Whatever stage of life my clients are at, they share one common concern: what are the chances of running out of money in retirement?
It doesn’t matter whether they have a few years work left, or they are well into their seventies. Everyone wants the confidence that they have enough money to enjoy the retirement lifestyle that they want.
Of course, there’s no simple answer to the question. It depends on a wide range of factors, ranging from how healthy you are to how conscientiously you saved for your retirement. However, there are some common factors to consider. Let’s start by looking at three reasons you might run out of cash when you retire.
3 reasons you might run out of money in retirement
- Taking too much, too early
One of the main reasons people run out of money in later life is because they deplete their pension savings too quickly.
According to data from the Financial Conduct Authority (FCA), the number of pension pots emptied at the first time of access in 2019/20 rose to 375,500 – up 5% from the previous year. While nine out of ten pots were worth less than £30,000, that’s still hundreds of thousands of people taking an entire pension pot in one go.
Studies have also found that more than two-fifths (42%) of regular withdrawals were being taken at an annual rate of 8% or more of the pot value. As we’ll see shortly, a sustainable rate for withdrawals is significantly lower than 8%. If you’re taking 8% of your pension savings annually, you’re highly likely to run out of money.
- Underestimating how long you’ll live for
A generation or two ago, retiring at 65 meant your pension might have to last you, if you were lucky, ten or fifteen years.
Now, if you retire at 55 you could easily find that your savings have to last you 30, 40 or even 50 years.
Most people at retirement age underestimate their chances of living until 75. Research shows that men who were born in the 1940s have an 83% chance of reaching this age. For women, it is 89%.
If you’re retiring in 2030, your pension pot is, on average, going to have to last you between 20 and 25 years. It’s important to factor this into your planning.
- Not taking advice
A study by financial analysts Moneyfacts found that clients who drawdown pension savings without taking financial advice are three times more likely to run out of money compared to advised clients.
This is because a greater proportion of retirees who did not take advice are withdrawing their savings at what is likely to be an unsustainable rate.
Moneyfacts head of pensions Richard Eagling says: “Drawdown has many appealing qualities for those seeking to maximise flexibility in their retirement planning but one of the key trade-offs is that individuals have to take on longevity risk for themselves.
“The fact that those individuals going it alone with their drawdown strategies are almost three times more likely to have depleted their fund compared with those taking professional advice should be a red flag moment.”
Canada Life technical director, Andrew Tully, agrees. He says: “The pension freedoms continue to be hugely popular but with this freedom and choice comes huge personal responsibility…we continue to see a drift away from financial advice as people choose to DIY drawdown…at what most professionals would argue is an unsustainable rate of income.”
Taking sustainable withdrawals
One of the key ways that you can ensure you don’t run out of money when you retire is to ensure the withdrawals you’re taking from your pension fund are sustainable.
Back in 1994, Bill Bengen established a framework for drawing down income in the form of a Sustainable Withdrawal Rate (SWR) of 4%. This rate is a percentage of the initial withdrawal, and then ongoing amounts are then adjusted for inflation.
Using US historical data, Bengen established that an initial withdrawal of $40,000 from a $1,000,000 portfolio invested in 50% US Equities and 50% US Intermediate Bonds, and then subsequent 4% withdrawals, would have seen the fund last 30 years, in the very worst-case scenarios.
This ‘4% rule’ has been a useful rule of thumb for many years and explains why retirees taking above this level are at risk of depleting their fund. FCA retirement income data has shown that 40% of withdrawals were at an annual rate of 8% or more.
However, while Bengen’s idea is useful, it’s important to stress that the 4% rule itself does not apply to everyone for the following reasons:
- Your portfolio is likely to be different to the one used to establish the SWR. The mix between equity, bonds, and other mainstream asset classes makes a difference to the sustainability of the withdrawal
- You may have longer or shorter time scales than the 30 years used in Bengen’s research
- You must account for the investment fees and taxes you’ll pay.
When you work with a financial planner to ensure you won’t run out of money in retirement, they will help you to develop a sustainable withdrawal strategy unique to you, your goals, and your circumstances.
Managing withdrawals is a delicate balancing act and there are lots of decisions to make including:
- Your withdrawal strategy – This should include consideration of future changes and how to deal with one-off lump sum withdrawals over and above your normal income needs.
- Your longevity – This is an estimate of how long you’re likely to live.
- The ‘success rate’ – This considers the chances that you may run into market conditions that would force you to adjust withdrawals in the future, if you want to avoid running out of money.
- The portfolio management strategy – This should include asset allocation, rebalancing, what proportion of portfolio (if any) to hold as a cash buffer, tax wrappers, and what order you’ll sell from asset classes.
- Any legacy you want to leave.
Get in touch
Former Pensions Minister, Steve Webb, recently told Money Marketing: “There is no doubt that crude rules of thumb about straight line withdrawal rates are no substitute for decent financial advice in retirement.”
As we have seen, taking financial advice on retirement makes it much less likely that you’ll run out of money when you retire. Find out what we can do for you – contact us today or call 01372 404417.