How Reliable Is The Safe Withdrawal Rate Rule?

The concept of a safe withdrawal rate (SWR) is well known and often used in retirement planning. It refers to the maximum rate at which one can withdraw money from their retirement savings without the pot depleting during their lifetime.

The most common figure used is 4%; meaning, if you withdraw 4% of your retirement portfolio in the first year of retirement, and then adjusting for inflation in subsequent years, the pot is likely to sustain you at, and through retirement.

Whilst the 4% rule is easy to understand and can help investors reduce the risk of running out of money, it may not necessarily be the most suitable approach for everyone.

As you can see below, from data produced by the FCA; in practice, many retirees are choosing not to follow this rule and, in some cases, there may be a clear and valid justification for this.

When both stocks and bond prices fell significantly back in 2022, portfolios made up of 50% equity and 50% bonds, fell by around 16% that year. What made matters worse in 2022 was the fact that inflation had reached double digits, which meant that retirees were having to take higher amounts from their shrinking pensions.

Poor market performance in the early years of retirement can significantly impact the sustainability of withdrawals over the long term so it’s important to be mindful of this and where possible, avoid drawing down from your pension during downturns in the market.

How can this be avoided?

What the FCA data does not show is the wider financial circumstances of an individual retiree such as their tax situation, their needs and objectives. Some may be funding their day to day living costs in retirement using state pensions, annuities or defined benefit schemes. As part of their retirement plan, they may have chosen to use their defined contribution pot to meet certain ad hoc larger expenses such as children’s weddings, holidays or house renovations. There may be certain years in which they don’t take anything at all and other years where they do need to dip in and go over and above that ‘safe withdrawal rate’.

On the other hand, if you have very little in the way of ‘guaranteed’ income and are using your defined contribution pensions alone to fund your retirement lifestyle, it’s imperative to understand the implications of taking large withdrawals as you are likely to see your pension pots deplete and not sustain you through retirement.

When considering making withdrawals from your pensions, it’s important to look at other assets you may have, and compare the income and inheritance tax implications of the withdrawal amount. A UK pension can be a highly efficient vehicle for inheritance tax planning as it is typically outside of the estate for UK inheritance tax purposes. This being the case, it may be more appropriate to draw down from other non-pension assets first.

Balancing the 4% Rule with Personal Circumstances

The safe withdrawal rate, particularly the 4% rule, provides a valuable framework for retirement planning and is simple and easy to understand. However, retirees should be aware of its limitations and maintain a flexible approach in their withdrawal strategies, that adapts to their personal circumstances and changing economic conditions.

Speak To Skybound Wealth Management Now

As international financial planners, Skybound Wealth can help you to build a tailor-made withdrawal plan that considers your expat status and future plans to help ensure your needs and objectives are met.