Is the 4% rule still applicable today?

Nebulous2

artyboy said:

GDB2222 said:

artyboy said:

GDB2222 said:

What is the effective tax rate on any money left in the drawdown fund after the pension owner and spouse have died - assuming the IHT nil rate band has been used up?

40% IHT to start with, PLUS the marginal tax rate of whoever it is left to, so potentially as much as a further 45% on top, which comes out at a worst case scenario of 67%

Except that it could be even worse than that, in that once your estate exceeds £2m, your RNRB is reduced by £1 for every £2 of extra estate value (in the same way as personal allowance if you have income above £100k).

Just brings another dimension to the need for effective estate planning!

One solution is to buy an annuity, I suppose.  That’s not very attractive at younger ages, but it would make sense later on. 

I really don't buy that. Invested the right way, you could draw down at a similar rate to what an annuity would pay, but still have the capital at the end of it - yes it would be heavily taxed, but something is still better than nothing.

Annuities are for people that want income
security, I really don't see it as being an effective IHT planning tool.

Nothing is finalised yet, but Dunstonh has previously posted that an annuity with a guarantee period of up to 30 years is likely to escape IHT. 

That gives some security, if you live 30 years you can spend or distribute it, if you don't your heirs will get it. 

Of course the older you are when you take it out, the less likely you are to get the full 30 years yourself. 

kempiejon

ali_bear said:

I thought the idea of a SWR was you can keep withdrawing that amount every year without regard to the ups and downs of markets, no? 

The amount is uplifted by a cost of living factor each year. During the 2009 financial jiggery and 2020 Covid some portfolios fell by >40% and GFC took years to recover, Covid was quicker. You've got to hold your nerve to blindly increase withdrawals for years as the pot withers.

I think investors could use it as a pointer rather than a prescriptive way to manage deaccumulation and of course people invest differently.

Triumph13

Nebulous2 said:

artyboy said:

GDB2222 said:

artyboy said:

GDB2222 said:

What is the effective tax rate on any money left in the drawdown fund after the pension owner and spouse have died - assuming the IHT nil rate band has been used up?

40% IHT to start with, PLUS the marginal tax rate of whoever it is left to, so potentially as much as a further 45% on top, which comes out at a worst case scenario of 67%

Except that it could be even worse than that, in that once your estate exceeds £2m, your RNRB is reduced by £1 for every £2 of extra estate value (in the same way as personal allowance if you have income above £100k).

Just brings another dimension to the need for effective estate planning!

One solution is to buy an annuity, I suppose.  That’s not very attractive at younger ages, but it would make sense later on. 

I really don't buy that. Invested the right way, you could draw down at a similar rate to what an annuity would pay, but still have the capital at the end of it - yes it would be heavily taxed, but something is still better than nothing.

Annuities are for people that want income
security, I really don't see it as being an effective IHT planning tool.

Nothing is finalised yet, but Dunstonh has previously posted that an annuity with a guarantee period of up to 30 years is likely to escape IHT. 

That gives some security, if you live 30 years you can spend or distribute it, if you don't your heirs will get it. 

Of course the older you are when you take it out, the less likely you are to get the full 30 years yourself. 

Ordinary annuities can also help with IHT by freeing up money for gifting if the annuity rate is higher than the SWR.  If a 70 year old can get a 6% indexed annuity rather than a 3% drawdown, then they can potentially gift half their capital  - tax free if they live another seven years.

That's an extreme example, but it's probably fair to say that the more of your needs /wants are covered by guaranteed income, the more comfortable you can be with gifting capital early.

GDB2222

artyboy said:

GDB2222 said:

artyboy said:

GDB2222 said:

What is the effective tax rate on any money left in the drawdown fund after the pension owner and spouse have died - assuming the IHT nil rate band has been used up?

40% IHT to start with, PLUS the marginal tax rate of whoever it is left to, so potentially as much as a further 45% on top, which comes out at a worst case scenario of 67%

Except that it could be even worse than that, in that once your estate exceeds £2m, your RNRB is reduced by £1 for every £2 of extra estate value (in the same way as personal allowance if you have income above £100k).

Just brings another dimension to the need for effective estate planning!

One solution is to buy an annuity, I suppose.  That’s not very attractive at younger ages, but it would make sense later on. 

I really don't buy that. Invested the right way, you could draw down at a similar rate to what an annuity would pay, but still have the capital at the end of it - yes it would be heavily taxed, but something is still better than nothing.

Annuities are for people that want income
security, I really don't see it as being an effective IHT planning tool.

It depends on life expectancy. If that’s 5 years, say, most of the drawdown is capital, and very little is from investment.  The variability in lifespan is very significant. 

Bostonerimus1

Johnnyboy11 said:

Bostonerimus1 said:

MallyGirl said:

Hence the shift in my mindset to drawdown all I can up to the 20% threshold, putting excess into an ISA. At least then our daughter will only have to pay the 40% IHT and not also get hit paying income tax on any that is left.

This is also my strategy. I face a couple of issues being in the USA and thinking about a return to the UK. The UK has a higher top rate of tax and the US mandates a certain level of withdrawals from DC accounts at age 75. So I'm paying US tax on DC withdrawals at a marginal rate of 22% now so I can get it into a "ROTH" DC retirement account which is tax free in the USA and the UK. However, right now the US IHT on my estate would be 0% and if I move back to the UK it would be 40% on most of it. To avoid some of that 40% tax hit I'm giving to family members before I move to the UK to make use of the generous gift rules in the US.

If you haven't already done so, do have a look at the new IHT rules that replaced UK Domicile in April this year. Assets held overseas are free from UK IHT until you become UK Long-term Resident (UK Resident for 10 or more of the last 20 UK tax years).

Yes, this is an area where I expect to pay for some professional US/UK tax advice before I do anything. I'm constrained to keep most of my money in the US even if I do move back to the UK because of the lack of investment options a US citizen has outside of the US. I'm a UK citizen and was born in the UK, but I've acquired US domicile so I think I won't be classed as UK Long Term Resident until I've lived there for 10 years, but I hope to live longer than that so my default planning assumes I'll be fully exposed to UK IHT on my worldwide assets.

Bostonerimus1

ali_bear said:

I thought the idea of a SWR was you can keep withdrawing that amount every year without regard to the ups and downs of markets, no? 

The Bengen/Trinity types of SWR models are full of caveats and assumptions. They do spit out an inflation linked beginning percentage withdrawal from a pot of money that has a good historical probability of not eating all your capital given sets of 30 years of the last 100, but they are to be used with extreme caution. These models use historical data and so a basic assumption is that the statistics of future investment markets will be the same as previous ones. Hume tells us that "uniformity of nature" is a requirement for inductive reasoning and it's considered essentially true in most sciences, but I think it's a big assumption for stock and bond markets statistics and interest rates. Another massive fly in the prediction ointment is how the retiree manages their money. So maybe the real question should be whether the "4% rule" ever made much sense at all.

So the "4% rule" is a planning starting point. Every retiree goes on a different withdrawal path and some might continue with 4% plus inflation in times of serious market down turns, but many will moderate their spending.

OldScientist

artyboy said:

GDB2222 said:

artyboy said:

GDB2222 said:

What is the effective tax rate on any money left in the drawdown fund after the pension owner and spouse have died - assuming the IHT nil rate band has been used up?

40% IHT to start with, PLUS the marginal tax rate of whoever it is left to, so potentially as much as a further 45% on top, which comes out at a worst case scenario of 67%

Except that it could be even worse than that, in that once your estate exceeds £2m, your RNRB is reduced by £1 for every £2 of extra estate value (in the same way as personal allowance if you have income above £100k).

Just brings another dimension to the need for effective estate planning!

One solution is to buy an annuity, I suppose.  That’s not very attractive at younger ages, but it would make sense later on. 

I really don't buy that. Invested the right way, you could draw down at a similar rate to what an annuity would pay, but still have the capital at the end of it - yes it would be heavily taxed, but something is still better than nothing.

Annuities are for people that want income
security, I really don't see it as being an effective IHT planning tool.

While I largely agree with your second statement (and, additionally, that an annuity might, depending on selected options, reduce the amount of legacy in the event of an early death - although see below), I don't think your first paragraph tells quite all of the story.

To take an example, current single life RPI annuity rates at 67yo are about 5.5%.

Using an inflation adjusted withdrawal rate of 5.5% (with 60% UK stocks*, 20% UK bonds, 20% cash), in the worst case, the portfolio was exhausted after 12 years, in 10% of historical cases it was exhausted after 16 years, and in 50% of cases exhausted by 25 years. In other words, historically there would have been quite a few cases where the portfolio would have been exhausted very early.

If only 3.5% was required for income, then spending about 60% of the portfolio on an annuity and using the remaining 40% to provide legacy (since they may be no need to spend from it) would be an alternative

* I've used returns and inflation from macrohistory.net. Yes, I'm aware that an international portfolio would produce better results ('how much better?' is then an important question, to which I don't have the answer), but I've also ignored platform and fund fees (likely to total around 15-50 bp in a modern SIPP).

OldScientist

kempiejon said:

ali_bear said:

I thought the idea of a SWR was you can keep withdrawing that amount every year without regard to the ups and downs of markets, no? 

The amount is uplifted by a cost of living factor each year. During the 2009 financial jiggery and 2020 Covid some portfolios fell by >40% and GFC took years to recover, Covid was quicker. You've got to hold your nerve to blindly increase withdrawals for years as the pot withers.

I think investors could use it as a pointer rather than a prescriptive way to manage deaccumulation and of course people invest differently.

You're right about the necessary nerve. The following shows the current portfolio value (in real terms as a percentage of the initial portfolio, %IPV) in the upper panel and real withdrawal rate in the lower panel for the first 10 years of a UK retirement starting in 1970*.


While the first few years of the retirement are rather calm (withdrawals taken, real value of the portfolio not too far from what it started at), by 1975 is had reduced to 40% of the original value (in real terms). It would take a strong stomached investor to withdraw the 3.5% real in 1975. Of course, the portfolio recovered somewhat from 1976 to the end of the decade but was still much reduced from the original value (as it happens, anyone holding their nerve would have found that the portfolio survived for at least 45 years, i.e. to 2015).



* Returns and inflation from macrohistory.net and a portfolio of 60% UK stocks, 20% UK bonds, and 20% cash (of course, the answer would have been different with an international portfolio, although good luck with holding a low cost, diversified world portfolio in 1970).

artyboy

OldScientist said:

artyboy said:

GDB2222 said:

artyboy said:

GDB2222 said:

What is the effective tax rate on any money left in the drawdown fund after the pension owner and spouse have died - assuming the IHT nil rate band has been used up?

40% IHT to start with, PLUS the marginal tax rate of whoever it is left to, so potentially as much as a further 45% on top, which comes out at a worst case scenario of 67%

Except that it could be even worse than that, in that once your estate exceeds £2m, your RNRB is reduced by £1 for every £2 of extra estate value (in the same way as personal allowance if you have income above £100k).

Just brings another dimension to the need for effective estate planning!

One solution is to buy an annuity, I suppose.  That’s not very attractive at younger ages, but it would make sense later on. 

I really don't buy that. Invested the right way, you could draw down at a similar rate to what an annuity would pay, but still have the capital at the end of it - yes it would be heavily taxed, but something is still better than nothing.

Annuities are for people that want income
security, I really don't see it as being an effective IHT planning tool.

While I largely agree with your second statement (and, additionally, that an annuity might, depending on selected options, reduce the amount of legacy in the event of an early death - although see below), I don't think your first paragraph tells quite all of the story.

To take an example, current single life RPI annuity rates at 67yo are about 5.5%.

Using an inflation adjusted withdrawal rate of 5.5% (with 60% UK stocks*, 20% UK bonds, 20% cash), in the worst case, the portfolio was exhausted after 12 years, in 10% of historical cases it was exhausted after 16 years, and in 50% of cases exhausted by 25 years. In other words, historically there would have been quite a few cases where the portfolio would have been exhausted very early.

If only 3.5% was required for income, then spending about 60% of the portfolio on an annuity and using the remaining 40% to provide legacy (since they may be no need to spend from it) would be an alternative

* I've used returns and inflation from macrohistory.net. Yes, I'm aware that an international portfolio would produce better results ('how much better?' is then an important question, to which I don't have the answer), but I've also ignored platform and fund fees (likely to total around 15-50 bp in a modern SIPP).

It's not a perfect like for like by any stretch, and as I mentioned, it does require the 'right' investment strategy and possibly a bit of luck. But then I refer you back to the second point I made about annuities being for those that want certainly... that you agreed with 

In my case I'd be looking at starting withdrawals at 57 rather than 67, and were I to go the whole hog and withdraw £100k a year based on a 'drain and give away' approach, it would be more like a 6-7% withdrawal rate anyway, increasing every year (barring some spectacular investment returns!). Fair to say that won't exactly be on the breadline, even if it ran out in 15 or so years.

westv

At the current time a RPI annuity (whether joint or single) provides a better income than any of the suggested drawdown rates floating around. That could change of course and an annuity leaves no pot of gold for descendants after you and your other half are dead.