Is the 4% pension rule dead? Why the 6% rule could replace it

After decades as the go-to pensions rule of thumb, the reign of the 4% pension ‘safe’ withdrawal rate could finally be over, as retirees look to keep their hard-earned retirement savings out of the hands of the taxman – by spending it all.

Many people taking their pension follow the 4% rule – in the first year of retirement, you withdraw 4% of your pension portfolio’s value. Then in the following years you take the same cash amount but adjust for inflation. This is considered a ‘safe’ amount to withdraw without running out of cash.

But for those with larger pension pots the rule is often used to limit how much they withdraw so the remaining pension can be passed on – free of inheritance tax – after they die (and free of income tax too if they die before age 75).

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The 2024 Autumn Budget turned that on its head. From April 2027, unused pension assets will be subject to inheritance tax. Thousands more over-55s have already pulled tax free lump sums from their pensions early as a result. Experts are predicting the trend to cash in pensions early will accelerate ahead of upcoming inheritance tax rule changes.

Andrew King, pensions specialist at wealth management firm Evelyn Partners, said: “It is inevitably the case that given the impending inclusion of unspent pension funds in IHT liability, more people are looking to spend or gift their pensions more quickly than before the Budget announcement.”

Without the need to hold some pension savings back for loved ones to inherit – and potentially pay 40% IHT on – how much more could retirees withdraw and enjoy during their lifetime?

MoneyWeek asked wealth managers Evelyn Partners to crunch the numbers – it turns out the new ‘safe’ withdrawal rate rule to spend it all could be more than 6%.

How much can I withdraw from my pension per year?

There is no limit to how much you can withdraw from your pension each year. But the aim of the game is to make it last as long as you do.

Taking three example pension pots – £100,000, £500,000 and £1 million – in exclusive calculations for MoneyWeek, Evelyn Partners looked at how much applying a 4% withdrawal rate would leave remaining in a pension, versus how much could be taken if the goal was to leave nothing left by age 90.

All assumptions are based on a 67 year old taking retirement and a 6% net investment growth every year.

How much can I withdraw from a £100k pension pot?

With a pension fund value of £100,000, after the 25% tax free cash is taken a fund of £75,000 remains.

If you took a 4% per year withdrawal (£3,000 a year) this would leave you with a fund of £118,267 at age 90.

However if you want the remaining £75,000 pension fund to run out at age 90, the difference would be that you could start taking £4,900 per year at retirement – a 6.5% withdrawal rate.

How much can I withdraw from a £500k pension pot?

With a pension fund value of £500,000, after the 25% tax free cash is taken there is £375,000 remaining.

If you withdrew 4% per year (£15,000 a year) this would leave you with a fund of £591,300 at age 90.

But if you want the remaining £375,000 pension fund to run out at age 90, the difference would be that you could start taking £23,500 per year at retirement – a 6.3% withdrawal rate.

How much can I withdraw from a £1m pension pot?

Finally, if you have a pension fund of £1,000,000, and take the 25% tax free cash, this leaves £750,000 to live on in retirement.

If you took a 4% per year withdrawal (£30,000 a year) this would leave you with a fund of £1,182,000 at age 90.

However if you want the remaining £750,000 pension fund to run out at age 90, the difference would be that you could start taking £44,500 per year at retirement – a 6% withdrawal rate.

Should I spend all my pension now?

Not everyone will be comfortable winding their pension pot down to zero. No one knows how long they are going to live and many people might want to maintain a fund for possible care costs.

But, said King, “these figures are just illustrative of the difference in income that can be withdrawn from a pension if that were the case, compared to the so-called ‘safe 4% rule’, that is in any case merely a popular rule of thumb”.

You can see from the figures above that with a 4% withdrawal rate, there would be substantial left over pension at age 90 that might – as proposals stand, and depending on the size of the estate – be subject to IHT and probably income tax.

Fidelity International recently looked at the effectiveness of the 4% rule in the decade since pension freedoms were introduced ­– the point when many more people were given the option of using invested pension savings to fund their retirement.

Ed Monk, associate director at Fidelity International, said: "We found that someone with £100,000 invested in a portfolio of global shares who took a 4%-a-year income that rises with inflation would have almost £190,000 today. That’s thanks largely to the strong period for markets we have seen, but also confirms how conservative the 4% rule actually is."

The government’s plan to levy inheritance tax on pensions changes "completely the way in which many will look at their retirement savings", Monk said. "Retired savers will now quite rationally be tempted to spend as much of their pension in their own lifetime rather than see it diminished by taxes after they die."

Before they do decide to increase their pension withdrawals, however, savers may want to consider the risk that they could overdo it and run out of money to fund their own retirement – especially in the event of a bear market or a bout of severe inflation, Monk added.

"And also bear in mind that if their withdrawals take them into a higher tax bracket they could end up paying more via income tax rather than IHT," he said.

A professional financial adviser would draw up bespoke and detailed financial plans based on your overall spread of assets and your needs and desires. That might mean a 4% withdrawal rate or something quite different, and the rate of withdrawal could well change through the years of retirement.

“That’s not to say the ‘4% rule is dead’, as in bespoke financial planning it doesn’t really exist as such,” said Evelyn Partner's King, “but as a guide for how much you can or should take out of your pension each year, it is quite blunt and probably now a bit outmoded”.