For the last two decades, the most widely used ‘rule of thumb’ when it comes to drawing on a pension pot in retirement has been the 4% rule – the assumption that for most people, drawing at a rate of 4% of the original pot, increasing each year in line with inflation, should be a sustainable approach.
A number of recent shifts, notably that we are now living in an ultra-low interest rate environment as a result of Quantitative Easing, means that this 4% rule is no longer sustainable for many people.
While there has been extensive analysis of the rule much of this doesn’t factor in investment and adviser charges and is focused primarily on the US market which has different conditions to the UK. This paper aims to take a fresh and current look at the issue using a simulation model to test various outcomes of different withdrawal rates.
Key findings include:
- Sticking to a 4% rule is three times more likely to lead to failure (ie running out of money) than in the market conditions of a decade ago
- Investment strategies and model portfolios in retirement need a complete review
- Higher allocations to growth assets need to be considered
- The impact of expenses has a very significant bearing on outcomes in a zero interest rate world
The report also has a number of recommendations, including:
- Investment strategies, drawdown portfolios and spending rules need to be reviewed, as the world has changed dramatically in the last decade
- Wealth managers and the financial services industry should review whether fee levels have adjusted sufficiently to reflect the new environment of low interest rates and low inflation;
- Government and regulators should support and incentivise those who are willing and able to work beyond traditional retirement ages to make their retirement pot more sustainable
