A story appeared in the media this month saying that the “safe withdrawal rate” for people with a pension pot was just 1.9%… a serious adjustment to the more commonly accepted 4%, if true. Mark Soper investigates.

The term “safe withdrawal rate” has been much bandied about since the advent of pension freedoms. But what is it?

Simply put it is the percentage a retiree can reasonably expect to withdraw from assets (including a pension fund) each year, whilst still ensuring that sufficient assets remain to provide a similar income in the future having taken into account future inflation.

The definition appears straightforward enough… but its calculation is hellishly difficult, as to be an accurate estimate a range of complex factors need to be considered – such as mortality rates, asset allocation, investments returns, length of retirement, changing spending patterns and even geographical considerations…

Much of the historic analysis driving this concept has been conducted in the United States, where for many years the safe withdrawal rate has been deemed to be around 4.0% p.a.

But whilst this rate may be deemed accurate in the US and centred on historical US returns and a fixed retirement period of 30 years, it cannot be applied globally as it is.

So what is a safe rate then?

Recently, Morningstar – a strategic partner of RetireEasy – conducted some detailed research into safe withdrawal rates within the UK market and plotted likely success rates depending upon the asset allocation of the assets and the period of time the withdrawals are required for.

The results were enlightening.

Morningstar calculated that a portfolio with a 40% weighting in equities had an 80% chance of achieving a safe withdrawal rate of 3.2% over a period of 30 years… but if the period was extended to 40 years the rate fell to 2.6%.

On the other hand, based on the same asset allocation and a shorter period of 20 years, the safe withdrawal rate increased to 4.5% p.a.

So what is the big overriding factor here? In a word……uncertainty!

Never mind the uncertainty driven by politics, economics and global events; science tells us we’re all going to live a lot longer… but no one can tell us for how long – and, more importantly, what our health is likely to be like in later life. The latest figures to emerge even suggest a slowdown in the increases in longevity we’ve grown used to seeing.

So what can we do to stay within the “safe withdrawal rate”?

It’s a plain fact of life that, when they do the sums, many would-be retirees recognise that they need to stay in some form of work or make major modifications to their lifestyle.

However, there is increasing evidence that retirees who are more financially able to plan for the rest of their lives are happy to take a more flexible approach. They will withdraw much more than the perceived safe withdrawal rate for an initial period of, say, 15 years when they are more ambitious about what they do with their retirement years. Later on, they curtail their spending when they may be less able to do the things they can today.

It’s fair to assume that lifestyle costs may well be less at age 80 than they are at age 70 – particularly if lifestyle is inhibited by physical limitations.

However, by the same token, spending on medical costs and care may well need to increase later in life… but in this scenario there is growing evidence that retirees feel increasingly comfortable about falling back on the value of their home.

In practice it makes an awful lot of sense to undertake some cash flow planning, based on a given level of spend, to determine how long liquid assets will last throughout one’s lifetime and it is important to review this at least annually.

Flexibility is also key – being able to reduce spending temporarily if markets suffer a setback can make a huge difference to the long-term sustainability of a portfolio.

Working through the possibilities available can be hugely time consuming as well as fiendishly complicated – but using the RetireEasy LifePlan allows you to test out a whole range of scenarios to see in detail how different options will affect your retirement finances.

RetireEasy’s Premium LifePlan allows you to see what effect a Home Downsize  would have on your finances in retirement as well as providing a host of additional features and options.  In addition you can model a Lifetime Mortgage.

Fortunately, everyone with a Premium LifePlan is able to run as many scenarios through the programme as they wish to see how taking a flexible approach to future drawdowns will affect their savings… if you haven’t already tried that out, do!