Is the 4% rule still applicable today?

Triumph13

westv said:

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.

At the moment annuity rates are good enough that you really need a good reason not to buy one.  There are plenty of such reasons, eg very early retirement or desire to leave a big inheritance, but for most people I would suggest an annuity, at least enough to cover their basic lifestyle, should be the default position.

Mutton_Geoff

The problem I see pinning your numbers on the "4% rule" is that it is US based and for most Americans, the sole source of retirement income whereas in the UK many will have full state pension plus a mish mash of pensions DB & DC. The state pension alone is "equivalent" to a pot of £300,000 from which you can make inflation linked drawdown starting at 4% for the rest of your life.

The SP gives UK SIPP investors much more flexibility since you already have the bedrock of a SP and possibly other pensions to provide for income in retirement.

In my case, I have SP & a DB pension that uses up all of my basic rate tax, all of my SIPP drawdown is thus exposed to higher rate (and above) tax so I draw out a % that brings me up to the insidious 60% rate band. This works out around 4-5% so coincidentally fits the much trumpeted figure but my intention is to adjust that as and when the fiscal drag tax allowances are eventually adjusted upwards and to cut discretionary spending, therefore % drawdown if the SIPP suffers a large drop in value (I'd consider 20% large).

Market performance since retirement (3 years) has preserved the value of the pot even when adjusted for inflation although I appreciate 3 years is a very small window in the investment world.

Bostonerimus1

Mutton_Geoff said:

The problem I see pinning your numbers on the "4% rule" is that it is US based and for most Americans, the sole source of retirement income whereas in the UK many will have full state pension plus a mish mash of pensions DB & DC. The state pension alone is "equivalent" to a pot of £300,000 from which you can make inflation linked drawdown starting at 4% for the rest of your life.

The SP gives UK SIPP investors much more flexibility since you already have the bedrock of a SP and possibly other pensions to provide for income in retirement.

In my case, I have SP & a DB pension that uses up all of my basic rate tax, all of my SIPP drawdown is thus exposed to higher rate (and above) tax so I draw out a % that brings me up to the insidious 60% rate band. This works out around 4-5% so coincidentally fits the much trumpeted figure but my intention is to adjust that as and when the fiscal drag tax allowances are eventually adjusted upwards and to cut discretionary spending, therefore % drawdown if the SIPP suffers a large drop in value (I'd consider 20% large).

Market performance since retirement (3 years) has preserved the value of the pot even when adjusted for inflation although I appreciate 3 years is a very small window in the investment world.

In your first paragraph you have things the wrong way around.

Only 56% of US workers contribute to a DC pension plan, and almost all Americans use the US equivalent of SP ie Social Security, as the foundation of their retirement income. US SS is a more generous benefit than UK SP. For example I qualify for full UK SP which is now about 10k pounds or $14k, but my projected US SS is more than double that at $30k. There is also a landscape of DB pensions in the US in strongly unionized and Government jobs.

The "4% calculations" have been done many times with UK and international stock market returns and the results come with enormous caveats, but for some generic UK type asset allocation the number might be 3.5% , but if you include pension and IFA type fees that might be as low as 2%. Or if you use some variable SWR it might jump up a percent or so overall. This is all highly dependent on the parameters of any model and personal circumstances.

Cus

The 4% 'rule' validity has nothing to do with what is a good idea as of today. To decide that as of today it's better to buy an annuity at a higher rate 'as a comparison' against the 4% rule misses the point of the idea imo.  Sometimes the 4% rule will feel like a stretch, sometimes like now it feels like a bad deal, all that really says is the 4% rule is a guessed safe average ignoring current conditions 

Bostonerimus1

Cus said:

The 4% 'rule' validity has nothing to do with what is a good idea as of today. To decide that as of today it's better to buy an annuity at a higher rate 'as a comparison' against the 4% rule misses the point of the idea imo.  Sometimes the 4% rule will feel like a stretch, sometimes like now it feels like a bad deal, all that really says is the 4% rule is a guessed safe average ignoring current conditions 

All income projections assume that future markets with provide returns similar to historical returns. This is Hume's principle of the "uniformity of nature" and is a requirement for inductive reasoning. It's a very big assumption for investment markets and while the insurance companies are making similar assumptions in pricing their annuities, if you buy one you will be insulated from that uncertainty. Of course what people tend to miss in SWR projections from DC pension pots is that the vast majority of projections at 4% will have ending DC pension pot values higher that at the start. 4% SWR might give a 5% chance of failure ie. zero pension pot before you die, but most of the time you'll be leaving lots of money to your heirs or will be able to spend far more than 4%. With an annuity you give up your capital which could be a big loss of utility. So I think people should partially annuitize to cover some basic spending and leave some capital for emergencies and maybe a legacy.

Mutton_Geoff

Bostonerimus1 said:

.. I think people should partially annuitize to cover some basic spending and leave some capital for emergencies and maybe a legacy.

It wasn't long ago that pensions were wholly intended for the person who worked for it with a smaller spouse benefit should they survive them.

Since "A Day" less than 20 years ago, personal pensions have become more of a vehicle for tax sheltering/legacy benefits.

It is my belief that the government will be viewing this legacy angle with tax £££ in their eyes. It's been an unintended consequence of changes to pension rules and I believe things in the future may tighten up so only the employee and spouse benefit from a the deferred income that is a personal pension.

Bostonerimus1

Mutton_Geoff said:

Bostonerimus1 said:

.. I think people should partially annuitize to cover some basic spending and leave some capital for emergencies and maybe a legacy.

It wasn't long ago that pensions were wholly intended for the person who worked for it with a smaller spouse benefit should they survive them.

Since "A Day" less than 20 years ago, personal pensions have become more of a vehicle for tax sheltering/legacy benefits.

It is my belief that the government will be viewing this legacy angle with tax £££ in their eyes. It's been an unintended consequence of changes to pension rules and I believe things in the future may tighten up so only the employee and spouse benefit from a the deferred income that is a personal pension.

The DC pension was always sold as a way to increase freedom and personal choice, when it was really about off loading risk and costs from the employer to the employee. The UK's DC pensions and ISAs are still fantastic tax sheltered accounts and can form the core of personal financial freedom when used prudently, but the only thing that is sure is change which makes planning difficult...see Hume and "uniformity of nature".

Spend less than you make
Almost never borrow money (only exception is a mortgage)
Invest as much as you can within pensions and ISAs
Educate your children about money and set them up with JISAs asap.

OldScientist

artyboy said:

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.

While I'd suggest that comparing an RPI annuity with inflation linked withdrawals is good a like for like  comparison, otherwise fair enough - each of us has different financial circumstances and requirements - there is no 'one size fits all'

I note that at 57yo, single life RPI annuity rates are currently around 4.3% which is not too shabby. For the same UK portfolio I used earlier, a constant inflation adjusted withdrawal of 4.3% led to around 10% of historical retirements running out after 20 years (i.e. to 77yo) while the median was around 40 years (i.e., to 97yo). Not a risk I would be happy taking, but each to their own.

OldScientist

Bostonerimus1 said:

Cus said:

The 4% 'rule' validity has nothing to do with what is a good idea as of today. To decide that as of today it's better to buy an annuity at a higher rate 'as a comparison' against the 4% rule misses the point of the idea imo.  Sometimes the 4% rule will feel like a stretch, sometimes like now it feels like a bad deal, all that really says is the 4% rule is a guessed safe average ignoring current conditions 

All income projections assume that future markets with provide returns similar to historical returns. This is Hume's principle of the "uniformity of nature" and is a requirement for inductive reasoning. It's a very big assumption for investment markets and while the insurance companies are making similar assumptions in pricing their annuities, if you buy one you will be insulated from that uncertainty. Of course what people tend to miss in SWR projections from DC pension pots is that the vast majority of projections at 4% will have ending DC pension pot values higher that at the start. 4% SWR might give a 5% chance of failure ie. zero pension pot before you die, but most of the time you'll be leaving lots of money to your heirs or will be able to spend far more than 4%. With an annuity you give up your capital which could be a big loss of utility. So I think people should partially annuitize to cover some basic spending and leave some capital for emergencies and maybe a legacy.

Just as an example of the wide range of historical outcomes for UK retirees*, the amount left in the pot (in real terms) after 30 years of running 3.5% withdrawals is shown as a function of retirement start year in the following graph



There were retirements where the portfolio was exhausted before the end of the 30 years period (centred around 1910 and 1937) with the earliest failure occurring after 23 years. However, there are also retirements where the amount in the portfolio was, in real terms, over 8 times larger than the initial portfolio (the median case left a portfolio the same size as the initial value).

* Returns and inflation from macrohistory.net, 60% UK stocks, 20% UK bonds, 20% cash (yes, an international portfolio would probably have done slightly better, but there would still have been a wide range of portfolio values at the end of retirement)

OldScientist

Bostonerimus1 said:

The "4% calculations" have been done many times with UK and international stock market returns and the results come with enormous caveats, but for some generic UK type asset allocation the number might be 3.5% , but if you include pension and IFA type fees that might be as low as 2%. Or if you use some variable SWR it might jump up a percent or so overall. This is all highly dependent on the parameters of any model and personal circumstances.

One could try to summarise the various retirement income tools as follows:

Constant inflation adjusted withdrawals (i.e., SWR) allow certainty in the amount withdrawn on a year-to-year basis but complete uncertainty in how long the withdrawals will last (and no way of predicting the latter).

Percentage of portfolio strategies provide zero certainty in the year-to-year income but the portfolio will last indefinitely (although it might become small).

Hybrid withdrawal strategies (Guyton Klinger being a well known example) reduce the variability of the year-to-year income but retain a small probability that the income will fall to zero.

Inflation protected guaranteed income (e.g., SP, RPI annuity, DB pension) provides complete certainty (in the absence of government default, loss in war, etc.) in both the amount of income and the length of time (i.e., to death) over which the income will be delivered but, in the case of an annuity, potentially at the cost of lower income or smaller legacy in good retirements. Whether the retirement will be good or not is, of course, unknown at the start of the retirement.

As a rule of thumb, fees reduce the SWR by roughly half the amount of the fee (i.e., fees of 50 bp would reduce the SWR by 25 bp). See https://www.kitces.com/blog/the-impact-of-investment-costs-on-safe-withdrawal-rates/