Trying to understand drawdown SWR

hildasmuriel

I think I must be missing something really obvious. Sorry if this is me being dim as a Toc  H lamp.

I see people discuss a SWR of 4%.

Isn't that what you'd get from a fixed rate savings account - meaning you could achieve 4% without ever touching your capital?
Why is the drawdown popular then - especially if it also carries a risk of your money losing some value in market swings?

VXman

If you have your money in a fixed rate 4% then you wouldn't be able to access it - therefore it won't be a drawdown. You'll need an instant access of which the best is 3.55%. 

I would suggest 4% is a minimum and takes into account possible market swings over a period of time. In normal times people would hope to get more than 4% growth on an investment account.

dunstonh

I see people discuss a SWR of 4%.

This applies to the US, not the UK and is only an opinion based on a range of assumptions and risk level and not fact.   Its a quick and dirty guide.  In the UK, 3.5% is considered to be more appropriate.

Isn't that what you'd get from a fixed rate savings account - meaning you could achieve 4% without ever touching your capital?

No.  You have to remember annual indexation and inflation.  Savings doesnt give you that.   Can you find a savings account that gives you 4% plus long-term inflation and annual indexation on those withdrawals?

Why is the drawdown popular then - especially if it also carries a risk of your money losing some value in market swings?

Drawdown is a method of drawing your pension and nothing to do with the investments in your pension.    you can have cash in your pension, property, fixed interest securities or equities.   

Risk based investments will go down periodically.   However, over the long term, they go up more than cash.   And that gives reduces inflation risk which cash would suffer badly with.

hildasmuriel

So the suggested amount (say 3.5%) is of the current total? Not the starting total? Because the rough guide I read said it was of the starting amount which makes no sense whatsoever because that means you would only ever take out 3.5% of the initial amount and  it would presumably grow and grow and you would never touch it. 

dunstonh said:

Drawdown is a method of drawing your pension and nothing to do with the investments in your pension.    you can have cash in your pension, property, fixed interest securities or equities.   

But, with the exception of cash, surely each of those can go down in value? Whereas with a fixed income, the amount you get is known for ever. For a non-risk taker, that has to be a big draw.

dunstonh

hildasmuriel said:

So the suggested amount (say 3.5%) is of the current total? Not the starting total? Because the rough guide I read said it was of the starting amount which makes no sense whatsoever because that means you would only ever take out 3.5% of the initial amount and  it would presumably grow and grow and you would never touch it. 

dunstonh said:

Drawdown is a method of drawing your pension and nothing to do with the investments in your pension.    you can have cash in your pension, property, fixed interest securities or equities.   

But, with the exception of cash, surely each of those can go down in value? Whereas with a fixed income, the amount you get is known for ever. For a non-risk taker, that has to be a big draw.

Cash has no investment risk but it carries inflation risk and shortfall risk.    So, you are not taking "no risk" with cash.  

in fact, being too heavy in cash can actually be higher risk for those needing an income compared to being balanced across assets classes.   if you want the least risk, you would buy an RPI linked annuity.

Prism

hildasmuriel said:

So the suggested amount (say 3.5%) is of the current total? Not the starting total? Because the rough guide I read said it was of the starting amount which makes no sense whatsoever because that means you would only ever take out 3.5% of the initial amount and  it would presumably grow and grow and you would never touch it. 

dunstonh said:

Drawdown is a method of drawing your pension and nothing to do with the investments in your pension.    you can have cash in your pension, property, fixed interest securities or equities.   

But, with the exception of cash, surely each of those can go down in value? Whereas with a fixed income, the amount you get is known for ever. For a non-risk taker, that has to be a big draw.

It would be 3.5% of the starting total. That is the only time that you ever calculate the percentage. Each year after that you increase the 'amount' taken by inflation. No bank account will keep up as they tend to only pay an interest rate at around the inflation level or beneath.

gm0

The notion of a drawdown amount calculated from a % is indeed often about the initial pot at retirement. 
That is how % works. It's the first year.  3% of the value is 3% of the value.

But there is a version of drawdown which applies a chosen fixed % to the pot value every year - whatever has happened.  So the income tracks the volatility of the investments.  If they are down 50% so is the income next time.  n% of half the value.  If they are up it's more.  If they are down >60% it's very sad.  Very variable income.  Not what most people need or want.

A lot of the analysis of how to manage extraction from an invested pot as a pension is based on the idea of addressing the question like this.  

What is the *largest* amount of <this pot> that I can take as income, indexed by some amount - say 3% for inflation (a traditional view of CPI say) and still come as close to a guarantee as possible that it won't deplete ALL capital and all returns in the planned 30 years / 40 years I need it to run.  In english.  What is the rate of inflation indexed income I can take that will last until the end.

Now that is partly a speculation about long term asset class returns - for equities, bonds etc. 

This can be modelled "looking back" - does this plan work in the history of investing for all start dates.

Which can *definitely* show you if a suggested plan would already have failed multiple times before. 

It doesn't (cannot) tell you what will happen next. 

Worked example: I say I'd like a 45 year retirement and a 10% drawdown amount from the start. Indexed by 3%.  Invested 100% in equities.  Spoiler:  It's not going to work - nearly all of the time).   Calculating the Maximum Safe Withdrawal Rate (MSWR) works like that.   Academic studies some while ago coined the 4% rule (in the US - one of the best performing markets in recent decades and in the correct base currency for those retirees.  People have replicated the work for UK pensioners investing globally but drawing sterling.

In practice if you are trying to stretch a pot of money to the practical limit - it's actually a lot more complex due to investment sequence of return, lower draw later with State Pension. And you can improve your success odds by accepting one of the many forms of variable income.  Or you can skip all that, buy a lifetime annuity with some indexation. And you know your outcome.  Nothing to pass to heirs.  But you have a known income until you die and markets can do as they please.  Somebody else's problem.

NoMore

The swr percentage is based on the total amount at start but you then increase that numeric value by inflation each year. 

So if you have 100k it’s 4k the first year but then if inflation is 10% second year you drawdown 4400. Another 10% in year 3 and your drawing 4840. 

It’s an extremely simplistic idea and probably not many people in reality end up following it to the letter. 

hildasmuriel

dunstonh said:

  if you want the least risk, you would buy an RPI linked annuity.

Then you have a further choice to make:

Run the risk of dying 6 months into your retirement and all your hard earned pension is gone for ever

OR

Accept a much reduced income so that it leave an amount for a surviving partner   


For the non-risk taker who is also a worrier, it's  a real dilemma.

hildasmuriel

gm0 said:

The notion of a drawdown amount calculated from a % is indeed often about the initial pot at retirement. 
That is how % works. It's the first year.  3% of the value is 3% of the value.

But there is a version of drawdown which applies a chosen fixed % to the pot value every year - whatever has happened.  So the income tracks the volatility of the investments.  If they are down 50% so is the income next time.  n% of half the value.  If they are up it's more.  If they are down >60% it's very sad.  Very variable income.  Not what most people need or want.

A lot of the analysis of how to manage extraction from an invested pot as a pension is based on the idea of addressing the question like this.  

What is the *largest* amount of <this pot> that I can take as income, indexed by some amount - say 3% for inflation (a traditional view of CPI say) and still come as close to a guarantee as possible that it won't deplete ALL capital and all returns in the planned 30 years / 40 years I need it to run.  In english.  What is the rate of inflation indexed income I can take that will last until the end.

Now that is partly a speculation about long term asset class returns - for equities, bonds etc. 

This can be modelled "looking back" - does this plan work in the history of investing for all start dates.

Which can *definitely* show you if a suggested plan would already have failed multiple times before. 

It doesn't (cannot) tell you what will happen next. 

Worked example: I say I'd like a 45 year retirement and a 10% drawdown amount from the start. Indexed by 3%.  Invested 100% in equities.  Spoiler:  It's not going to work - nearly all of the time).   Calculating the Maximum Safe Withdrawal Rate (MSWR) works like that.   Academic studies some while ago coined the 4% rule (in the US - one of the best performing markets in recent decades and in the correct base currency for those retirees.  People have replicated the work for UK pensioners investing globally but drawing sterling.

In practice if you are trying to stretch a pot of money to the practical limit - it's actually a lot more complex due to investment sequence of return, lower draw later with State Pension. And you can improve your success odds by accepting one of the many forms of variable income.  Or you can skip all that, buy a lifetime annuity with some indexation. And you know your outcome.  Nothing to pass to heirs.  But you have a known income until you die and markets can do as they please.  Somebody else's problem.

Thanks - very good description.  It's all very scary (and I know it's the same for everyone!) - and a wrong decision could be for life.

NedS

hildasmuriel said:

dunstonh said:

  if you want the least risk, you would buy an RPI linked annuity.

Then you have a further choice to make:

Run the risk of dying 6 months into your retirement and all your hard earned pension is gone for ever

OR

Accept a much reduced income so that it leave an amount for a surviving partner   


For the non-risk taker who is also a worrier, it's  a real dilemma.

Once you are dead, I wager you won't care.

If there is a partner to consider, buy a joint life annuity that protects the surviving partner. Or take the risk of drawdown. Or do a combination of both to lessen the risk.