Foolishness of the 4% rule

pensionpawn

Malthusian said:

MK62 said:

So, all things considered, as a starting point for a UK retiree with a 30 yr timeframe, 3.5-4% seems reasonable to me......just be prepared to alter course if, when the real data comes in, it starts looking like the plan is going awry.....

I accept Mordko's assertion that starting at 4% and then just blindly taking an index linked raise on that each year, no matter what, might well turn out to be foolish......but in reality, I don't think there are many doing that...even if that's how some start out.

Nobody in the history of UK drawdown pensions has ever withdrawn 4% (or 3.5% or a similar amount) of the starting amount in the first year and then increased their withdrawals by the rate of inflation, each year every year, without paying any attention to what the market is doing, until death. Or for more than, say, 10 years (drawdown is only 30 years old so "till death" is a bit of an unfair challenge).

If you disagree then name two people who did and I'll happily update my knowledge.

People have started with 4% of the starting value and then left it there, or increased it based on "gut feel", or even applied elaborate rules like Guyton-Klinger, but that isn't the same thing.

Our baseline is the tax allowance which isn't moving for the foreseeable future. So with one draw down at 4% and another not (and via UFPLS) our finances are going to remain ~ £30k pa tax free whatever as we hold well in excess of a year in cash and both have full SPs at 67. As taxation is only going up for the remainder of my lifetime maximising tax free withdrawals each year is a must. If a large unplanned capital expense materialises we just take the money and we save what we don't need from the draw down. There is a shed load of equity in the house if a real emergency comes along. We're trying to keep it as simple as possible in retirement.

[Deleted User]

There are 4 “buckets” that each retiree needs to think about:

1. Basic, routine needs.  Food. Shelter. Car if you need it. Books. Newspapers. Beer.  Those kinds of things.  This income is best secured by something actually safe. State pension. Other DB pension. Annuity. Government bond (sucks right now).   Stockmarket is highly variable and the future is unknown.  Stocks can’t do this job. Keep in mind that longevity  is a good thing but also a risk for someone who relies on highly volatile investments.  And if you are on a pension board then chances are you will live longer than an average Brit. 

2. Contingency.  Roof needs replacing.  Your son needs help. Not necessarily “emergency” but non-routine expenditure. This requires a liquid source of funds.  Your stocks are technically liquid but not if you use “4% rule”.  In that case your investments are needed to secure your future 4% withdrawals and can’t be touched.  For this pot you need a separate “slush fund” in cash. 

3. Discretionary income.  Things that are “nice to have”.  Annual holidays in Hawaii. New  Porsche every 5 years. Major upgrades to your property.  Stocks are perfect for this pot. They are volatile but do provide the best chance of long term growth. Given you already secured 1 and 2 with genuinely safe sources of funds, you can and should be invested aggressively. This pot should be 100% in stocks and depleted based on the size of the pot. 4% rule does not apply. If this pot goes up by a factor of 2 in 5 years or 4 in 20 years (as it often does), it would be dumb to withdraw based on its size 5 or 20 years ago. 

4. Legacy. This pot could be in stocks (and combined with 3).  Or it could be insurance. Or certain types of annuities. 

Sea_Shell

Deleted_User said:

There are 4 “buckets” that each retiree needs to think about:

1. Basic, routine needs.  Food. Shelter. Car if you need it. Books. Newspapers. Beer.  Those kinds of things.  This income is best secured by something actually safe. State pension. Other DB pension. Annuity. Government bond (sucks right now).   Stockmarket is highly variable and the future is unknown.  Stocks can’t do this job. Keep in mind that longevity  is a good thing but also a risk for someone who relies on highly volatile investments.  And if you are on a pension board then chances are you will live longer than an average Brit. 

2. Contingency.  Roof needs replacing.  Your son needs help. Not necessarily “emergency” but non-routine expenditure. This requires liquid source of funds.  Your stocks are technically liquid but not if you use “4% rule”.  In that case your investments are needed to secure your future 4% withdrawals and can’t be touched.  For this pot you need a separate “slush fund” in cash. 

3. Discretionary income.  Things that are “nice to have”.  Annual holidays in Hawaii. New  Porsche every 5 years. Major upgrades to your property.  Stocks are perfect for this pot. They are volatile but do provide the best chance of long term growth. Given you already secured 1 and 2 with genuinely safe sources of funds, you can and should be invested aggressively. This pot should be 100% in stocks and depleted based on the size of the pot. 4% rule does not apply. If this pot goes up by a factor of 2 in 5 years or 4 in 20 years (as it often does), it would be dumb to withdraw based on its size 5 or 20 years ago. 

4. Legacy. This pot could be in stocks (and combined with 3).  Or it could be insurance. Or certain types of annuities. 

If you don't need #4, does that change your view of #1, 2 and 3?

[Deleted User]

Sea_Shell said:

Deleted_User said:

There are 4 “buckets” that each retiree needs to think about:

1. Basic, routine needs.  Food. Shelter. Car if you need it. Books. Newspapers. Beer.  Those kinds of things.  This income is best secured by something actually safe. State pension. Other DB pension. Annuity. Government bond (sucks right now).   Stockmarket is highly variable and the future is unknown.  Stocks can’t do this job. Keep in mind that longevity  is a good thing but also a risk for someone who relies on highly volatile investments.  And if you are on a pension board then chances are you will live longer than an average Brit. 

2. Contingency.  Roof needs replacing.  Your son needs help. Not necessarily “emergency” but non-routine expenditure. This requires liquid source of funds.  Your stocks are technically liquid but not if you use “4% rule”.  In that case your investments are needed to secure your future 4% withdrawals and can’t be touched.  For this pot you need a separate “slush fund” in cash. 

3. Discretionary income.  Things that are “nice to have”.  Annual holidays in Hawaii. New  Porsche every 5 years. Major upgrades to your property.  Stocks are perfect for this pot. They are volatile but do provide the best chance of long term growth. Given you already secured 1 and 2 with genuinely safe sources of funds, you can and should be invested aggressively. This pot should be 100% in stocks and depleted based on the size of the pot. 4% rule does not apply. If this pot goes up by a factor of 2 in 5 years or 4 in 20 years (as it often does), it would be dumb to withdraw based on its size 5 or 20 years ago. 

4. Legacy. This pot could be in stocks (and combined with 3).  Or it could be insurance. Or certain types of annuities. 

If you don't need #4, does that change your view of #1, 2 and 3?

Nope. It does not. 

pensionpawn

Deleted_User said:

There are 4 “buckets” that each retiree needs to think about:

1. Basic, routine needs.  Food. Shelter. Car if you need it. Books. Newspapers. Beer.  Those kinds of things.  This income is best secured by something actually safe. State pension. Other DB pension. Annuity. Government bond (sucks right now).   Stockmarket is highly variable and the future is unknown.  Stocks can’t do this job. Keep in mind that longevity  is a good thing but also a risk for someone who relies on highly volatile investments.  And if you are on a pension board then chances are you will live longer than an average Brit. 

2. Contingency.  Roof needs replacing.  Your son needs help. Not necessarily “emergency” but non-routine expenditure. This requires a liquid source of funds.  Your stocks are technically liquid but not if you use “4% rule”.  In that case your investments are needed to secure your future 4% withdrawals and can’t be touched.  For this pot you need a separate “slush fund” in cash. 

3. Discretionary income.  Things that are “nice to have”.  Annual holidays in Hawaii. New  Porsche every 5 years. Major upgrades to your property.  Stocks are perfect for this pot. They are volatile but do provide the best chance of long term growth. Given you already secured 1 and 2 with genuinely safe sources of funds, you can and should be invested aggressively. This pot should be 100% in stocks and depleted based on the size of the pot. 4% rule does not apply. If this pot goes up by a factor of 2 in 5 years or 4 in 20 years (as it often does), it would be dumb to withdraw based on its size 5 or 20 years ago. 

4. Legacy. This pot could be in stocks (and combined with 3).  Or it could be insurance. Or certain types of annuities. 

Beer (& wine / spirits), books and newspapers I wouldn't classify as basic needs / essential. For me the essential list is rent / mortgage / council tax (so you have a place to sleep safely) / food (not takeaways) / insurance / utilities / medication / and basic smartphone (as we all need to communicate and the landline isn't sufficient in our society), basic transport. All that should be quite manageable via two full SPs, which provide the safety net.

Contingency / discretionary, for us, comes initially from what is saved from maximum tax free draw down (much higher than 2 x SP) minus essentials, dipping into taxable draw down as necessary. 2 x 20% band pa (£60k) is quite a buffer. However the equity in the house, as a last resort, is the safety net.

Legacy: The house plus anything remaining in the pot. However our view of legacy (and this isn't disposal of assets) is to help our offspring (when they need it, not when they want it...) whilst we're still around.

Each to their own.... 

[Deleted User]

Yes, its personal. I don’t spend anything on beer. Its whatever one needs to secure basic enjoyment of life. 

Helping offspring when they really need it is more of a contingency in my classification but this will vary. 

michaels

Sea_Shell said:

Deleted_User said:

There are 4 “buckets” that each retiree needs to think about:

1. Basic, routine needs.  Food. Shelter. Car if you need it. Books. Newspapers. Beer.  Those kinds of things.  This income is best secured by something actually safe. State pension. Other DB pension. Annuity. Government bond (sucks right now).   Stockmarket is highly variable and the future is unknown.  Stocks can’t do this job. Keep in mind that longevity  is a good thing but also a risk for someone who relies on highly volatile investments.  And if you are on a pension board then chances are you will live longer than an average Brit. 

2. Contingency.  Roof needs replacing.  Your son needs help. Not necessarily “emergency” but non-routine expenditure. This requires liquid source of funds.  Your stocks are technically liquid but not if you use “4% rule”.  In that case your investments are needed to secure your future 4% withdrawals and can’t be touched.  For this pot you need a separate “slush fund” in cash. 

3. Discretionary income.  Things that are “nice to have”.  Annual holidays in Hawaii. New  Porsche every 5 years. Major upgrades to your property.  Stocks are perfect for this pot. They are volatile but do provide the best chance of long term growth. Given you already secured 1 and 2 with genuinely safe sources of funds, you can and should be invested aggressively. This pot should be 100% in stocks and depleted based on the size of the pot. 4% rule does not apply. If this pot goes up by a factor of 2 in 5 years or 4 in 20 years (as it often does), it would be dumb to withdraw based on its size 5 or 20 years ago. 

4. Legacy. This pot could be in stocks (and combined with 3).  Or it could be insurance. Or certain types of annuities. 

If you don't need #4, does that change your view of #1, 2 and 3?

It might do as you might decide (4) is your swing/reserve pot which would give you more flexibility to be 'aggressive' with your other pots as you could draw on pot 4 in an emergency.

Malthusian

MK62 said:

I'm a bit confused by this tbh....as that's pretty much what I said......"I don't think there are many doing that"

Apologies for being unclear - I was agreeing with you. "You" was to people in general who keep going on about the 4% rule as if it's something that people actually do (sleepwalking into fund exhaustion as a result).

[Deleted User]

Malthusian said:

MK62 said:

I'm a bit confused by this tbh....as that's pretty much what I said......"I don't think there are many doing that"

Apologies for being unclear - I was agreeing with you. "You" was to people in general who keep going on about the 4% rule as if it's something that people actually do (sleepwalking into fund exhaustion as a result).

I doubt anyone does it during bad times but I do think its very popular during good times or for planning purposes.  Leads to bad plans and bad decisions. Ultimately to poorer and more risky retirement.

Audaxer

Deleted_User said:

There are 4 “buckets” that each retiree needs to think about:

1. Basic, routine needs.  Food. Shelter. Car if you need it. Books. Newspapers. Beer.  Those kinds of things.  This income is best secured by something actually safe. State pension. Other DB pension. Annuity. Government bond (sucks right now).   Stockmarket is highly variable and the future is unknown.  Stocks can’t do this job. Keep in mind that longevity  is a good thing but also a risk for someone who relies on highly volatile investments.  And if you are on a pension board then chances are you will live longer than an average Brit. 

Many retirees without DB pensions will unfortunately not have their basic income needs covered by State Pension(s) alone, and therefore they do also rely on income from stocks in their DC pot and/or S&S ISA for part of their routine income needs. I would say the aim is to have a big enough pot, including cash, to also cover Contingency and Discretionary Income.