Retirement planning can be tricky, with so many variables to consider and decisions to make. While you may have been saving into a pension throughout your working life, do you understand exactly what will happen when you retire? Do you know how you will access your pot, or how long it needs to last?
Worse still, you may be concerned you’ll make a mistake in your planning that you later come to regret, as many prospective retirees do.
Indeed, new research from Legal & General shows that 1 in 5 people who withdrew a cash lump sum from their pension did so as soon as they turned 55, the earliest age at which you can access your pot (rising to 57 in 2028).
That may well seem like a tempting idea, accessing the funds you saved throughout your career at the earliest opportunity. But, the research also revealed that 24% of those who did take a cash lump sum didn’t understand this would impact their means-tested benefits. And, given the choice again, 1 in 5 said they would have withdrawn less or no money as a lump sum.
While this approach may seem reasonable and even enticing, jumping in feet first to withdraw funds from your pension could leave you with some real problems further down the line.
According to Legal & General’s research, for people without other sources of income, a pension pot typically runs out by the age of 77. With average life expectancy currently at 86, it’s clear to see how this shortfall could cause hardship.
All this underlines the importance of a clear strategy for accessing your pension, helping to prevent these issues and ensuring your pension funds last the distance.
Be wary, however, of following too many established “rules” – while they might offer you some guidance, financial planning is often a bespoke exercise that works most effectively when tailored to your specific circumstances.
Read on to explore three such common retirement planning “rules”, why it’s sensible to approach them with caution, and how personalised advice could be more effective in helping you achieve your objectives.
1. The 4% rule
Devised by US financial planner William Bengen in the 1990s, this rule offers up the theory that withdrawing 4% of your pension pot annually will prevent you from running out of funds.
However, this figure was initially reached using only US data, including certain assets that aren’t available in the UK, and was intended to be a worst-case scenario for US pensioners.
Life is also full of unpredictable variables: in this case, you can’t always accurately predict your investment returns, inflation levels, and how long you’ll live. Other factors you have more control over, such as your spending habits, can nevertheless fluctuate – if you have a large unexpected bill or other expenditure, for example.
Ultimately, there’s no one-size-fits-all figure that will work for everyone. Instead, it can be sensible to take a tailored approach to your pension withdrawals that fits your lifestyle and circumstances.
2. The bucket strategy
Under this rule, you break down your assets into three “buckets”:
- Short-term bucket: For funds you’ll need in the next 3 – 5 years, such as living expenses. These investments would be in what are traditionally considered “safe” liquid assets, such as cash or short-term bonds.
- Intermediate-term bucket: For funds you’ll need in the next 5 – 10 years, which could be invested in longer-term bonds and stocks.
- Long-term bucket: For investments you want to grow throughout your career with your retirement in mind. This could be in long-term stocks and bonds, often within your pension.
So far so good. However, according to Forbes, there are both “practical and theoretical problems” with this strategy. For example, you might end up “refilling” one bucket with another, effectively draining the very funds you’ve been saving for the longer term.
Market fluctuations can also affect the value of your long-term bucket, and you might have unrealistic expectations that this bucket would be insulated from these.
In theory, this strategy makes some sense – indeed, a professional adviser might suggest thinking about your wealth in terms of your short-, medium-, and long-term goals.
But, applied in practice, it might not work in terms of meeting your specific goals. You may prefer holding more in your short-term bucket if you have a low tolerance or capacity for risk. Or, you could want to invest more in your long-term bucket while you’re working to maximise your retirement savings.
As a result, a bespoke strategy based on your needs could serve you better.
3. The percentage-of-portfolio strategy
This method suggests that you spend a fixed percentage of your portfolio each year. This allows you to rest assured that you aren’t depleting your portfolio while enabling you to spend and adapt your budgets accordingly each year. It’s similar to the 4% rule, but with greater flexibility.
However, under this approach, you could be completely at the mercy of the markets, which could lead to you not having enough to live on during poor market conditions. Meanwhile, more favourable times could see you withdrawing more than you actually need.
Taking a personalised approach could be more effective
As you can see, the theories behind these three approaches are fairly sound. However, once you apply them in the real world, they can quickly fall apart.
Taking a one-size-fits-all strategy and trying to make it fit your personal circumstances is entering into “square-peg-round-hole” territory, and could leave you in a slightly more precarious position.
The more realistic and financially pragmatic approach is to find a solution that’s tailored to your life and spending needs. A financial planner can help you work out your own pension fund withdrawal strategy to give you peace of mind that you’ll have a consistent, steady income throughout your retirement years.
If you’re looking for a financial planner in Bristol to help you make your own personal retirement plan, we’re here to support you.
Please get in touch either by email at helpme@aspirellp.co.uk or by calling 0117 9303510.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
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