Why the 4 per cent income rule is flawed

The '4 per cent rule', the amount that retirees can safely withdraw from their pension pots, has been described as outdated.

Most financial advisers stress that a maximum withdrawal rate of 4 per cent is sensible, and that it's preferable for retirees to draw only the income produced by the pension investments (the natural yield) rather than stripping away capital.

The 4 per cent figure, rather than being plucked out of thin air, was based on academic research. The premise is that over any 30-year period the income payments will always be met, increasing in line with inflation.

The overall capital may fall or remain intact, depending on market conditions. But the capital value will last the full 30 years.


William Bengen, a former financial planner, carried out the calculations two decades ago, using a portfolio of 50 per cent in American shares and 50 per cent in American government bonds. Bengen's research found the safe withdrawal rate was 4 per cent.

But research by pension company Aegon and actuarial firm EValue, has found that economic conditions and improvements in life expectancy are casting doubt over the historic rules of thumb designed to help those in drawdown determine a 'sustainable' retirement income level.

Number crunching by the firms found that a 65-year-old entering drawdown in a low-risk portfolio today and taking 4 per cent each year has a one in five chance of running out of money within 30 years.

Instead the 'safe withdrawal rate' should range between 1.7 per cent and 3.6 per cent, concludes the report. The exact figure will largely depend on an individual's risk appetite.

Separate research last year by Morningstar put the 'safe withdrawal rate' for UK pension savers at 2.5 per cent.

The reason why the figure is lower is that bond yields are much lower than when Bengen carried out his study in the early 1990s.

A typical balanced portfolio consisting of 50 per cent shares and 50 per cent bonds is therefore unlikely to generate income of 4 per cent today.


Steven Cameron, pensions director at Aegon, adds: 'The 4 per cent "sustainable income" rule was developed in the US in the 1990s, at a time when interest rates were significantly higher.

'More recent studies in the US and UK have brought this figure down, but any attempt to come up with a single number will never work across a wide range of clients with different life expectancies, risk appetites, and capacity for loss.'

Cameron adds that people who have assets to fall back on outside of their pension may be more comfortable with a higher probability of their pot running dry in retirement, while those relying on it as their sole income will want more certainty.

This sentiment was echoed by Simon Massey, a wealth management director at MetLife UK. According to Massey, those who have 'cash reserves' are better placed to ride out market falls.

He adds that recent research by MetLife UK found around three-quarters of over-45s agree that guaranteed income for life is important, but the trouble is that it is difficult to put a figure on what is a sustainable level of income.

'Those who want to do not want to buy an annuity but would also like some peace of mind should putting some of their pot into guaranteed drawdown,' suggested Massey.

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