How much should you be taking out for pension?
Could you live comfortably on a 4% drawdown from your investment pot?
If so, happy retirement. If not, keep plugging away.
The 4% is the magic figure financial planner William Bengen came up with in a study in 1994. Based on a study over 75 years' worth of returns, Bengen found that retirees who draw down no more than 4.2% in the first year, and adjust that amount in subsequent years for inflation, stand a good chance their money will outlive them.
He also found that retirees who draw down 5% a year run a 30% chance their investment pot will bite the dust before they do.
Since then, his analysis has been disputed in both ways. It's seen as being a bit too mean for some people who, quite understandably, want to take out a big chunk on retirement and work their way through their money while they're still willing and able to. On the other hand, it's been criticised as being too generous in today's world of near meaningless interest rates, when trustworthy gilt yields are tiny.
The 1998 "Trinity Study" agreed with the 4% safe withdrawal rule-of-thumb. It concluded that in a retirement portfolio that includes a mix of stocks and bonds, then 4% works well over the long run.
This study accepted that withdrawals may exceed the income earned, and the value of the portfolio will shrink during bear markets. It also assumed that the portfolio needs to last 30 years.
What about me?
The 4% rule seems a good one to live by if you can, and if you like the idea of your capital staying in place.
But the truth is there is no "one size fits all" approach. It all depends whether you want to whittle away your capital while you can, or leave it in place for your dependents or your care if you live a very long time.
Of course, it also depends on what you perceive that you need to live on. I'm sure we all know people in retirement from both ends of the spectrum. There are those who spend nothing like 4% of their non-home assets annually as they're trapped in a penurious lifestyle that was a real necessity earlier in life. Then there are those who live to the financial maximum while they still can.
So the 4% rule has to be taken for what it is -- a guide to stick to if you want your investments to pay your way and to stay in place.
Fools do better
I would imagine that most Fools do a lot better than 4% as an overall measure of capital growth. But then most Fools probably aren't typical of the population as a whole; I would guess they're a lot better informed than average, with generally larger pension pots.
I certainly hope so anyway. The latest data from the Department for Work and Pensions show that just 38% of working-aged people in the UK are saving into private pensions; the lowest level for a decade.
There are lots of shares around that will give you much better than 4% return in dividend yields if they're sustainable. But what about inflation? Funnily enough, the Consumer Prices Index was running at exactly the same rate (4.2%) as Bengen's suggested pension draw-down in December. So if you're okay at 4.2%, you should theoretically be treading water at least. But you're going to have to just beat 4.2% as an annualised return to stand still and take an income while keeping pace with the rising cost of living.