Make sure your pension savings outlast you

published 19 August 2016

Thousands of pension savers taking advantage of the new pensions freedom rules may be at risk of running out of money during retirement because they're drawing too much income from their pension funds. Data from the Association of British Insurers (ABI) suggests that while many savers with income drawdown plans are managing their money carefully, significant numbers are being less prudent.

The ABI said 57% of savers with such plans withdrew less than 1% of their funds during the first quarter of the year. But many savers took out substantially more: 9% almost 7,500 savers made withdrawals of more than 4% during the first quarter, with almost half of those savers withdrawing more than 10%.

Income-drawdown plans have become popular since the pensions freedom reforms of 2015, since they allow people over the age of 55 to take money direct from their pension funds in retirement rather than converting it into income via an annuity. Money that isn't immediately needed can be left invested, in order to generate further growth. Given that annuity rates are now lower than they have ever been, it's not surprising that more savers are opting to do this, with sales of drawdown plans now running 50% ahead of annuity purchases.

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However, while annuities offer a guaranteed income for life, no matter how long the saver lives, income drawdown requires savers to manage their withdrawals so they don't runout of money later in retirement. The ABI's data suggest many savers may be struggling to manage this risk.

The figures don't provide the full picture, since the ABI does not have data on what other savings income drawdown plan-holders have. Those making large withdrawals may have additional sources of income to fall back on. But with the average life expectancy of the typical 65-year-old in Britain now standing at around 20 years, savers making pensions withdrawals at higher rates risk running out of cash, even assuming their remaining savings earn reasonable investment returns.

So how much can pension savers safely withdraw while minimising the risk of running out too soon? Retirement advisers have often cited the work of the US wealth manager William Bengen, who developed the "Bengen rule". This suggests that savers who draw down no more than 4% of their savings from a fund each year stand a good chance of their money outliving them.

However, Bengen's research was based on investment returns in the US during the second half of the 20th century. These now look over-optimistic given both the lower returns of the past 15 years or so and the fact that the US was one of the best-performing markets in the world during the time Bengen studied. For this reason, many financial advisers believe an annual withdrawal rate of between 2.5% and 3% is more prudent. However, in practice, the figures will vary from saver to saver, depending on their individual circumstances.

For example, those with several sources of income may feel more comfortable taking greater risk with drawdown withdrawals than those entirely dependent on their plans. Moreover, savers have a range of options. One possibility is to secure a guaranteed minimum income by using some of your pension fund to buy an annuity while taking the remainder via drawdown.

Other savers could opt for drawdown early in retirement with the intention of purchasing an annuity later on, when rates may be higher if interest rates return to normal levels. These decisions are extremely important and complex, so if you're unsure what to do, consider taking independent financial advice.

David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.