Withdrawing from your pension

How much of my pension can I spend each year and not run out of money?

A very common question we are asked is “how much can I withdraw from my pension each year to fund my lifestyle, whilst ideally ensuring there is sufficient capital remaining to provide a similar level of income into the future?”

Recent research has indicated that for a pension fund invested broadly 50% in shares and 50% in Bonds/Fixed Interest, a safe starting amount to withdraw each year is around 2.5/3% per annum, see chart below.

This may surprise many and trigger a chorus of “surely I can withdraw more than this each year as this percent is no more than an annuity”?

The ”4% Rule” A (Historical) UK Perspective

The ''4% Rule'' A (Historical) UK Perspective

We’ve seen some recent suggestions and solutions proposing withdrawals of up to 7% per annum as realistic, whilst not wishing to dismiss these as fantasy, we do think the appliance of some “withdrawal rules” is absolutely essential.

Jonathan Guyton, a US adviser and William Klinger, a US Computer Scientist, created 4 withdrawal rules to ensure a 5.5% sustainable withdrawal rate over 40 years (based on US data).

4 pension withdrawal rules:

  1. The withdrawal rule: Increase withdrawal in line with inflation in the previous years, unless the previous year’s portfolio total return was negative. This is by far the most effective of the rules. By making sure that withdrawals are frozen in the years following a negative portfolio return, the danger of pound-cost ravaging (the accelerated depletion of a pension fund due to simultaneous investment falls and pension withdrawals) is drastically minimised. Following the rule means clients do not ‘make up’ for missed withdrawal increases.
  2. The portfolio management rule: Extract the gains from an asset class (Shares/Bonds) that has performed best in the previous year to provide the income, and move excess portfolio gains (beyond what is needed for the withdrawal) into a cash account to fund future withdrawals.
  3. The capital preservation rule: If the current withdrawal rate rises above 20% of the initial rate, then current spending is reduced by 10%.
  4. The prosperity rule: Spending in the current year can be raised by 10% if the current withdrawal rate has fallen by more than 20% below the initial withdrawal rate. Doing this means the client does not miss out on higher sustainable spending when markets are doing well..

What rules do you apply to ensure the sustainability of your pension fund? We can help you calculate and design your own sustainable pension withdrawal rate.

Swindells is always here to answer any questions you have. So please give us a call on 01825 76 33 66 or fill in the contact form.