Drawdown : Safe Withdrawal Rate and SP/DB factored In

DT2001

There is an excellent thread started by jamesd (Drawdown : Safe Withdrawal Rate) in which he provided some excellent links and explanations. My thanks to him and westv who recently bumped it.

I followed some of the links including one to Guyton/Klinger and the use of guardrails. I am quite happy to accept a variation in our income in retirement (possibly as a result of both OH and myself being self employed for 25+ years with income that has fluctuated). This allows for a higher starting rate for withdrawals (at what level I am unsure of as the research I have seen tends to be based on the US or U.K. and not a more globally diversified portfolio that I think is more prevalent now). With ‘guardrails’ I think getting the initial rate right is not as important as adjustments are built in.

I intend to fund the years between retirement and DB/SP from my investments pots plus cash. Some of the ‘cash’ element will cover the ‘missing’ SP element. I am questioning what percentage of the investment pots should be in equities and how to treat the SP/DB’s. My thinking is that as the SP is inflation linked and DB partially it should increase the equity ratio. How do you value the SP/DB?

My figures are roughly
SP £185 p.w.
DB £9.25K to be roughly 50% increasing by CPI max 3% and 50% with no increase.

SIPPs and ISAs £520k

If I value the SP at say £300k (being roughly a 3% return on ‘capital’) and the DB at say £150k to reflect only partial inflation protection it gives me a ‘guaranteed’ income pot of 46% of the total. My take is that this is the non equity element of my income generation. Do others agree with this thought process? Guyton Kinger look to 65/35 as a starting point and a 15% swing in allocation depending on their estimation of whether equities are overvalued.

On this basis I was looking at an initial withdrawal rate of 5% with the added caveat that I expect expenditure to reduce overtime (post 75/80) and care costs to be met from property (downsizing/equity release if needs be).

I have seen the 4 criteria for a successful retirement shown as - Income, risk, buying power and predictability/stability.

The order of importance should reflect the strategy chosen I believe however I am unsure if I have reached the correct conclusion!

My order of importance is

Income - (front loading withdrawals, if possible)

Risk - which I understand to be having something left at the end (using guardrails)

If expenditure falls overtime it counters the potential loss of buying power of the expected freezes/cuts.

Predictability/stability - not averse to variable income

Any thoughts on, in particular, how we should treat DB/SP income in respect of equity/bond/cash ratio and people’s ranking of priorities in retirement.

NedS

There are a number of ways you can approach this depending on your circumstances.

How old are you, and how many years do you need to cover between early retirement and DB/SP kicking in?

Will DB+SP be enough, or are you looking for a portion of your DC investments to remain at SP age to top up DB/SP income?

I prefer the "pots" approach, so I would mentally put aside the amount you need between early retirement and DB/SP into a "pot", and maybe look to invest that in individual government gilts or other fixed rate investments in a bond ladder type arrangement.

The remainder (another "pot") can then be invested for the longer term to provide that top up income to supplement your DB/SP.

With respect to asset allocation, you can view the DB/SP as guaranteed fixed income/bonds (low risk) and your DC investments as the risky portion of your portfolio, which may allow you to hold a higher percentage of equity in your DC investments that you otherwise would - as long as you are able to handle the additional volatility (e.g, by having the ability to flexibly vary your income if needed).

However, Safe Withdraw Rates do not consider what income you need, they only consider what income may be sustainable from any given pot.

dunstonh

If I value the SP at say £300k (being roughly a 3% return on ‘capital’) and the DB at say £150k to reflect only partial inflation protection it gives me a ‘guaranteed’ income pot of 46% of the total. My take is that this is the non equity element of my income generation. Do others agree with this thought process? Guyton Kinger look to 65/35 as a starting point and a 15% swing in allocation depending on their estimation of whether equities are overvalued.

Why would you put any capital value on something that has no capital value.  

I wouldn't be too worried about the occasional times that they do not keep up with inflation as any forecasting will be wrong and by a margin greater than the rate of inflation.

Any thoughts on, in particular, how we should treat DB/SP income in respect of equity/bond/cash ratio and people’s ranking of priorities in retirement.

You don't.

If you need £x a year income, you deduct the DB and SP from that need.  That leaves you the shortfall figure.     
You then address the shortfall from the invested assets and leave the secure income out of the equation.

Ideally, you want the target lump sum able to produce that £x from less than 3.5% of the lump sum (3% if retiring in in your 50s. Even less if you are a cautious investor).

Linton

Rather than treating SP and a DB pension as a hypothetical pot I think it makes more sense to simply deduct them from the target income.  After all they are 100% guaranteed and there seems no advantage in modelling them by more volatile investments.

After 18 years of retirement my ranking of priorities remains:

1) Sufficient regular income to maintain the same standard of living as before retirement.  It should be constant in real terms throughout my life.   Savings  from a less active life will be gradually replaced by increased costs for local travel and help/support at home etc. Anything beyond that such as large one-offs come from pre-retirement savings supplemented by excess post retirement investment growth.

2) Stability.  Forced cutting of regular income and cuts in planned large expenditures are not acceptable.  I do not see how Guyton Klinger would actually work in practice. How for example do you cut your expenditure by a worthwhile amount at short notice?  Could you cut enough sufficiently quickly to have a significant effect? Would you cancel your long booked world cruise because Guyton Klinger told you to?  

3) Risk.  The "something at the end" is the measure of risk and can vary in order to satisfy (1) and (2).  Clearly if the plans show it dropping to a low level some sacrifice of (1) in the long term may be necessary.  However after the first few years of retirement this is unlikely to occur as the serious risks of early SOR wont happen for most people most of the time.

I have a number of disagreements with the whole SWR-based strategy and so have never tried to use it .

Pat38493

dunstonh said:

You don't.

If you need £x a year income.
You deduct the DB and SP from that need.  That leaves you the shortfall figure.     
You then address the shortfall from the invested assets and leave the secure income out of the equation.

Ideally, you want the target lump sum able to produce that £x from less than 3.5% of the lump sum (3% if retiring in in your 50s. Even less if you are a cautious investor).

Yes but if you are bridging an income for some years before one or both those pensions kick in, you shouldn't be constrained to a 3% withdrawal rate as once you have those guaranteed incomes in play, you might be only withdrawing 1% or less.

I would suggest the OP takes a look at the VPW (variable percent withdrawal) documentation - if you google it, you can find links to the relevant forums and there are some spreadsheets you can play around with where you can maintain your guaranteed income and pot amounts.  It's developed in Canada but seems usable here as far as I can tell if you are willing to adopt a flexible spending style.

There are also other tools - might have a read of the "Early Retirement Now" blogs - there is a whole series of blogs he has done with way more stats than you would ever want to read about SWR.  He also has a spreadsheet you can play around with (which actually does indeed assign a "capital value" to your future cash flows which was a point of debate in the comments on his blogs as it's open to some strange results if you put in windfalls that are very far into the future).

You can also use sites like cfiresim - this allows you to model withdrawal scenarios with a few parameters as a ball park and test against historical issues - granted it's mainly based on US markets but it's a good rough guide.

Of course as you know, there are also tools used by professionals like Timeline and Voyant which allows you to model these scenarios from a cash flow point of view and test them against various issues and events.  I am sure you use these tools yourself as I think you are an IFA?

OP should also understand what is their spending floor i.e. what is the minimum amount of money they could realistically live on.

Linton

Pat38493 said:

dunstonh said:

You don't.

If you need £x a year income.
You deduct the DB and SP from that need.  That leaves you the shortfall figure.     
You then address the shortfall from the invested assets and leave the secure income out of the equation.

Ideally, you want the target lump sum able to produce that £x from less than 3.5% of the lump sum (3% if retiring in in your 50s. Even less if you are a cautious investor).

Yes but if you are bridging an income for some years before one or both those pensions kick in, you shouldn't be constrained to a 3% withdrawal rate as once you have those guaranteed incomes in play, you might be only withdrawing 1% or less.

I would suggest the OP takes a look at the VPW (variable percent withdrawal) documentation - if you google it, you can find links to the relevant forums and there are some spreadsheets you can play around with where you can maintain your guaranteed income and pot amounts.  It's developed in Canada but seems usable here as far as I can tell if you are willing to adopt a flexible spending style.

There are also other tools - might have a read of the "Early Retirement Now" blogs - there is a whole series of blogs he has done with way more stats than you would ever want to read about SWR.  He also has a spreadsheet you can play around with (which actually does indeed assign a "capital value" to your future cash flows which was a point of debate in the comments on his blogs as it's open to some strange results if you put in windfalls that are very far into the future).

You can also use sites like cfiresim - this allows you to model withdrawal scenarios with a few parameters as a ball park and test against historical issues - granted it's mainly based on US markets but it's a good rough guide.

Of course as you know, there are also tools used by professionals like Timeline and Voyant which allows you to model these scenarios from a cash flow point of view and test them against various issues and events.  I am sure you use these tools yourself as I think you are an IFA?

OP should also understand what is their spending floor i.e. what is the minimum amount of money they could realistically live on.

If you are bridging an income before guaranteed pensions kick in I think you should have that money in a separate very low risk pot set up well before you retire.  This gives you more time to invest your long term pot at higher risk without worrying about SOR events.

All these automated drawdown approaches are fine for checking scenarios and showing an IFA's clients what-ifs but I find it difficult to  believe anyone would actually use them for on-going management of their retirement, at least not for long.  In my view needs/wants should drive drawdown rather than a drawdown strategy driving expenditure.

Personally I have never looked at a spending floor as I have no intention of ever needing to find out.  With on-going monitoring and planning one should be able to make adjustments well before getting anywhere near that level.

Pat38493

Linton said:

If you are bridging an income before guaranteed pensions kick in I think you should have that money in a separate very low risk pot set up well before you retire.  This gives you more time to invest your long term pot at higher risk without worrying about SOR events.

All these automated drawdown approaches are fine for checking scenarios and showing an IFA's clients what-ifs but I find it difficult to  believe anyone would actually use them for on-going management of their retirement, at least not for long.  In my view needs/wants should drive drawdown rather than a drawdown strategy driving expenditure.

Personally I have never looked at a spending floor as I have no intention of ever needing to find out.  With on-going monitoring and planning one should be able to make adjustments well before getting anywhere near that level.

Yes but OP made a point of saying that they were prepared to live on a flexible income unlike you.  

It also depends how big your pot is and how safe your situation is - if your pot is big enough that it should survive the worst possible historical scenarios even if invested heavily in equities, you might choose to take that approach in the knowledge that there is a high chance you will end up even better off than you needed.  

michaels

Linton said:

Pat38493 said:

dunstonh said:

You don't.

If you need £x a year income.
You deduct the DB and SP from that need.  That leaves you the shortfall figure.     
You then address the shortfall from the invested assets and leave the secure income out of the equation.

Ideally, you want the target lump sum able to produce that £x from less than 3.5% of the lump sum (3% if retiring in in your 50s. Even less if you are a cautious investor).

Yes but if you are bridging an income for some years before one or both those pensions kick in, you shouldn't be constrained to a 3% withdrawal rate as once you have those guaranteed incomes in play, you might be only withdrawing 1% or less.

I would suggest the OP takes a look at the VPW (variable percent withdrawal) documentation - if you google it, you can find links to the relevant forums and there are some spreadsheets you can play around with where you can maintain your guaranteed income and pot amounts.  It's developed in Canada but seems usable here as far as I can tell if you are willing to adopt a flexible spending style.

There are also other tools - might have a read of the "Early Retirement Now" blogs - there is a whole series of blogs he has done with way more stats than you would ever want to read about SWR.  He also has a spreadsheet you can play around with (which actually does indeed assign a "capital value" to your future cash flows which was a point of debate in the comments on his blogs as it's open to some strange results if you put in windfalls that are very far into the future).

You can also use sites like cfiresim - this allows you to model withdrawal scenarios with a few parameters as a ball park and test against historical issues - granted it's mainly based on US markets but it's a good rough guide.

Of course as you know, there are also tools used by professionals like Timeline and Voyant which allows you to model these scenarios from a cash flow point of view and test them against various issues and events.  I am sure you use these tools yourself as I think you are an IFA?

OP should also understand what is their spending floor i.e. what is the minimum amount of money they could realistically live on.

If you are bridging an income before guaranteed pensions kick in I think you should have that money in a separate very low risk pot set up well before you retire.  This gives you more time to invest your long term pot at higher risk without worrying about SOR events.

All these automated drawdown approaches are fine for checking scenarios and showing an IFA's clients what-ifs but I find it difficult to  believe anyone would actually use them for on-going management of their retirement, at least not for long.  In my view needs/wants should drive drawdown rather than a drawdown strategy driving expenditure.

Personally I have never looked at a spending floor as I have no intention of ever needing to find out.  With on-going monitoring and planning one should be able to make adjustments well before getting anywhere near that level.

What is a very low risk pot?  Cash/bonds are subject to inflation risk, the past years events show that is not negligible even over a 12 month time horizon let alone a possible 10-20 years before SP/DB pensions become payable.

Linton

michaels said:

Linton said:

Pat38493 said:

dunstonh said:

You don't.

If you need £x a year income.
You deduct the DB and SP from that need.  That leaves you the shortfall figure.     
You then address the shortfall from the invested assets and leave the secure income out of the equation.

Ideally, you want the target lump sum able to produce that £x from less than 3.5% of the lump sum (3% if retiring in in your 50s. Even less if you are a cautious investor).

Yes but if you are bridging an income for some years before one or both those pensions kick in, you shouldn't be constrained to a 3% withdrawal rate as once you have those guaranteed incomes in play, you might be only withdrawing 1% or less.

I would suggest the OP takes a look at the VPW (variable percent withdrawal) documentation - if you google it, you can find links to the relevant forums and there are some spreadsheets you can play around with where you can maintain your guaranteed income and pot amounts.  It's developed in Canada but seems usable here as far as I can tell if you are willing to adopt a flexible spending style.

There are also other tools - might have a read of the "Early Retirement Now" blogs - there is a whole series of blogs he has done with way more stats than you would ever want to read about SWR.  He also has a spreadsheet you can play around with (which actually does indeed assign a "capital value" to your future cash flows which was a point of debate in the comments on his blogs as it's open to some strange results if you put in windfalls that are very far into the future).

You can also use sites like cfiresim - this allows you to model withdrawal scenarios with a few parameters as a ball park and test against historical issues - granted it's mainly based on US markets but it's a good rough guide.

Of course as you know, there are also tools used by professionals like Timeline and Voyant which allows you to model these scenarios from a cash flow point of view and test them against various issues and events.  I am sure you use these tools yourself as I think you are an IFA?

OP should also understand what is their spending floor i.e. what is the minimum amount of money they could realistically live on.

If you are bridging an income before guaranteed pensions kick in I think you should have that money in a separate very low risk pot set up well before you retire.  This gives you more time to invest your long term pot at higher risk without worrying about SOR events.

All these automated drawdown approaches are fine for checking scenarios and showing an IFA's clients what-ifs but I find it difficult to  believe anyone would actually use them for on-going management of their retirement, at least not for long.  In my view needs/wants should drive drawdown rather than a drawdown strategy driving expenditure.

Personally I have never looked at a spending floor as I have no intention of ever needing to find out.  With on-going monitoring and planning one should be able to make adjustments well before getting anywhere near that level.

What is a very low risk pot?  Cash/bonds are subject to inflation risk, the past years events show that is not negligible even over a 12 month time horizon let alone a possible 10-20 years before SP/DB pensions become payable.

20 years before SP/DB is a very early retirement.  That could put access to the guaranteed pensions on average halfway through  one's retirement.  I think this is well outside what the vast majority of people would be able to afford and certainly a scenario I have never considered.

For a 10 years gap a suitable pot could be something like 5 years cash and 5-10  years in  something like CGT or other wealth preservation fund with an allowance of say 3% annual inflation.  Perhaps VLS20/40 may be appropriate now that bonds have revalued to a better place.  Any money beyond the 10 years period could be high equity.

So overall it could be similar to a 60/40 portfolio but with separate management of the components and a targetted choice of investments.

Surely Inflation is not a serious problem in a 1 year time frame.  Even the recent 10% during the year which had not previously been seen for 40+ years should be manageable within the bounds of accuracy of predicted expenditure.  Of course it would not cope with hyperinflation but nothing would.

enthusiasticsaver

All these suggested drawdown percentages are only a guideline as no one knows exactly how the market will perform, inflation rates etc etc. We draw 4% per year from now until our SPs kick in (2024 and 2026) and then we will probably stop drawing on investments so then 2%  possibly for 2 years then nothing. We did not draw at all through 2020-2022 and lived off savings so our current drawdown is actually to replace those savings rather than to cover expenditure.  Our main income is DBs.  We don't yet get SPs but will treat them as we do our DBs which are guaranteed inflation linked income. 

Am I to understand that you do not have a figure in mind that you will need in income to cover outgoings? Even if you were self employed and used to erratic income surely you have a ballpark figure in mind which you would not want to go below? I personally would not want to go any higher than 60% equities and luckily we do not need to increase our risk level to possibly achieve higher growth. 

gm0

I also think that it is better to think about the essential income target alongside guaranteed sources of income as income not capital.  And not to artificially translate income to capital using an assumption and then convert back later in calculation drifting that assumption.

My approach would be to estimate full target income (from household budget) real terms now.
Then assess discretionary spend items within that to create estimate of "essential" income floor still real terms now
Make any macro "these things stop by age x" adjustments as needed

Reduce essential income floor (household) by SP (or SP x2 for a couple) at current rates again

Leaving a gap to essential income required rain or shine or decade long storm post SP from DC drawdown

And also net off any other DB or similar not-correlated with equity markets guaranteed cashflows you have that are active at that point.

A calculation on the income gap if there is one - to the essential floor that remains can be done to indicate the quantity of assets in drawdown which probably belong in "minimal risk". 
Essential income is then covered whatever happens to growth asset/equity markets.  Without firesales.  You could for a first approximation regard these minimal risk elements as short gilts and cash.  You can choose (if you like) to include other cash bufffer savings and emergency cash you have in these numbers to reduce the pension investible assets so allocated.  All choices you can make about how you view overall portfolio and carve

A liability (cashflow) matched portfolio "pot"

Sat alongside an invested growth pot.

Giving a view on a static asset allocation for the investible assets. 
You look again using that allocation and drawdown rules of sustainability thumb - to see if it can generate full target income as desired.  Asset allocation also interacts with the viability of a given % drawdown. 

If you have the liability matched element as capital to cover essential income.  And 3.5% on the rest is delivering the target plan.  Then it looks in good shape.  If the residual growth portfolio doesn't deliver the full goods then you need to save more or invest more aggressively which then comes with risks to essential income. 

Your balloon.  Squeeze it how you like.

It's just one way of cutting the cake to test a portfolio design against drawdown modelling and backtesting for realism.

You could take those parameters for a montecarlo spin as well using something like flexible retirement planner.  To see what different market return std dev and inflation ranges do with a wide range of sequences. And at what boundary condition for long term asset return the plan starts to look rocky a decent % of the time

Bridging the early retirement years to SP requires a specific solution with a higher planned drawdown % perhaps.  And to taste - fatter SORR cash buffers during that phase.

Bernstein (Rational Asset Allocation) covers this liability matching ground briefly.