More flexibility in how we access pensions since 2015 mean retirees have far greater control over how much they withdraw each year. Data shows that, on average, retirees are taking between 4% and 10% from their pension annually, but what is a sustainable withdrawal level for you?
The figures from Royal London indicate that some retirees are leaving themselves open to potential financial insecurity later in life. The general rule of thumb is that retirees should take no more than 4-5% of their pension annually to ensure it lasts a lifetime. As a result, some may find they fall short later in life.
However, the headline figures aren’t as simple as that. How you use your pension and what’s sustainable will depend on other assets. The research found that higher withdrawals were usually taken from smaller pensions that had a value of below £25,000. A withdrawal rate of 10% wouldn’t be sustainable for a pension that needed to last a lifetime, but it may be sustainable if it’s being used for a short period before another pot or asset is accessed.
Retirees accessing larger pensions with a value over £250,000, were likely to be doing so at a much lower median rate of 4%, suggesting those enjoying life after work are thinking long term.
Lorna Blyth, Royal London’s Head of Investment Solutions, said: “What the data tell us is that following the introductions of Pension Freedoms there is no such thing as a typical income drawdown customer. Regardless of pot size people are utilising income drawdown to help them structure a retirement income that meets their needs.”
What is sustainable for you?
With responsibility for ensuring a pension provides an income throughout retirement, it’s natural to feel anxious about it. According to a survey, 45% of those aged over 55 are worried about how to fund old age and almost half feel unprepared for retirement.
If you’re not sure how much you should be saving in employment or what you can sustainably afford to withdraw each year, concerns can be expected. But by taking control of your pension and understanding the likely income it can generate in retirement can boost your confidence.
Whilst it’s often stated you shouldn’t withdraw more than 4% annually, the answer isn’t as simple as that. What is a sustainable sum will depend on a variety of factors, including:
1. Life expectancy
No one wants to think about passing away. However, your life expectancy is an important part of calculating how long your pension needs to last and, therefore, what a sustainable withdrawal level will be.
Previous generations may have planned to spend 20 years in retirement. Those just entering retirement now could well see their retirement last 40 years. It means you’re likely to have far more time to spend as you choose, whether that’s travelling, indulging family or investing in hobbies. But it also means you need to carefully manage money to last over an extended period of time.
It’s worth noting here that many people underestimate how long they’ll live. Research shows that people in their 50s and 60s underestimate their chances of celebrating their 75th birthday by around 20%. It’s a misconception that could have serious implications for financial security.
What will your retirement lifestyle look like? Will your income needed to achieve this be the same throughout retirement or will it vary?
Many people looking forward to retirement make significant plans to kick off the milestone. If this is the case, you may find that your initial withdrawal rate would be deemed ‘unsustainable’ under the 4% rule. However, when you factor this lasting for only a relatively short period of retirement, with spending decreasing in the future, it may not harm your financial security.
Here, it’s important to understand what you want from retirement and the long-term consequences of your decisions. Increasing pension withdrawals, even for short periods of time, may affect your future lifestyle. Financial planning can help you see how your wealth and income will be impacted by taking out larger amounts at different points. It’s a process that can give you confidence and the peace of mind to enjoy retirement.
Over you’re working life, it’s likely you’ve accumulated several pensions. Taking a look at the type of pensions they are, and the value of them, may change how you access an income and at what rate.
If you’ve frequently swapped jobs, you may find you have numerous smaller pensions rather than a single large pot. If this is the case, it may be more tax-efficient and simpler from a management perspective to run down a pension before accessing the next one. The Royal London research indicates this is what many retirees are doing when their withdrawal rate would usually be seen as unsustainable.
Alternatively, you may have Defined Benefit pension, which will pay out a defined income for the rest of your life, as well as Defined Contribution pensions. In this case, you may feel comfortable taking large lump sums from Defined Contribution schemes at different points, knowing that a Defined Benefit pension will provide a reliable income source to cover essentials.
4. Other sources of income
It’s rarely just pensions that are used to fund retirement, other assets will play a role too. Including savings, investments, property or alternative assets that you intend to use to provide income is a critical step when retirement planning.
Knowing that you have other assets to draw on at later points or having assets that provide a relatively stable income, may again mean you’re in a position to make withdrawals from a pension that would otherwise be advised against.
If you’re approaching retirement or have already retired and would like to better understand the level of pension income that’s sustainable for you, please get in touch.