Retirement drawdown: Use cash buffer first or drawdown proportionally?

GazzaBloom

I've been musing on the different ways to use a cash buffer in retirement when drawing from a DC pension portfolio.

So, assuming you have 3 year's worth of drawdown requirements held as a cash buffer, which seems to be generally viewed as sensible in many posts I read. What is people views on how to deploy that cash?

Would you either:

Scenario A: Commence monthly drawdown in year 1 from all cash then if other portfolio assets have grown at the end of year 1 top it back up to the full 3 years buffer and start again, and, if the other assets had declined, leave them alone to recover and use another years cash from  year 2 expenses?

Scenario B: Commence monthly drawdown as a mix of cash/other assets proportionally to their portfolio allocation percentages (let's say 85% growth assets/15% cash for arguments sake) and rebalance at the end of the year, letting the rebalancing do it's thing over time by using the cash to buy the growth assets while they are down etc.?

In Scenario A - what happens if there is an extended market downturn and you get into using the final year 3 cash?

In Scenario B you could be drawing from growth assets during a year as they decline sharply, which doesn't seem sensible, what would you do when faced with a sharp mid year market crash? keep drawing down the growth assets?

Any retirees using either of the above strategies or something different care to share a view?

Linton

My strategy is to put all income, including drawdown, into a short term buffer and take all expenditure from it. So there is no direct link between income and expenditure and no switching between different income sources driven by short term market events. My current account is considered to be part of the buffer.

The need for replenishment is reviewed annually but actually carried out much less frequently.  In my view emptying the short term buffer indicates a strategic failure.  At best it should be a last resort when all else has failed, including cutting expenditure. But I have a much larger short term buffer than you are proposing.

In early pre-SP retirement one factor to consider is maximum use of tax allowances, so get as much money out of your pension at minimum tax as possible. 

GazzaBloom

Linton said:

My strategy is to put all income, including drawdown, into a short term buffer and take all expenditure from it. So there is no direct link between income and expenditure and no switching between different income sources driven by short term market events. My current account is considered to be part of the buffer.

The need for replenishment is reviewed annually but actually carried out much less frequently.  In my view emptying the short term buffer indicates a strategic failure.  At best it should be a last resort when all else has failed, including cutting expenditure. But I have a much larger short term buffer than you are proposing.

In early pre-SP retirement one factor to consider is maximum use of tax allowances, so get as much money out of your pension at minimum tax as possible. 

Interesting point about strategic failure. Calls into question how big the buffer should be and to what unknown future scenarios that may impact the growth/income assets that it and they need to be able to ride through.

Is running down growth asset capital when they have declined to replenish the cash a strategic failure though? It is if you intent to preserve all of the original starting capital, but, not if you aim is to use at least some of the capital to fund retirement. Depleting all of the capital is obviously a strategic failure.

Modelled scenarios using historical data helps.

jim8888

I've followed Scenario A which is working okay, although I keep putting off cashing equities to rebuild the three year buffer in the hope the market improves. But who knows what the market will do? There's no perfect drawdown strategy, there never will be, so to an extent I'm "playing it by ear" and staying flexible. After all, if I'd taken a five year cash buffer I'd now be fretting about inflation. I dithered over drawdown strategies for a year before deciding on what to do that was best for me. As ever, the relief of making a decision and taking action on it went a long way to putting my mind at ease.

Linton

GazzaBloom said:

Linton said:

My strategy is to put all income, including drawdown, into a short term buffer and take all expenditure from it. So there is no direct link between income and expenditure and no switching between different income sources driven by short term market events. My current account is considered to be part of the buffer.

The need for replenishment is reviewed annually but actually carried out much less frequently.  In my view emptying the short term buffer indicates a strategic failure.  At best it should be a last resort when all else has failed, including cutting expenditure. But I have a much larger short term buffer than you are proposing.

In early pre-SP retirement one factor to consider is maximum use of tax allowances, so get as much money out of your pension at minimum tax as possible. 

Interesting point about strategic failure. Calls into question how big the buffer should be and to what unknown future scenarios that may impact the growth/income assets that it and they need to be able to ride through.

Is running down growth asset capital when they have declined to replenish the cash a strategic failure though? It is if you intent to preserve all of the original starting capital, but, not if you aim is to use at least some of the capital to fund retirement. Depleting all of the capital is obviously a strategic failure.

Modelled scenarios using historical data helps.

The intention is to manage any required reduction in growth capital in a controlled manner over time rather than being forced to do so as a result of short term economic circumstances.

In my case a significant part of my income is from fixed rate annuities and so I know I will need to move more money from growth into income funds in the future.  Better, I think, that one's long term growth gains are used for long term purposes rather than continually drained away at possibly the wrong time meeting day to day expenditure.

GazzaBloom

Linton said:

GazzaBloom said:

Linton said:

My strategy is to put all income, including drawdown, into a short term buffer and take all expenditure from it. So there is no direct link between income and expenditure and no switching between different income sources driven by short term market events. My current account is considered to be part of the buffer.

The need for replenishment is reviewed annually but actually carried out much less frequently.  In my view emptying the short term buffer indicates a strategic failure.  At best it should be a last resort when all else has failed, including cutting expenditure. But I have a much larger short term buffer than you are proposing.

In early pre-SP retirement one factor to consider is maximum use of tax allowances, so get as much money out of your pension at minimum tax as possible. 

Interesting point about strategic failure. Calls into question how big the buffer should be and to what unknown future scenarios that may impact the growth/income assets that it and they need to be able to ride through.

Is running down growth asset capital when they have declined to replenish the cash a strategic failure though? It is if you intent to preserve all of the original starting capital, but, not if you aim is to use at least some of the capital to fund retirement. Depleting all of the capital is obviously a strategic failure.

Modelled scenarios using historical data helps.

The intention is to manage any required reduction in growth capital in a controlled manner over time rather than being forced to do so as a result of short term economic circumstances.

In my case a significant part of my income is from fixed rate annuities and so I know I will need to move more money from growth into income funds in the future.  Better, I think, that one's long term growth gains are used for long term purposes rather than continually drained away at possibly the wrong time meeting day to day expenditure.

I get that but I struggle with is "long term purposes" as time rolls on they start to be come near term and that long term growth accumulation could just as easily take a hit just at the wrong time.

GazzaBloom

jim8888 said:

I've followed Scenario A which is working okay, although I keep putting off cashing equities to rebuild the three year buffer in the hope the market improves. But who knows what the market will do? There's no perfect drawdown strategy, there never will be, so to an extent I'm "playing it by ear" and staying flexible. After all, if I'd taken a five year cash buffer I'd now be fretting about inflation. I dithered over drawdown strategies for a year before deciding on what to do that was best for me. As ever, the relief of making a decision and taking action on it went a long way to putting my mind at ease.

Thanks @jim8888 where are you in terms of depletion of your cash buffer so far if you don't mind me asking?

Pat38493

I was watching a video recently which pretty much described approach A.  

"look for profits in the longer term buckets at time of re balancing".  If there aren't any, consider deferring the rebalancing.

The approach was not to make subjective judgments on whether "markets are down" but to look at your own profits in your funds at that time.

Also take a pragmatic approach - if you defer something, you don't necessarily have to defer it for a whole year you could decide to delay the re balancing by a quarter or whatever.

If you just rigidly apply the same rule every time at the same frequency, you might as well just buy a single fund that matches your overall mix as you'll probably get the same long term result.

GazzaBloom

Pat38493 said:

I was watching a video recently which pretty much described approach A.  

"look for profits in the longer term buckets at time of re balancing".  If there aren't any, consider deferring the rebalancing.

The approach was not to make subjective judgments on whether "markets are down" but to look at your own profits in your funds at that time.

Also take a pragmatic approach - if you defer something, you don't necessarily have to defer it for a whole year you could decide to delay the re balancing by a quarter or whatever.

If you just rigidly apply the same rule every time at the same frequency, you might as well just buy a single fund that matches your overall mix as you'll probably get the same long term result.

Sounds sensible @Pat38493, do you have a link to the vid?

Linton

GazzaBloom said:

Linton said:

GazzaBloom said:

Linton said:

My strategy is to put all income, including drawdown, into a short term buffer and take all expenditure from it. So there is no direct link between income and expenditure and no switching between different income sources driven by short term market events. My current account is considered to be part of the buffer.

The need for replenishment is reviewed annually but actually carried out much less frequently.  In my view emptying the short term buffer indicates a strategic failure.  At best it should be a last resort when all else has failed, including cutting expenditure. But I have a much larger short term buffer than you are proposing.

In early pre-SP retirement one factor to consider is maximum use of tax allowances, so get as much money out of your pension at minimum tax as possible. 

Interesting point about strategic failure. Calls into question how big the buffer should be and to what unknown future scenarios that may impact the growth/income assets that it and they need to be able to ride through.

Is running down growth asset capital when they have declined to replenish the cash a strategic failure though? It is if you intent to preserve all of the original starting capital, but, not if you aim is to use at least some of the capital to fund retirement. Depleting all of the capital is obviously a strategic failure.

Modelled scenarios using historical data helps.

The intention is to manage any required reduction in growth capital in a controlled manner over time rather than being forced to do so as a result of short term economic circumstances.

In my case a significant part of my income is from fixed rate annuities and so I know I will need to move more money from growth into income funds in the future.  Better, I think, that one's long term growth gains are used for long term purposes rather than continually drained away at possibly the wrong time meeting day to day expenditure.

I get that but I struggle with is "long term purposes" as time rolls on they start to be come near term and that long term growth accumulation could just as easily take a hit just at the wrong time.

Long term is mainly inflation over the long term rather event that happens in the long term.

A significant part of the strategic adjustment is to move money from growth into income shares so it does not matter much when in the economic cycle that is done.  Also the large buffer gives flexibility on timing.  Moving money from hrowth into the buffer should never be a major emergency action.

LHW99

With regard to option B, I would probably not do monthly sales / withdrawals, but make a single once per year withdrawal to the buffer account. This annual withdrawal would take into account (some of) the performance of the drawdown portfolio over the past 12 months, so could be less if there was no growth, more if things are doing well.

Having said that, I think you would need at least a proportion of your income requirements covered by SP / small DB / annuity. If you were relying on withdrawals at a certain level to fund your whole living costs this scheme wouldn't work well.