerbated by the coronavirus pandemic – and suggests the new rule of thumb should be something closer to 3%.

If you’re currently withdrawing funds from your pension, what can you do to ensure you don’t run out of money? And if you’re due to retire soon, how can you make sure that you have a large enough pension pot?

The ‘golden rule’

The so-called ‘rule’ was popularised in the 1990s when interest rates were higher. Back then, 4% withdrawals would still allow for pension growth, while giving you the retirement lifestyle you wanted.

Things have changed in the last twenty years and even in the last decade, the change is clear. Sticking to the 4% rule in 2010 would have seen a £200,000 pot grow to £337,000 over 20 years. In 2020, the pot would be eroded to £102,000.

Those retiring now and following the ‘broken’ and ‘outdated’ 4% rule are three times more likely to run out of money in retirement than someone retiring just a decade ago.

The case against the ‘golden rule’

The 4% ‘rule’ was only ever a rule of thumb – a guide rather than a fix-all.

The rule doesn’t consider other pensions or investments you hold or the timing of any withdrawals you make from them. It is also inflexible. It can’t take into account periods of market volatility such as we saw at the start of this year due to the coronavirus pandemic.

During a market downturn, the value of the units you sell decreases, meaning you must sell more to receive your ‘usual’ withdrawal amount. This can erode your investment faster than you expect.

Taking enough money from your pension, without taking too much, is a difficult juggling act. But we can help. By putting in place a long-term financial plan, we can help you map out your retirement, ensuring you keep your desired standard of living without running out of money.

Making sustainable withdrawals

  • Take only what you need

You might have been using the 4% rule to take withdrawals from your pension, without understanding the implications. But do you need to take that much?

The latest LCP figures suggest a 25% cut in withdrawal amounts, from 4% to 3%, is more sustainable.

Taking out more from your pension fund than you need has other downsides too. You’ll likely hold the withdrawn amount in cash. This is great if you need quick and easy access to it but if you don’t, taking invested funds out of the market risks your money losing value in real terms.

Money invested has a chance of making the most of market rises, although of course, no investment is without risk. Prices fluctuate daily and the value of your invested pot can fall as well as rise.

  • Take less when markets are low

As we’ve already seen, when markets are low you will need to sell more units to raise what might be your usual withdrawal amount.

A carefully constructed financial plan will have considered periods of short-term volatility, giving you the buffer you need to withdraw slightly less during market downturns.

You might also be able to supplement the lower income by using savings or investments held elsewhere.

  • Remember other investments

Factor other savings and investments into your pension income plans. Think about timings too.

If you started to receive drawdown in your fifties, remember that in your sixties you’ll become eligible for the State Pension (worth £9,110.40, in the 2020/21 tax year) although the actual amount you may receive will be based on your national Insurance records. This extra income could allow you to lower your private pension withdrawals.

If you have investments held in cash, you might consider withdrawing the cash elements of your portfolio when markets are down, in the hope that the invested elements will be able to take advantage of a future rise.

Get in touch

Your pension is intended to provide you with an income for the whole of your retirement. It is therefore crucial that the withdrawals you make from it are sustainable, as well as providing you with enough money to enjoy your desired standard of living.

If you’d like to discuss the sustainability of your pension withdrawals, or any aspect of your retirement savings, get in touch. Please email info@investmentsense.co.uk or call 0115 933 8433.

Please note

A pension is a long-term investment not normally accessible until 55. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits and the income available.

Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation, and regulation which are subject to change in the future.