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How much should you take from your pension each year?
Retirees opting for drawdown pensions will need to figure out how much money they can withdraw each year without running out.
by Michelle McGagh on Feb 23, 2016 at 09:00
Drawdown is becoming the go-to option in retirement thanks to the flexibility it offers but retirees should be aiming to take no more than 4% of their savings a year to avoid running out of cash.
With the advent of pension freedom, more over-55s are choosing to put their pension into drawdown and continue investing for income as well as accessing lump sums.
The regulator has recorded a 46% jump in the number of drawdown policies since pension freedom; 22,741 were sold in the first quarter of 2015 and 33,218 were sold in the second quarter. Over the same period, annuity sales fell 18%.
Adrian Boulding, pension expert at the Tax Incentivised Savings Association, said drawdown was also becoming more widely available within pension schemes and ‘58% of people did not have to move pension provider’ in order to benefit from drawdown.
Although it may be easier and more attractive to go into drawdown, retirees must not underestimate the challenges they face in making their money last throughout their retirement.
Boulding said there were four main questions that retirees in drawdown faced: where to invest the money, the appropriate level of withdrawal, how to respond when the market falls, and what charges were realistic.
‘A good investment approach…is going to take account of the needs of the retiree, their risk profile…tolerance for loss...and will diversify [their investments]. [The investments] need to selected by someone who knows what they are doing and [who will] act in the member’s best interest,’ he said.
While getting the right investments is crucial, knowing how much money to take from the drawdown policy is arguably of greater importance.
Boulding said: ‘If you are 55 and you are taking out 14% of your pension year-on-year then it’s not going to last very long. Equally, if you are 70 years old and you are taking 3.5% there will be a great wake at the end [of your life]. People need help, they need to know what a safe withdrawal rate is.'
Safe withdrawal rate
He said there was a ‘US rule of thumb’ which is to take 4% of the pension fund as income each year.
The US research took a drawdown policy invested in 50% US equities and 50% US bonds and it found if you took 4% income a year, then there was a 95% chance of dying before the money runs out – meaning you have only a 5% chance of outliving your money.
‘The research then looked at different equity markets around the world,’ said Boulding ‘Looking at UK markets (with a 50/50 UK equity and UK bond split) the safe rate [of withdrawals] was 3.5%, if you take out 3.5% a year you have a 95% chance of dying before you run out of money.’
While annuity sales may have fallen, Boulding went on to compare how long a drawdown policy would last if a retiree took the equivalent annuity rate.
He said the average annuity was currently paying 5.6% (meaning a £100,000 annuity would pay £5,600 a year).
‘If you took that out of drawdown every year you have a 29% chance of running out of money – that means one in two taking the same out of drawdown as they would get through an annuity would run out of money,’ he said.
‘People need help [to determine] the appropriate rate of withdrawal – they need to be alerted if they take too much and they may need encouragement to take more.’
Graham Vidler of the Pensions and Lifetime Savings Association said there were ‘new risks’ that emerge as people were tasked with ‘managing their money over a long time and judging their own longevity’.
‘They have to make a judgement to avoid spending too little and not enjoying their retirement or spending too much and running out of money before they die,’ he said.
He said there was a lack of confidence when it came to making financial decisions in retirement.
‘Half of people feel confident about making financial decisions but that gets worse when it is a retirement decision as only a third feel confident. The majority of people would like regular income but the ability to dip into it now and again – a managed form of drawdown.’
But he added that as such a product ‘doesn’t, by and large, exist out there’, retirees were forced to make their own, difficult, retirement choices.
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