Pension drawdowns: why you should forget the 4 percent rule

When it comes to drawing down from your pension, how much is enough? It used to be the “4 percent rule”.   An annual drawdown of 4 percent of your pension would see you through 30 years of retirement without you running out of money.

But the popular rule has been brought into question in recent years by several studies. No longer can you withdraw 4 percent of your pension, index this by inflation and be assured your capital will not be exhausted if you accept a 60/40 equity/fixed interest mix. In fact, closer to 3 percent now looks to be the right ballpark.

With the state pushing back retirement ages, and our lifestyles leading more of us to live longer, it’s harder to know where the balance lies between enjoying retirement to its fullest and facing the terrible prospect of funds running out. Working out a safe drawdown is no longer simple.

The solution? Planning. It pays to look at your retirement like a long-term business plan.

Produce a comprehensive financial plan, outlining your inflows of capital and earnings. Detail as best you can your expenditure, and project this forward with assumed rates of return on capital assets (such as your pension). It’s worth doing this to 100 years old.

Download a spreadsheet to help you organise your finances

How income drawdown works:

• You can choose to take up to 25% (a quarter) of your pension pot as a tax-free lump sum.
• You then move the rest into one or more funds that allow you to take an income at times to suit you. – Most people use it to take a regular income.
• The income you receive might be adjusted periodically depending on the performance of your investments.
• There are two main types of income drawdown product:

Flexi-access drawdown – introduced from April 2015, where there is no limit on how much income you can choose to take from your drawdown funds.

Capped drawdown – only available before 6 April 2015 and has limits on the income you can take out; if you’re already in capped drawdown there are new rules about tax relief on future pension savings if you exceed your income cap.

Source: Money Advice Service

Conduct regular pension reviews before and after retirement

In the first 10 years, it’s likely you will want to travel more often and further afield; therefore, your expenditure for travel and leisure is likely to be higher.

The second chapter begins around 75 and involves less travel. When we approach the third chapter, from 85 onwards, we often consider expenditure such as motoring or taxis and medical expenses.

Pensions remain the most tax-efficient means when planning for retirement. Just make sure you have accrued enough to enjoy the time off.