Revealed: the amount of income pension savers can safely withdraw

Kyle Caldwell
19 May 2016

Savers who took advantage of the pension freedoms when they were introduced last April have had a rough ride, with the FTSE 100 index losing 9% over the period.

The falls highlight the challenges and risks involved for those who choose to draw an income directly from their investments at retirement.

One of the biggest dilemmas is deciding how much income to withdraw each year, while avoiding the nightmare scenario of leaving the retirement cupboard bare.


Is there a 'magic' percentage that can help retirees withdraw a safe amount of income from their pension, such that sufficient capital remains to deliver a similar level of income each year during their retirement?

Safe withdrawal rate

According to analysis by Morningstar, the 'safe withdrawal rate' for UK pension savers is 2.5%. This is based on historical returns, on a portfolio split equally between shares and bonds.

The 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 the 30 years.


Morningstar's study is notably more conservative than other academic research that has been carried on the same subject.

William Bengen, a former financial planner, carried out the same calculations two decades ago, but instead used a portfolio of 50% in American shares and 50% in American government bonds. Bengen's research found the safe withdrawal rate was 4%.

But Dan Kemp, co-author of Morningstar's report, says for British retirees a safe withdrawal rate of 4% is unrealistic, for several reasons.

"Most studies on the topic have been conducted for US investors using US data, and it was increasingly dangerous to leave this assumption unchecked, given the greater number of UK retirees who must now familiarise themselves with the concept of safe withdrawal rates in light of the pension freedom rules," Kemp says.

Morningstar also assumed an annual charge of 1% for the hypothetical portfolio - something which Bengen did not include.

Challenging environment

Moreover, Kemp adds that for those who choose to remain invested at retirement the current environment is more challenging. In the current climate, with bond yields near historic lows, the natural yield of a portfolio equally split between shares and bonds would fall short of 4%.

"With more retirees expected to select pension drawdown over the purchase of an annuity, estimating a UK-relevant safe withdrawal rate is key to helping those individuals manage their retirement savings," he says.

"In the current environment of low yields and high asset prices, clients and their advisers need to set realistic return expectations. We hope this analysis provides advisers with a framework to use with clients when considering the question of retirement spending.

"The generous investment returns of the last century that supported a comfortable and long-lasting retirement portfolio for previous generations of retirees are no longer with us."

Investors looking to use income drawdown should ensure they are not totally reliant on this pot by having other sources of secure income (state pension, annuity, final salary pension).

Choosing to draw only the income produced by the pension investments (the natural yield), rather than stripping away capital, helps preserve the pension pot over the longer term.

This article was written for our sister website Money Observer.

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