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  • Writer's pictureNoel Watson

Is the 4% safe withdrawal rate still valid for UK retirees - part 2?

Updated: May 9

In part one of this retirement planning series (we recommend starting there if you haven't already read it), we looked at Bill Bengen's research and four 'challenges' specifically related to data issues you might want to consider when evaluating the '4% rule'. In this post, we continue to address these potential challenges; this time, we look at those related to the 'real world'.



Challenge Five: Zero fees


Bill Bengen's research did not make an allowance for investing costs. There are many costs a retiree needs to consider, and 'How much does a financial adviser cost for retirement planning (and am I getting good value)?' looks at these in more detail, including the following:

  • Platform fees

  • Fund charges

  • Discretionary fund manager fees

  • Financial adviser fees

Recall from the previous article that for a 50% stock portfolio with zero costs, the historical safe withdrawal rate (SWR) was 3.37%, with the money running out after around 22 years (eight years short of a 30-year retirement horizon). If we apply a 1% per annum (pa) total cost, the SWR has fallen to 2.99%.


Note that this is less than the 1% reduction in SWR that we might expect. In poor scenarios (i.e. the ones that tend to produce the worst-case historical SWRs), the costs tend to drop along with the portfolio value (assuming the fees are charged on a percentage of the invested assets basis). In contrast, inflation-adjusted withdrawals tend to increase over time, meaning that in these poor scenarios, the costs are relatively small versus the withdrawals and, hence, have a smaller impact than might be expected.


Fees reduce safe withdrawal rate, but not as much as you might expect.
Fees reduce safe withdrawal rate, but not as much as you might expect.

In the worst case, the portfolio is now exhausted after around 18 years, a reduction of four years.


And reduce portfolio sustainability in the worst case.
And reduce portfolio sustainability in the worst case.

Total costs for those using a financial adviser are estimated to be between 1.9% and 2.3% per annum. If we increase the total costs to 2.5% pa (these levels of costs are unfortunately more common than you might expect/hope), the SWR has reduced to 2.47%.


High fees can have a dramatic impact on safe withdrawal rate.
High fees can have a dramatic impact on safe withdrawal rate.

In the worst case, the portfolio is now exhausted after 15 years.


Potentially putting retirement viability at risk.
Potentially putting retirement viability at risk.


Challenge Six: 30-year retirement horizon


Bengen's research looked at portfolio sustainability for a minimum 30-year retirement, which we have used for challenges one to five. Timeline can incorporate the Office of National Statistics (ONS) survival rates, and we can use this option to forecast when either David or Samantha has a survival probability of 10% or less. For David and Samantha, at their retirement ages of 60 and 55, respectively, this would be when Samantha is 100. This increases the retirement horizon from 30 to 45 years.


The impact of the retirement pot having to last for an extra 15 years reduces the SWR from 3.37% (from Challenge One) to 2.91%.


Extending retirement horizon reduces safe withdrawal rate.
Extending retirement horizon reduces safe withdrawal rate.

You can see that in the worst case, the pot runs out a long way before Samantha's 100th birthday, and this scenario assumes zero fees!


The worst case has the pot exhausted less than 50% of the way through the plan.
The worst case has the pot exhausted less than 50% of the way through the plan.


Challenge Seven: Not evaluating whether the money is likely to outlast the retiree


We have so far looked at fixed 30 and 45-year retirement horizons. In the real world, we care about whether or not we outlast our money. We have two variables to consider:

  1. The chance of a retiree's portfolio running out at a given point in time.

  2. The chance of the retiree being alive at this point.

If we look at the 45-year horizon we used in challenge six, the diagram below shows that:


1. The chance of David or Samantha being alive at the end of Samantha's 99th year is 10% (as covered in challenge six).

2. The chance of the portfolio making it this far is 93%.


The chance of David and Samantha being alive at this age and the portfolio running out is, therefore, less than 1%.


(10% chance of them being alive multiplied by 7% portfolio failure rate = 0.7%)


Longevity-adjusted success rate
Longevity-adjusted success rate


Challenge Eight: Not adjusting spending throughout retirement as remaining life expectancy changes


As described above, at the outset, David and Samantha would have to adjust their SWR downwards from 3.37% to 2.91% if they wanted to extend their retirement horizon from 30 to 45 years. But that is just at the beginning of their retirement. How would things look if they were 15 years older (David would now be 75 and Samantha 70) and both in good health? Assuming that inflation and market returns had been reasonable, could they not consider increasing their spending at a faster rate than the initial inflation-adjusted 2.91%? Our original thirty-year horizon had the SWR at 3.37%, and at Samantha's age of 70, they may want to plan for 30 years remaining (which might make our original 30-year 3.37% SWR more appropriate).


It's worth mentioning that as people get older, their life expectancy (which is different from their remaining life expectancy) increases. For example, in the UK, the life expectancy of a 65-year-old male is 85 (20 years remaining life expectancy), according to the ONS.



ONS life expectancy for a 65 year old male.
ONS life expectancy for a 65 year old male.

For a 75-year-old man, this increases to 87 (12 years remaining life expectancy). This is because there was a non-zero chance of them dying between the ages of 65 and 75, and the fact they didn't means their life expectancy increased (although their remaining life expectancy will, of course, reduce).



ONS life expectancy for a 75 year old male.
ONS life expectancy for a 75 year old male.


Challenge Nine: Spending is assumed to increase with inflation each year


Bengen's logic assumed that David and Samantha increased their spending in line with inflation each year. In the real world, spending doesn't necessarily follow this pattern, with spending tending to grow at less than inflation.



Typical changes in expenditure as we age.
Typical changes in expenditure as we age.

If we modify David's and Samantha's spending to increase by 1% less than inflation each year, the starting SWR increases from 3.37% to 3.58%.


Limiting expenditure to 1% less than inflation each year improves safe withdrawal rate.
Limiting expenditure to 1% less than inflation each year improves safe withdrawal rate.


Challenge Ten: Does not allow for spending flexibility


Bengen's annual inflation-adjusted withdrawals method does not cater for spending flexibility. For example, say that David and Samantha want to spend an extra £20,000 five years after retirement to take the family (including their three children and partners) on holiday to celebrate Samantha's 60th. This would be tricky to incorporate into the existing methodology. Would they take the £20,000 and spend £5,000 less over the following four years? The rigid logic does not cater for these real-world spending patterns.



Challenge Eleven: Other income sources are not taken into account


One of the assumptions we made for David and Samantha was that they had no other sources of income. The reality is that most people in the UK will receive some form of state pension. 2019 research suggests that most get at least 75% of the full state pension, which is broadly our experience when dealing with our clients. With the full state pension now over £10,000, a couple with full state pensions could see their gross income increase by over £20,000 per year when they reach their late 60s.


If we add two full state pensions for David and Samantha, we can see that they can now spend over £50,000 per year vs the original £33,700.


Adding the state pension improves safe withdrawal rate of the investment pot
Adding the state pension improves safe withdrawal rate of the investment pot


Challenge Twelve: Dying with too much money


So far, we have looked at worst-case outcomes, which determine the historical SWR. The reality is that there is a vast range of retirement outcomes. Let's revisit challenge one in the previous article, with an SWR of 3.37%. We can see that if David and Samantha start with a 4% withdrawal (£40,000) and increase with inflation each year, the average scenario (blue line) has the investment pot being larger in inflation-adjusted terms (around £1.2 million) at the end of the 30 years than when they started.


The median historical case has David and Samantha dying with a big pot of money.
The median historical case has David and Samantha dying with a big pot of money.

Indeed, in the best case, the investment pot is over six times larger in real terms after thirty years than at the outset.


While the best historical case has David and Samantha dying with a big pot of money.
While the best historical case has David and Samantha dying with a big pot of money.

Put another way, if David and Samantha had retired in 1981, they would have been able to have a starting withdrawal of 11.1%, which is over three times (3.37%) had they started in 1915.


1981 was a great year to retire for David and Samantha!
1981 was a great year to retire for David and Samantha!

It's worth noting that the median outcome allows us to take a 6% inflation-adjusted withdrawal with the money (just!) lasting the entire 30 years.


The median case allThe median case allows a 6% inflation-adjusted withdrawal.ows a 6% withdrawal.
The median case allows a 6% inflation-adjusted withdrawal.

Using a fixed withdrawal rate can have you dying with too much money, which some might feel is almost as bad as running out of money. The Timeline extract below shows the balances for every one of David and Samantha's retirement years when withdrawing an inflation-adjusted £40,000 per annum.


Historical outcome for each year.
Historical outcome for each year.

Our challenge is that we don't know what outcome we will likely experience. David and Samantha may get lucky, or they may not. Luck, in this case, tends to mean a good first decade. This is frustrating for us retirement planners; as you can see from Challenge Nine, spending tends to be highest in early retirement, and we want to encourage our clients to spend their money while they (hopefully) have good health. Unfortunately, at this point, we don't yet know how the first decade will pan out in terms of portfolio returns and inflation and whether we may have a favourable tailwind or a painful headwind!



Challenge Thirteen: Not adjusting spending depending on how "lucky" your retirement outcome is


Following on from challenge twelve, the fixed annual inflation-adjusted withdrawal approach does not allow for flexibility of retirement spending if our early retirement years turn out to be reasonably favourable (or at least not disastrous).


For example, if we take our best case (1981 retirement), after the first (pivotal) decade, David and Samantha's portfolio balance has approximately doubled in real terms. Given this favourable tailwind, they may feel justified in increasing their spending over inflation. Bengen's rigid logic does not allow for this.


The early years are key for determining successful outcomes.
The early years are key for determining successful outcomes.


Conclusion


This article focused on real-world challenges and how they impact the retirement plan. In part three, we look at investor challenges of the 4% rule.



Want to find out more


If you want help building a robust retirement plan, please get in touch.


About us


The team at Pyrford Financial Planning are highly qualified Independent Financial Advisers based in Weybridge, Surrey. We specialise in retirement planning and provide financial advice on pensions, investments, and inheritance tax.

Our office telephone number is 01932 645150.


Our office address is No 5, The Heights, Weybridge KT13 0NY.


Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.




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