Written by Patrick Ingram, Retirement Specialist 03rd September 2019

Every Adviser worth their salt who specialises in retirement planning knows about the 4% withdrawal theory, popularised by Bill Bengen and based on his research into US markets from 1926 to the 1970s.

In 1994, Bengen concluded that by drawing 4% a year, inflation adjusted, you could expect a balanced portfolio to last over 30 years. He revised his research in 2012 to look at 4.5% withdrawals.

Seven years later, does Bengen’s research still hold true? We used the Parmenion Income Manager Tool to put it to the test:

Meet our test client, Mr C.A. Head

Setting up a test client takes only a couple of minutes on the Parmenion platform. Our test case, the aptly named Mr C.A. Head, is aged 65 and in average health. He lives in the same postcode area as I do, with a fund of £100,000.

Plugging that information in, I can see the likelihood of a 4% withdrawal strategy’s success, based on independent, forward looking (not historical) market projections from Scottish actuaries Hymans Robertson, in seconds.

Here are the results based on drawing 4% (£4,000 a year) with inflation increases. Forward looking inflation is calculated by Hymans Robertson from the index linked gilt yield curve. Success is defined as his portfolio outliving him.

Table 1: Viability of an annual 4% withdrawal rate, from age 65 for a £100,000 pension pot
Portfolio risk grade Chance of success
(Viability Score)
25% probability of portfolio
exhausted at age:
3 57% 87
4 68% 88
5 74% 88
6 76% 89
7 78% 89
8 79% 89

Note: In our recent Sticker Price Retirement webinar we asked advisers what risk grade they would tend to select for drawdown. The most popular answer was Risk Grade 5 or below, with only a few selecting Risk Grade 6 and none considering Risk Grade 7.

As you can see from the table, the Hymans Robertson results suggest that a 4% real withdrawal rate may not be sustainable over 30 years.

True, there is a very good chance the portfolio will survive you - 76% likely in Risk Grade 6 - but it’s far from certain. If investment returns over the next few years are not positive enough to sustain the portfolio, then the portfolio is substantially depleted by withdrawals in a low return environment, and if then it hits a really rough patch in 10 to 15 years’ time, the strategy could be in real jeopardy.

Fortunately, Bengen also explored how to hedge this risk of disappointment. In his 2012 research he wrote:

“If a portfolio is suffering (or expected to suffer) from low investment returns, it might make sense to transfer some of the investment risk to an insurance company via an annuity.”¹

We’ve deliberately emphasised ‘some of the investment risk’. At 65, investors are generally looking for flexibility, not absolute certainty. Certainty is a need that usually arises later in life, although early annuity purchase can be appealing for those who want to believe they will benefit from the possibility of above-average longevity. Parmenion’s Income Manager Tool can produce forecast costings for annuity purchase, to help with your conversations and stress test different plans.

It can, for example, show you the chances of a portfolio succeeding compared to an annuity with RPI linking. This rate (from Hargreaves Lansdown, correct as at 14 August 2019) for an inflation linked single life annuity at 65 is £2,883 for a £100,000 purchase cost². How likely is it that a portfolio could match this outcome?

Table 2: Viability of an annual inflation linked withdrawal of £2,883 from age 65 for a £100,000 pension pot
Portfolio risk grade Chance of success
(Viability Score)
25% probability of portfolio
exhausted at age:
3 90% 96
4 93% 98
5 93% 100
6 93% 101
7 94% 102
8 93% 105

These results look relatively positive and underscore the view that risk is your friend in drawdown. They are also a reminder of one of the advantages of staying invested - flexibility.

You retain the option to reduce withdrawals when circumstances allow or dictate. You could, say, start your journey at 4 or 5%, but easily flex withdrawals if the money is not being spent or the outlook looks more challenging.

Exploring the balance between certainty and flexibility and the respective sacrifices involved in both is where the IMT comes into its own. Get in touch to see how our fast, intuitive retirement modelling tool can enrich your advice and help point to better outcomes for all.

¹How much is enough?
Bill Bengen - www.fa-mag.com/news/how-much-is-enough-10496

²Best Annuity Rates, 14 August 2019
Hargreaves Lansdown - www.hl.co.uk/retirement/annuities/best-buy-rates

“The above article is intended to be a topical commentary and should not be construed as financial advice from either the author or Parmenion Capital Partners LLP. If a client wishes to obtain financial advice as to whether an investment is suitable for their needs, they should consult an authorised Financial Adviser. Past performance is not an indicator of future returns.”

Any news and/or views expressed within this document are intended as general information only and should not be viewed as a form of personal recommendation. All investment carries risk and it is important you understand this. If you are in any doubt about whether an investment is suitable for you, please contact your financial adviser.