According to some pension commentators, pensioners are misbehaving. They are putting their pension savings into income drawdown then withdrawing the wrong amounts.
Their observations remind me of my first meeting with my House Master when starting secondary school in the 1960s. He said if I got eight detentions in a year then I’d have an appointment with him with his cane. Go the whole year without a detention and I’d also be seeing him because, as he said: “You are a boy and I will want to know what is wrong with you.”
Are those pensioners enjoying themselves by spending too much, often in excess of 8% of their pension pot, deserving of the cane? They are doomed, they will run out of money before they die. As for those who are not drawing enough – what is wrong with them?
It is not just pension commentators. I have seen a thread on social media where advisers admit to dropping clients for spending more than they recommend.
One of the proposed default drawdown investment pathways, resulting from the Financial Conduct Authority (FCA) Retirement Income Review, is for people who plan to draw a lifetime income in the next five years.
I cannot see any mention in the proposed FCA rules regarding the recommended income that should be drawn to make sure that income is sustainable. A recipe for pensioners doing the wrong thing being created by the FCA?
In the USA there is a rule of thumb known as the 4% rule. It is also referred to as a safe withdrawal rate.
This is the result of academic work undertaken in the 1990s by William Bengen. If you invest a retirement fund, 50% in US Equities and 50% in US Bonds, and withdraw 4% per annum income increasing with inflation, there is a 90% probability of having money left after 30 years. Obviously, these results are only applicable to the USA.
Similar work has been carried out in the UK using UK Equities and UK Bonds. The UK safe withdrawal rate comes out at around 3.5%. But how many have their pension drawdown funds invested 50/50 in UK equities and bonds?
We have a number of naughty pensioners who are not behaving correctly, but who is to say what is correct.
Retirement is all about spending. We see things we want and spend money to get them. You can categorise spending into essential and discretionary. There is also regular and ad-hoc spending. If a person has insufficient income to cover more than their regular essential spending then they will want a regular income stream.
On the other hand, if such spending is covered by defined benefit (DB) and state pensions, and the retiree has a modest defined contribution (DC) pension in addition, are they going to take a regular income from it? Will they hold it as a reserve to cover spikes in their outgoings?
In retirement, houses still need repairing, cars and boilers still need replacing. There are other one-off spending items to cover, that golden wedding anniversary, for example.
When working we cover such items by borrowing. However, if you have saved studiously you do not need to borrow in retirement for such items. Why pay interest to a bank when you can ‘bankroll’ yourself? Large withdrawals will, however, put you in the eight detentions in a year category of pensioner.
The housing factor
The observations made by pension commentators are based purely on pension wealth.
Many retirees have more housing wealth than pension wealth. How they use that housing wealth will impact upon their pension decisions.
They could take their pension tax-free cash sum and live off that while they find a more suitable home for their retirement. If the new house cost less than the one they are selling, they would be advised to live off the balance of their tax-free lump sum and the proceeds of their house move before touching the rest of their retirement pot.
Alternatively, they may have decided to draw 8% of their pension fund for a few years, enjoying their new retirement freedoms. Then in a few years they will cut back and use equity release to fund the remainder of their retirement.
As can be seen, commentary on what people should be withdrawing from their pensions is not helpful. There are many good reasons for not following rules of thumb.
What is required is for commentators to educate the public on the alternatives that may be available to them and how they can fund the dream retirement they have worked hard to enjoy.
Bob Champion is chairman of the Air Later Life Academy