More pensioners are choosing to forgo a guaranteed income that comes from an annuity, instead favouring making withdrawals directly from their pension using flexi-access drawdown. While providing more flexibility, the latest data suggests that those using drawdown may face financial hardship later in life.
Ensuring that your savings will support you throughout your later years is a critical part of financial planning. Part of this is making sustainable withdrawals from your pension.
Two years ago, the average pension withdrawal rate was 4.7%. The figure now stands at 5.9%, according to figures from the Financial Conduct Authority (FCA). Retirees are increasingly using their Pension Freedoms to achieve the retirement they want. However, steps need to be taken to ensure it can provide a comfortable income throughout later years.
Taking regular payments or lump sums out of a pension means it needs to generate greater returns to maintain value. Once you factor in other charges of between 1.5-2%, you’re looking at a significant challenge. To ensure the pension maintains value in real terms, you’re likely to need to generate returns of 7-8%.
How much of your pension should you take?
Of course, you expect to use your pension during your retirement years. The challenge is striking the right balance to ensure your savings support you through your entire life. With life expectancy rising and more people needing care, it can be complex.
The first thing to note is there’s no one-size-fits-all figure.
A sustainable level of income for you, reflecting multiple different retirement income sources, may be very different than someone else’s. In practice, a sustainable level of income needs to support you throughout your life, taking a variety of factors into consideration.
You may have heard of the ‘4% rule’, suggesting that you shouldn’t take more than 4% from your pension annually. However, a realistic, sustainable figure could be lower. A typical 65-year-old would need to take their pension at a flat rate of 3.5% to be sustainable, according to research from the Institute and Faculty of Actuaries.
The figure suggests some pensioners might be better off searching for a competitive annuity product over using drawdown.
Six tips when accessing your pension through drawdown
If you’re considering using drawdown to access your pension, taking a sustainable income should be a core priority. These six tips can help assess the level of income you can afford to take.
1. Factor in life expectancy
When assessing retirement income, your life expectancy is key. Underestimate and you could be left struggling financially. But, on the other hand, you don’t want to be living frugally when it’s not necessary. The average person over 50 underestimates how long they’ll live by up to six years, research from Retirement Advantage revealed. The current life expectancy for a 50-year-old is between 86 and 89.
2. Consider taking a guaranteed income
You don’t have to choose between taking a guaranteed income and drawing cash out when you need it. If you’re concerned about your pension lasting a lifetime, a hybrid approach can work, while still offering you flexibility. Using a portion of your pension to purchase an annuity product that will cover basic costs can give you peace of mind.
3. Pause withdrawals
If you plan to take money from your pension at regular intervals, remember to assess your finances each time. If the money isn’t needed, you’ll typically find it’s better left invested. With low interest rates, it’s likely that any cash you hold will decrease in value in real terms.
Whether you still have money remaining from the last withdrawal or are benefitting from other sources of income, a pause means your pension can continue to grow.
4. Match withdrawals to investment performance
With the above point in mind, it’s possible for invested money to decrease in value too. If your pension has experienced a downturn, leaving it invested for a period to recover can be beneficial. Over the long term, your pension investments should increase. However, it’s likely to see temporary decreases at points too, particularly if you’ve opted for a higher risk strategy.
Matching your withdrawals to investment performance, so you don’t withdraw at the low points, can help maximise the value of both your pension and the amount you’re taking out.
5. Regularly monitor your pension
Those people approaching retirement will often keep a close eye on their pension. Don’t let that good habit go once you’re retired.
Regularly taking the time to review your pension, how it’s performing and assessing how much longer it will last is essential. Should you be taking a level of income that’s unsustainable, it means you’ll be aware sooner, allowing you to take the necessary steps to address it.
6. Seek financial advice
Financial advice and cash flow forecasting are your friends. With the information to understand what your income needs are and how this will affect your pension, you’re in a better position to take a consistent, sustainable level of income throughout your retirement years.
If you want to understand how your pension can support you throughout all your retirement, contact us today. We’ll help you assess how much you can afford to take out of your pension in the context of your retirement goals and other assets.