Making Your Money Last in Retirement
Should you follow the 4% rule?
- How long do you anticipate needing an income for?
- What rate of real return (i.e. taking inflation into account) do you expect from your assets?
- Do you expect to have to draw off any large lump sums that will deplete the pot?
- Are you expecting to receive any other income (e.g. from a State pension or property)?
The Simplest Answer
Were you to leave the £200,000 in cash, earning zero real (post-inflation) return and anticipating that you will make no withdrawals other than the income you need, the calculation would simply divide your capital by the number of years you expect to need the money for. For example, you would like an income for at least 30 years, therefore your £200,000/30 is £6,667 per year. Over 25 years, the answer is £200,000/25 at £8,000, and so on.
The Impact of Different Rates of Return
Introducing an annual return on your money is more realistic for most investors but also complicates things; since we do not know what rate of return we can earn in advance, say from assets such as equities, this income needs to be estimated. The following chart shows how much you could afford to draw off your fund at three assumed annual growth rates over a period of 30 years.
The 4% Rule
Devised by William Bengen, the 4% rule came from a study on the performance of a 60% equity, 40% bonds portfolio. I will side-step all of the detail here to get to the conclusion: over a 30-year period, a withdrawal rate of 4% per annum of a mixed fund should not deplete it within 30 years, provided you adjust for inflation and any dividend or interest distributions received during the year. This conclusion would broadly support the middle band of the chart above.
Does It Work?
Things to bear in mind about the famous study and its well-publicised result are:
- When the study was conducted, inflation and interest rates were higher than they are now
- Life expectancy is rising all the time
- Bengen’s 60:40 equity/bond portfolio may not mirror your own.
My conclusion would therefore be that whilst the 4% rule is a useful starting point and benchmark, a wise investor will want to actively monitor their retirement fund and expectations as market conditions unfold and adjust their rate of withdrawal accordingly.