Advisers favour modelling tools over 4% rule for ‘safe’ income drawdown

Jenna Brown reports

Advisers have moved on from the traditional 4% rule when determining safe income drawdown withdrawal rates with a shift towards the use of modelling tools, research finds.

Figures from Aegon and NextWealth showed 38% of advisers now use modelling tools, an increase from 28% last year. The provider said such tools, like cash flow modellers, had become the preferred method to work out the sustainability of retirement income.

Advisers still using the fixed-rate method for withdrawals had fallen from 41% to 37% over the last year and, where it was used, there was an increase in using a rate of less than 4%  – a third using a lower rate (32%) compared to 21% a year ago.

Advisers said modelling tools had become more valuable than ever during the pandemic as they give them the ability to illustrate numerous outcomes. It was especially true during market falls in the first quarter of 2020, they said.

Aegon added the traditional 4% rule could be “inconsistent with cashflow modelling”, particularly if clients have irregular income needs or during a period of volatility.

Other methods, such as basing income on annuity rates or taking portfolio income, have also fallen in popularity, with advisers citing the continuing challenging interest rate environment, said the provider.

Pensions director Steven Cameron said: “The rate at which you withdraw income in retirement is a crucial consideration and advisers look to strike a balance between meeting clients’ current objectives while ensuring they have enough money to maintain an income throughout their life. The research highlights that for the first time more advisers are using modelling tools over a fixed rate to determine a ‘safe’ withdrawal rate.

“Historically, it was common to base a fixed rate on the 4% rule of thumb for those with regular income needs, but advisers are increasingly considering whether adhering to this strategy is the best approach, particularly in volatile markets.”

He added: “Modelling tools allow for a more dynamic way to manage a sustainable income and will have been heavily relied upon during the market downturn at the onset of the Covid-19 pandemic. Furthermore, where a fixed-rate approach is taken, there has been a big increase in advisers using a rate below 4%.”

Aegon and NextWealth surveyed more than 200 advisers on their preferred retirement income withdrawals methods for its Managing Lifetime Wealth: retirement planning in the UK 2021 report.

Tax-free cash

Elsewhere, the report looked at how clients access their 25% tax-free lump sum from defined contribution pensions. It said advisers had a key role to play in helping clients make the most of their money.

The research showed advisers were split on whether clients have taken more or less tax-free cash at the point of retirement over the last three years, with 23% saying less and the same proportion saying more.

Some 79% said “drip-feed” drawdown was the main reason for clients taking less tax-free cash at retirement. It explained this is where proceeds are vested in stages with a combination of drawdown income and tax-free cash.

Another popular reason for deferring taking a tax-free lump sum at retirement is that it can remain invested tax efficiently and potentially provide a higher value of tax-free cash later in retirement, the research added.

“The prospect of being able to take 25% of the full pot as a tax-free lump sum immediately on retirement may look like the obvious choice, but there can be good reasons for taking less immediately and instead, phasing this,” saidCameron.

“Pensions providers have facilitated phased withdrawals through drip-feed drawdown products, allowing advisers to structure flexible withdrawals for their clients through a mixture of tax-free cash and taxable income in a way that best suits their clients’ tax position.”

He added: “The research shows advisers are split on whether people have taken more or less tax-free cash at the point of retirement over the last few years but where they have taken less, use of drip-feed drawdown was the driving force.”