I have had a few conversations recently about what level of income can be safely withdrawn from an investment portfolio over time. This is often referred to as the safe withdrawal rate (SWR). The importance and relevance of the SWR has grown in recent years as fewer people use their pension to buy an annuity, and more people prefer to continue with their pension investments in retirement and to simply withdraw from this an income each year. (Note that in this case, we use the term income to mean an income to the recipient: it is not necessary for this to be income that the portfolio has generated).
There has been a lot of mathematical research on this over the years, starting with Bill Bengen in 1994, and this report by the Institute and Faculty of Actuaries being a more recent (and UK focussed) example. Bengen's original research lead to the "4% rule", and subsequent research has given similar results (the actuarial paper gave 3.5%).
What this means in practise is as follows. (Figures in brackets show your income that year, assuming an initial investment fund of £100,000 and inflation of 2.5% per year).
- In the first year, you withdraw 4% of the investment value. This is your income in year 1. (£4,000).
- In the second year, you give yourself a pay-rise to cover inflation, so drawdown slightly more than you did last year. Note though, that the income you draw is not based on the value of your investments in this year - it is set at the start of the process. (£4,100).
- Over time, for a medium risk portfolio, then this level of index-linked income should be sustainable. If you are fortunate with the combination of investment returns and inflation then it may be that over time your pension pot retains its value, or perhaps even grows. If you are less fortunate then your fund may reduce in value over time, but in theory it shouldn't run out earlier than you need.
- Having said all of the above, as with all financial planning then this is a process rather than a one-off event, and so annual reviews are a vital part of ensuring that you remain on track (that you don't run out of money), and to take corrective action if and when required.
Morton Fraser continue to publish articles online to help clients deal with the current changes, particularly the constantly changing backdrop for employment law. There are a couple of potentially relevant articles that my team have published recently. Sue Hunter, whom many of you know, has written about three lockdown trends that could affect you (covering Power of Attorney, Wills, and Financial Planning). And Sue and I have jointly written about why now may be a good time for those considering gifting down the generations.