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Sustainability of Income in Retirement

With annuities being at historically low levels, and providing poor value in many cases, the majority of people use a ‘drawdown’ product to provide their income in retirement. This involves them retaining their pension in a monetary form, in a similar way to how it was invested and built up in the years pre-retirement. An income is then drawn or taken from the pension fund.

One of the questions that we are often asked by clients is “how much income can I take from my pension fund”. The answer to this question is largely dependent on matters such as the client’s objectives, other sources of income, their age, their health, life expectancy, their marital status etc. We have various ways of projecting and modelling scenarios to ensure that whatever income is being taken, it can be sustained over the long term. The biggest risk with a drawdown strategy is the money runs out. However, is there a simpler way of explaining what is possible?

In the early 90’s a gentleman by the name of Bill Bengen conducted a number of empirical simulations of historical market behaviour and concluded that a person could withdraw up to 4% annually from their pension/investment portfolio without fear of outliving their money. His research was published in 1994 and has been the bedrock of all other research and writing in this area of financial planning. This 4% withdrawal rate has become the ‘Bengen Rule’ in his honour. He was a practicing financial adviser until he retired in 2013, but his early life and education meant that he received a degree in aeronautics and astronautics. So, although financial planning isn’t rocket science, his findings were based on an analytical and academic approach!

Many people have built on his research and findings, but the 4% still remains a useful rule of thumb when we are analysing client situations and making recommendations. If we are presented with a situation where a client wants a higher level of income than 4%, it does not mean that we cannot support this approach, but a full and detailed discussion would explain that a higher level of income has a greater potential that the money will run out sooner.

The reality is that people usually want differing levels of income throughout their retirement years. For example, we often find that when you are in your late 70’s and early 80’s your need for income might actually decrease.

This is an important and sometimes complex area of financial planning, and the only way to navigate it properly is for there to be regular meetings between client and adviser, and to review the progress of any agreed strategy.

This entry was posted on July 24, 2018