Pension freedom withdrawals 'sensible' at 4% a year
Figures from the Association of British Insurers (ABI) show that in the first full year since the pension freedoms began, the majority of retirees are being sensible.
Retirees taking advantage of the pension freedoms introduced last year are being sensible rather than reckless, according to figures released by the Association of British Insurers (ABI).
The ABI published data for the first full year since the pension freedoms began, from April 2015 to April 2016.
One of the key findings was that the majority of retires – six in ten – are withdrawing money from their pension pots at a rate of around 4% a year. Only the minority, around 5%, have opted to take big withdrawals, equal or greater than 40% of their pots.
According to the ABI, "the majority of savers are taking a sensible approach". The trade body, however, cautioned that "there are signs a minority may be withdrawing too much too soon and at rates that would see their money run out in a decade or less".
One of the biggest dilemmas for retirees who decide against buying an annuity have is establishing how much income to withdraw each year in order to avoid the nightmare scenario of leaving the retirement cupboard bare.
Most financial advisers stress that a maximum withdrawal rate of 4% is sensible, and that it’s preferable for retirees to draw only the income produced by the pension investments (the natural yield), rather than stripping away capital.
But recent research by Morningstar concluded the 'safe withdrawal rate' for UK pension savers is 2.5%.
Morningstar’s premise is that over any 30-year period the income payments will always be met, increasing in line with inflation. The overall capital may fall or remain intact, depending on market conditions. But the capital value will last those 30 years.
This story was originally written for our sister publication, Money Observer.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Association of British Insurers
Established in 1985, the ABI is the trade body for UK insurance companies. It has more than 400 member companies that provide around 90% of domestic insurance services sold in the UK. The ABI speaks out on issues of common interest and acts as an advocate for high standards of customer service in the insurance industry. The ABI is funded by the subscriptions of member companies.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.