Foolishness of the 4% rule

NedS

ukdw said:

I personally had a big debate with myself about whether to go for £12.5k drawdowns or £50k drawdowns - I went for £12.5k for a while, but kept thinking I might regret not using any of the 20% band (and risking paying a higher rate in the future),  so in the end I changed to £50k for the next few years, with excess drawdowns being reinvested into S&S ISAs.

I agree that the probability of the current basic rate of income tax (20%) rising is greater than it falling, so on that basis it probably makes sense to get out as much as you can now at 20% tax than risk having to pay more than 20% in the future. I will be somewhat annoyed if I've largely received 20% tax relief on the way in, only to defer to paying more than 20% tax on the way out.

[Deleted User]

Don’t let the tax tail wag the dog. Future taxes are unpredictable. Base your withdrawal schedule on safety and affordability first. 

Sea_Shell

Deleted_User said:

Don’t let the tax tail wag the dog. Future taxes are unpredictable. Base your withdrawal schedule on safety and affordability first. 

But if you're pulling it out of a pension and immediately reinvesting in an ISA, in a similar (if not identical fund) where's the risk?

[Deleted User]

Sea_Shell said:

Deleted_User said:

Don’t let the tax tail wag the dog. Future taxes are unpredictable. Base your withdrawal schedule on safety and affordability first. 

But if you're pulling it out of a pension and immediately reinvesting in an ISA, in a similar (if not identical fund) where's the risk?

That’s fine. Its just that in this topic we have been talking about withdrawal in a sense of “spending” rather than “changing the wrapper for my investments”. In the particular example it would appear the withdrawal strategy is way too conservative and designed to minimize  tax rather than afford the highest expenditure safely. To me, thats a better objective. 

Thrugelmir

Deleted_User said:

Sea_Shell said:

Deleted_User said:

Don’t let the tax tail wag the dog. Future taxes are unpredictable. Base your withdrawal schedule on safety and affordability first. 

But if you're pulling it out of a pension and immediately reinvesting in an ISA, in a similar (if not identical fund) where's the risk?

That’s fine. Its just that in this topic we have been talking about withdrawal in a sense of “spending” rather than “changing the wrapper for my investments”. In the particular example it would appear the withdrawal strategy is way too conservative and designed to minimize  tax rather than afford the highest expenditure safely. To me, thats a better objective. 

That's the inherent danger when trying to simplify a complex topic and make it a case of one size fits all.  Taxation, investment returns, fees, inflation are all going to influence how long a pot of money will last at a given rate of net withdrawl.  With the majority of people in the UK holding the bulk of their investments in pension wrappers. Taxation has a material bearing. As the 4% figure is gross. Not the net that will end up in somebodys pocket as spending money. 

DT2001

Thrugelmir said:

Deleted_User said:

Sea_Shell said:

Deleted_User said:

Don’t let the tax tail wag the dog. Future taxes are unpredictable. Base your withdrawal schedule on safety and affordability first. 

But if you're pulling it out of a pension and immediately reinvesting in an ISA, in a similar (if not identical fund) where's the risk?

That’s fine. Its just that in this topic we have been talking about withdrawal in a sense of “spending” rather than “changing the wrapper for my investments”. In the particular example it would appear the withdrawal strategy is way too conservative and designed to minimize  tax rather than afford the highest expenditure safely. To me, thats a better objective. 

That's the inherent danger when trying to simplify a complex topic and make it a case of one size fits all.  Taxation, investment returns, fees, inflation are all going to influence how long a pot of money will last at a given rate of net withdrawl.  With the majority of people in the UK holding the bulk of their investments in pension wrappers. Taxation has a material bearing. As the 4% figure is gross. Not the net that will end up in somebodys pocket as spending money. 

You are correct that it is a complex topic however if you do not try to simplify it do you end up ‘turning people off’ the subject that you want them to explore and understand better?
The 4% rule was a media interpretation of Bengen’s research that found 4.15% to be SWR for two asset classes in the US.
However if you someone asks you for a starting target for a retirement pot you could say 25 x your gross salary less any expenses you’ll no longer have in retirement. Hopefully a catalyst to research the options, their expenditure and future budgets. It is the start… 

Audaxer

DT2001 said:

Thrugelmir said:

Deleted_User said:

Sea_Shell said:

Deleted_User said:

Don’t let the tax tail wag the dog. Future taxes are unpredictable. Base your withdrawal schedule on safety and affordability first. 

But if you're pulling it out of a pension and immediately reinvesting in an ISA, in a similar (if not identical fund) where's the risk?

That’s fine. Its just that in this topic we have been talking about withdrawal in a sense of “spending” rather than “changing the wrapper for my investments”. In the particular example it would appear the withdrawal strategy is way too conservative and designed to minimize  tax rather than afford the highest expenditure safely. To me, thats a better objective. 

That's the inherent danger when trying to simplify a complex topic and make it a case of one size fits all.  Taxation, investment returns, fees, inflation are all going to influence how long a pot of money will last at a given rate of net withdrawl.  With the majority of people in the UK holding the bulk of their investments in pension wrappers. Taxation has a material bearing. As the 4% figure is gross. Not the net that will end up in somebodys pocket as spending money. 

However if you someone asks you for a starting target for a retirement pot you could say 25 x your gross salary less any expenses you’ll no longer have in retirement. Hopefully a catalyst to research the options, their expenditure and future budgets. It is the start… 

That is quite a good way of looking at it, but I would also advise adjusting down the pot size to take account of State Pension income when that is due to start.

michaels

Audaxer said:

DT2001 said:

Thrugelmir said:

Deleted_User said:

Sea_Shell said:

Deleted_User said:

Don’t let the tax tail wag the dog. Future taxes are unpredictable. Base your withdrawal schedule on safety and affordability first. 

But if you're pulling it out of a pension and immediately reinvesting in an ISA, in a similar (if not identical fund) where's the risk?

That’s fine. Its just that in this topic we have been talking about withdrawal in a sense of “spending” rather than “changing the wrapper for my investments”. In the particular example it would appear the withdrawal strategy is way too conservative and designed to minimize  tax rather than afford the highest expenditure safely. To me, thats a better objective. 

That's the inherent danger when trying to simplify a complex topic and make it a case of one size fits all.  Taxation, investment returns, fees, inflation are all going to influence how long a pot of money will last at a given rate of net withdrawl.  With the majority of people in the UK holding the bulk of their investments in pension wrappers. Taxation has a material bearing. As the 4% figure is gross. Not the net that will end up in somebodys pocket as spending money. 

However if you someone asks you for a starting target for a retirement pot you could say 25 x your gross salary less any expenses you’ll no longer have in retirement. Hopefully a catalyst to research the options, their expenditure and future budgets. It is the start… 

That is quite a good way of looking at it, but I would also advise adjusting down the pot size to take account of State Pension income when that is due to start.

The early retirement now website has done some calcs on how much to adjust an SWR to reflect pensions, alternatively they an be added in to the online calculators (although not the triple lock aspect)
The Ultimate Guide to Safe Withdrawal Rates – Part 4: Social Security and Pensions – Early Retirement Now
https://earlyretirementnow.com/2017/07/19/the-ultimate-guide-to-safe-withdrawal-rates-part-17-social-security/

[Deleted User]

DT2001 said:

Thrugelmir said:

Deleted_User said:

Sea_Shell said:

Deleted_User said:

Don’t let the tax tail wag the dog. Future taxes are unpredictable. Base your withdrawal schedule on safety and affordability first. 

But if you're pulling it out of a pension and immediately reinvesting in an ISA, in a similar (if not identical fund) where's the risk?

That’s fine. Its just that in this topic we have been talking about withdrawal in a sense of “spending” rather than “changing the wrapper for my investments”. In the particular example it would appear the withdrawal strategy is way too conservative and designed to minimize  tax rather than afford the highest expenditure safely. To me, thats a better objective. 

That's the inherent danger when trying to simplify a complex topic and make it a case of one size fits all.  Taxation, investment returns, fees, inflation are all going to influence how long a pot of money will last at a given rate of net withdrawl.  With the majority of people in the UK holding the bulk of their investments in pension wrappers. Taxation has a material bearing. As the 4% figure is gross. Not the net that will end up in somebodys pocket as spending money. 

You are correct that it is a complex topic however if you do not try to simplify it do you end up ‘turning people off’ the subject that you want them to explore and understand better?
The 4% rule was a media interpretation of Bengen’s research that found 4.15% to be SWR for two asset classes in the US.
However if you someone asks you for a starting target for a retirement pot you could say 25 x your gross salary less any expenses you’ll no longer have in retirement. Hopefully a catalyst to research the options, their expenditure and future budgets. It is the start… 

The beauty of the 4% rule is its simplicity. That’s why it has taken off. That’s also the danger of the 4% rule.  Its a rule of thumb which applies to supposed ability to safely withdraw at a constant rate from a highly variable portfolio.  Conceptually its nonsense. Could end up in tears. 

Various variable withdrawal methods are far more meaningful and give a better idea of what one might be able to safely withdraw but in terms relative to the ongoing variable portfolio value. VPW table provides such indication for that method (age dependent).

Both SWR and VPW apply to the pre-tax portfolio value.  Figuring out the tax efficient withdrawal strategy and net of tax income is the next level of complexity.  One really ought to first decide how much to withdraw and only then focus on the most tax efficient way to withdraw that amount.  A helpful method of accounting for potential future taxes is to project net as well as gross value of your portfolio. I track the net value by applying an assumed tax rate, depending on the wrapper (30% for pension, 10% for non-registered investments and 0% for ISA). 

Sea_Shell

Since July 2018, our outgoings have averaged 2.3% of the pot total at the start of any given 12 month period, and 2.16% of the pot as it currently stood at the end of each 12 month period.    As growth has seen our spends reduce relative to current pot value, compared to where we were 12 months earlier IYSWIM.

So 4% would be a spending bonanza!!!!