An outdated 'golden rule' for income drawdown could leave some pensioners penniless, insurers are warning.
Back in 1994 a US study produced the ‘4% rule’ which stated that someone who left their pension invested in the stock market could afford to withdraw 4% a year to fund their lifestyle without running out of cash.
However, new research from pension firm Aegon and actuarial firm EValue found that a 65-year-old withdrawing 4% of their initial pension pot each year now stands a 20% chance of running out of money later in life.
The introduction of pension freedoms back in 2015 has led to over a million pensioners accessing their pension pots and withdrawing cash to fund their retirement.
Income drawdown, which allows you to keep your pension invested but to withdraw a regular income, has been used to take £9.2 billion since April 2015. It’s feared the majority of those withdrawals may not have been thought through properly.
Just 20% of people accessing their pensions take professional financial advice with the rest relying on their own assessment of their income needs and investment skills to fund their later life.
Why the 4% ‘golden rule’ doesn't stack up
The problem is today’s combination of increased life expectancy and lower interest rates mean withdrawing 4% of your pot a year puts you in great risk of burning through your pension and being left with nothing in the last years of your life.
A 65-year-old withdrawing 4% of their initial pension pot each year stands a one in five chance of running out of money if they live to be 95 according to analysis by Aegon and EValue.
“Planning a retirement income to last a lifetime requires careful thought and those tempted to ‘do it themselves’, taking an income based on the historic 4% rule of thumb, need to be aware of the risks of running out of money,” says Steven Cameron, pensions director at Aegon.
“The 4% rule was developed in the US in the 90s, at a time when interest rates were significantly higher.”
The research found that an annual income rate of between 1.7% and 3.6%, depending on your life expectancy and investment strategy was more likely to leave you with enough money to get you to the end of your days.
How to make your pension last
Working out how much you can afford to take out of your pension each year and leave enough to fund you for decades is incredibly difficult.
You need to factor in your attitude to risk, forecast life expectancy, consider future care costs and estimate how your pot will grow.
Get your sums wrong and you could find yourself running out of money just at the point in life when you need plenty of cash to cover increasing care costs.
“For such an important decision, we always recommend people speak to a financial adviser who can offer a personal recommendation,” says Cameron.
“Advisors can also keep a close eye on how investments are performing as well as reviewing changes in personal circumstances, suggesting changes to income, whether up or down on an ongoing basis.”