Fiona Tait: My take on sustainable withdrawal rates

Fiona Tait questions the concept of sustainable withdrawal rates for drawdown clients and highlights the importance of ongoing financial advice through retirement

The latest contribution to the debate around sustainable withdrawal rates (SWR) has come from the Institute and Faculty of Actuaries (IFoA), a group who are better qualified than most to opine on such things.

According to their recent policy briefing paper, Can we help consumers avoid running out of money in retirement? a 3.5% per annum withdrawal rate is highly likely to be sustainable for the average 65-year-old retiree. This is slightly lower than the famous Bengen SWR of 4% and the difference has attracted some attention. It is not however what drawdown should be about.

Default pathway?

Since the 2014 budget speech annuities have become increasingly disliked and many people are choosing to drawdown instead, increasingly without taking financial advice. In order to help this group, it has been suggested that default drawdown solutions could be created which protect them against the risk of running out of money too soon.

This is a laudable intention however there is a risk that creating these default solutions could lead people to believe that a drawdown plan is an annuity in all but name, and it’s both more and less than that.

My problem with the so-called SWR is that it suggests:

  1. That it is “safe”, which some people might see as the equivalent of “secure”
  2. That it can be calculated once and followed for life

That does not sound like a drawdown plan, it sounds much more like an annuity.

Firstly, the safe withdrawal rate is not entirely “safe”. However good the science is, it cannot be absolutely sure of what will happen in the future. The IFoA‘s definition of “highly likely” means there is a 90% probability of a £100,000 pot not running out after 30 years. It also shows that in the median scenario the fund would run out at age 100. This is not at all bad but it is not a lifetime guarantee.

Secondly, the 3.5% figure is based on a scenario where income withdrawals start at age 65 and are based on a fixed original fund value. In reality, the fund value will rise or fall according to market conditions and while 3.5% may be a suitable figure in one year, it may not be the year after.

If there is a fall in the markets the individual may find that they need more than 3.5% to meet their expenses in that year; conversely if markets do well a lower percentage might be sufficient or they might like to take more income. The ability to take changing income levels which adapt over time is one of the greatest advantages of income drawdown.

What I’m building up to is that a suitable withdrawal rate should ideally be personal to the individual’s own circumstances, including their likely life expectancy, specific income needs and willingness to take investment risk.

It should also be recalculated on a regular basis to ensure it adapts to changes in those circumstances as time goes on. We do in fact have a phrase for this process – it’s called cashflow modelling.

Rule of thumb

None of this is the fault of the IFoA paper, boiling it down to this single figure is over-simplistic and unfair. If you read it in full you can see that the 3.5% is meant to be taken as a “rule of thumb” and in that context it is very useful.

We no longer have GAD rates so we do have to provide some sort of parameters for people to use as a reality check if they are unwilling or unable to take financial advice. We must simply be careful that it is not seen as any more than that.

The paper also recognises that annuities still have a part to play. Many people still want their plan to simply pay out a predicted level of income for the rest of their lives but also want the possibility of a higher income later on.

This could be achieved either by an annuity underpin, which guarantees the payment of essential income while leaving the remainder invested for potential growth, or by using an annuity to insure against longevity at a selected point later in retirement.

What all of this does do in my mind is to perfectly illustrate the value that ongoing financial advice can offer. No matter how good your science is, it cannot be sure in advance what will actually happen in the future.

Fiona Tait is technical director at Intelligent Pensions