Some lament the passing of the pre-pension freedom capped drawdown. However, the capped drawdown limits offered no comfort as to the sustainability of the income being drawn from the investments held.
Bengen’s 4% rule for safe withdrawals is often cited. However, this is derived from historical USA equity and bond returns. Many advisers today use sophisticated modelling tools that show for a particular investment portfolio and income pattern, the probabilities of when the money will run out.
My cent’s worth
Watching the regional news, the other evening, mention was made of a man aged 112 – the oldest man in the world in fact – who had to cancel his birthday celebrations. My wife said she knew people lived beyond 100, but never realised they could live to that age. I pointed out that the oldest person in the UK died in 2018 aged 117.
To what age should you expect to live if you are going to depend almost entirely upon income drawdown for your retirement income? At age 65 it is not a risk-free assessment to assume you will live a further 20 years when you actually might live a further 40 years.
One lesson we learn from the ‘under the bonnet’ calculations that drive Bengen, and the tools that advisers use, is that poor returns in the early years of retirement reduce the period a portfolio will sustain a given pattern of retirement income.
A simple way to illustrate this – if you begin with a portfolio of £100, add 4% return each year, deduct £4 for income and £1 for fees and expenses, you’ll have £99 at the end of the first year.
Repeat this year after year and the portfolio will sustain this pattern for just over 41 years. If you repeat the exercise but incur a 15% loss in year three, (instead of the 4% return) the portfolio will only sustain for 28 years. If the 15% loss occurs in year 37, just over one year is lost from the original 41.
Obviously, many other factors come into play, the above paragraph is simplified to illustrate the point.
Pension freedoms came into being in 2015, so many who have taken advantage of it are still in the early period of retirement. The one thing they did not need however was for markets to plunge in the way they have. They are, therefore, likely to be in need of quality advice.
For those who are saving for retirement the message, keep calm and carry on as before holds true. This, however, is not the case for those in income drawdown.
Some will have been advised to hold a cash reserve. They should consider whether now is the time to call down on that reserve while allowing their portfolio to recover. How long will that reserve last and can they be confident that markets will recover sufficiently to recommence drawing down on the investment portfolio by then?
Others may have their assets segregated. They may find the bonds they hold have not suffered as much as other assets. If they draw their income from those bonds, they could be increasing the risk profile of their portfolio and will need to rebalance the portfolio sometime in the future. I am of course assuming that there is no scope for a significant reduction in spending.
Bricks and mortar
If these options are not palatable or practicable, where does that leave the recently retired? Most who have income drawdown will be homeowners. Downsizing may not be an option until the housing market gets back on its feet. This may take some time after the current lockdown restrictions are lifted. Also, would downsizing be the most efficient solution?
They need to cover their income needs over the next few years while they give their income drawdown portfolio respite until economies and markets get back to some sort of normality.
An equity release drawdown facility could meet many income drawdown customer’s requirements in these times.
However, it may need an investment adviser and a specialist equity release adviser working together to get this outcome. The investment adviser to educate the client as to why their drawdown portfolio needs a period of respite; the equity release adviser to help identify the plan and features that best suit the client’s needs.
The need for holistic retirement income advice may well have arrived.
Bob Champion is chairman of Air Later Life Academy