A Sobering Income Drawdown Demonstration One Year On

When we left our UK Invested Income Drawdown dependent Retiree’s a year ago there was trouble afoot.  Our 4% Withdrawal Rate Retiree, which remember is the Safe Withdrawal Rate (SWR) Rule of Thumb many talk about and even use, was particularly vulnerable having lost between 11% and 24% of wealth in only 6.5 years.  Since then a couple of notable things have occurred:

• The 2014 budget saw the income drawdown rules again altered.  From the 27 March 2014 retiree’s are now able to withdraw from their pensions at the rate of 150% of the Government Actuary’s Department Tables (GAD Tables).  Additionally flexible drawdown, allowing unlimited withdrawals from your pension pot, is now available for anybody with a guaranteed income of £12,000.  Then from April 2015 these rules will change again and allow unlimited access to our pensions from age 55.
• The second is that Professor Wade Pfau published research showing a UK retiree positioned with a 50% UK Equities/50% UK Bonds portfolio and drawing down using the 4% SWR rule of thumb would actually run out of wealth 23.8% of the time within a 30 year period.  Scary stuff given how loosely the 4% Rule is bandied around the personal finance blog world these days.  Professor Pfau then calculated that if history should repeat (and of course past performance is not necessarily indicative of future results) then to ensure you don’t run out of money over a 30 year period your withdrawal rate before investment expenses and taxes are deducted has to actually be less than 3.05%. 

Going forwards this is going to make life interesting.  For a retiree to draw down £24,856, the equivalent of current average UK earnings (Office for National Statistics KAB9 dataset), requires wealth (including Pensions, ISA’s and non-tax efficient investments) of £814,950 if we are to minimise depletion risk over 30 years according to Pfau’s research.  At the same time from next year we can grab whatever we like from a pension pot that on average only contains £36,800 at retirement according to the Association of British Insurers.  Of course many of us don’t just save in pensions (for example only 43% of my wealth is in a Pension of which only 14% is sitting with expensive inflexible insurance companies) and of course not all of us will withdraw crazy amounts to buy Lamborghinis (if the rules haven’t changed I’ll be withdrawing as much as possible to keep my total earnings just below the Higher Rate tax limit with the difference between spending and withdrawal being put into an ISA) but it’s probably uncontroversial to suggest it does have the potential to leave the uneducated very exposed.

With that in mind let’s look at how our UK Invested Income Drawdown dependent Retiree’s are doing one year on.  For consistency all assumptions are unchanged.  Re-emphasising some of these assumptions:

• Our Retiree’s are drawing down at the stated withdrawal rate plus investment expenses.  This means any trading commissions, wrapper fees, buy/sell spreads and taxes have to be paid out of the earnings taken.  For example, our 2% Initial Withdrawal Rate Retiree is actually drawings down at between 2.25% and 2.36% dependent on the asset allocation selected.   
• All calculations are in real (inflation adjusted) terms meaning that a £ in 2006 is equal to a £ today.
• 6 Simple UK Equity / UK Bond Portfolio’s are simulated for our retiree.  The UK Equities portion is always the FTSE 100 where the iShares FTSE 100 ETF (ISF) is used as the proxy.  For the bonds portion a simulation is run against UK Gilts (FTSE Actuaries Government Securities UK Gilts All Stock Index) where the iShares FTSE UK All Stocks Gilt ETF (IGLT) is used as the proxy and the bond type I prefer in my own portfolio, UK Index Linked Gilts (Barclays UK Government Inflation-Linked Bond Index), where the iShares Barclays £ Index-Linked Gilts ETF (INXG) is used as the proxy.
• The wealth accrued at retirement (the 31 December 2006) is £100,000.  To simulate a larger or smaller amount of wealth just multiple by a constant. For example if you want our retiree to have £600,000 just multiply all the subsequent pound values by 6.

A 4% Initial Withdrawal Rate

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Our 4% Withdrawal Rate Retiree, meaning annual withdrawals of £4,000, is I would say now in some serious trouble.  Last year after 6.5 years of retirement between 11% and 24 % of portfolio value had already been lost.  Step forward a year and the situation has worsened again with between 14% and 25% of portfolio value now lost.  If this were me I’d now be starting to quickly reconsider either cutting back spend and/or looking for some supplemental income.

A 3% Initial Withdrawal Rate

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Dropping the initial withdrawal rate to 3%, or £3,000 withdrawn per annum, which including investment expenses is actually a withdrawal rate of between 3.25% and 3.36% and so very close to Pfau’s 3.05% SWR shows our Retiree pretty close to treading water at this stage.  Last year wealth depletion in real terms of between 3% and 17% had occurred.  Today the depletion is between 5% and 16%.

The 2% Initial Withdrawal Rate

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Even the situation of our lowly 2% withdrawal of starting portfolio value is still not looking great.  Remember, to achieve £24,856 per annum at this withdrawal rate requires wealth, that very few will ever attain, of £1,242,800.  A year ago even at this low withdrawal rate problems were still afoot with only one of the six portfolios above the initial £100,000 starting point.  Today we have seen a small improvement with two portfolios now above the magic £100,000 line.  The change in real wealth is between a positive 4% and depletion of 6%.  So after more than 5 years of this current equities bull market and we still have four of six portfolios under water.  Interestingly the two positive portfolios are both Index Linked Gilts based.

To Conclude

With us now more than 5 years into an equities bull market and 24 of the 26 portfolios examined above still under water it really does highlight the risks associated with living off capital and particularly blindly following a mechanical safe withdrawal method of any description.

This is all reinforcing some of my current thoughts which is to ensure you continually PDCA and to work towards withdrawing at a rate that is less than the interest and dividends received from your portfolio.

Are any readers out there currently in Income Drawdown?  How are you getting on?  I’d particularly like the musings of anyone who retired in 2007.

As always DYOR.