SEQUENCE of RETURNS RISK, 4% RULE & RETIREMENT PLANNING // Personal Pensions UK
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- čas přidán 1. 10. 2021
- SEQUENCE of RETURNS RISK, 4% RULE & RETIREMENT PLANNING on a Cashflow Plan!
One of the biggest fears for someone approaching or just about to retire is the point at which they begin drawing down on their pension pot, the pension pot that they have potentially spent decades building up. And it is that point at which hopefully they have some idea as to the value of their pension pot and to the likely amount that they will need to take out as an income to be able to provide them with the standard of living they are after. The two key risks at this stage that any retiree has to contend with is the percentage that they are looking to take from their pot, to ensure it is sustainable and doesn’t run out and the potential risk of significant volatility in the early years of retirement, known as sequence of returns risk.
From Will Bengen's research, well known for his research into the safe withdrawal rate in which he looked back at various time periods to see what impact certain asset allocations would have on a clients retirement and also how the volatility at various points in someone's retirement would impact the chances of their fund running out in retirement.
There are really two schools of thought to this process, one is the probability-based model, which tends to focus on the historical performance of markets over very long periods of time and then assumptions are made as to what sustainably can be taken and the asset allocation required, this being Will Bengen's area. The second is the safety first approach that would assume someone uses low risk assets, annuities and defined benefit benefit pensions to provide secure income that is less reliant on the stock market.
The issue for most retirees is that it will be unlikely that they will have enough value in their pension fund that will buy themselves a secure income that increases with inflation and that provides any kind of value on death. The demise of the defined benefit pension scheme also means that individuals are pushed further into the probability based approach. The probability based approach is really drilling down on likely outcomes, on weighing up and taking a calculated risk. The variability of future outcomes is huge but we have to base the future potential of an outcome within the parameters of what would be considered reasonable. So is what we are looking at reasoned and reasonable.
The conclusion that Will Bengen got to having looked at various periods of time and asset allocations was that depending on the asset allocation and period of time in question there is a percentage amount from which can be drawn from the fund that is sustainable and this was possibly oversimplified into the ‘4% rule’ and then after subsequent research completed later, the 4.5% rule which is based on a minimum of 30 years of longevity using a portfolio made up of 35% US large cap stocks, 18% US small cap and 47% intermediate government bonds with yearly rebalancing. Essentially a 50%50% split between bonds and equities.
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Thanks so much for watching! 👍
See you next time! 😊
Thank you really good video, showing the scenarios. I currently have roughly the same amount in my ISA and SIPP., and looks like I can retire using my ISA income, until I get to 57
What is the software/website you used for forecasting, as I would like to try different scenarios for retirement ?
Fascinating stuff
Thanks
The company I worked for was bought out in December and I sold some share options, paid off my mortgage and loans and consolidated and topped up my pensions, took a settlement from work, and then realised that I might just be able to retire early (57), courtesy of watching some of your (and a few others) videos on youtube.
Sounds great Andrew!! 👍👍 It’s all about fully understanding your position, your objectives and going in with open eyes as to potential/likely risks! There can always be curve balls but at least if your plan is grounded in the realms of reality then you have done all you can!!
And thanks for the ‘Super Thanks’ Andrew!! 🙏🙏
Very helpful video 👍
Thanks so much!! 🙏🙏
Excellent, esp with the recent drop of the market
Thanks Richard!! 👍 Yup bit if a hit especially in the areas that have done ridiculously well over last decade!
Good quality video. My spreadsheet using similar data gives me 3.5% drawdown rate for the level or risk I will tolerate. Also it emphasis the need to set a flexible income target. Taking out less in those recession years allowing the fund to grow more as the market recovers.
Thanks! 🙏 Sounds like you have a realistic plan and I really think that is half the battle to set expectations and have a full appreciation that income levels might well need to be managed inline with returns!
Love this sort of content, v thought provoking 😎👍🏻
Thanks so much Phil!!! 🙏🙏
Due to retire next year, I timed the March 2020 market drop perfectly but assuming the subsequent rise was just a central bank sponsored "dead cat bounce", have missed out completely. Now I feel that I can't risk buying back in "at the top" and will thus have to wait for a significant pull-back. And I thought work was stressful !
This is so understandable and a very easy position to get into Michael!! And it’s so hard to call the market direction especially when the media and it’s headlines are constantly cycling through various positions whether pro stocks or calling a crash. Also seeing that some stocks and asset classes do look, on a historic basis very bubbly and other areas are ignored. And then the gov is there and has been since 2008, arguably propping up asset prices and holding down interest rates… very large numbers sold out at the bottom in 2008 and a lot of that money will never have come back in. At least you haven’t sold out into a decline and will have benefited from the increases that we have seen. It’s very stressful as basically you take all the risk as opposed to having a salary from an employer or a nice defined benefit pension scheme where the risk is borne by the scheme.
Your content is always so professionally delivered with clear precise detail …. Thanks again top video
Thanks Will!! That’s really appreciated! 👍
“The only ones who get hurt on a roller coaster are those who get off before the end”, Dave Ramsey.
Thanks Bob.
Although I think the problem for some is that they don’t have a choice… and don’t know how bad the ride is until well into it!
Sequence of return risk is real. Enjoyed this 👍, good video! Nice to see a bit of cash calc as well 😊. Good point on the end as far are hedging longevity risk via an annuity.
Thanks so much 🙏 🙏 You have to love a bit of Cashcalc and rolling the dice with the Monte Carlo… I think it’s definitely easy to underestimate longevity and market risk as we have had such solid periods of return over such long periods… such a fine balance for some clients between not taking too much and not taking too little.
Appreciate your informative videos and watch every one!
Thanks for the kind comment!! 🙏🙏
Great content again, I’d always assumed the 4% rule would be calculated per annum of remaining ‘pot’ meaning some years would be slightly leaner than others. Do you think this would stretch the timeframe out more successfully?? Rather than calculating that 4% of £500k initially and increasing by inflation on the £20k annual income, come hell or high water. Or would it be much the same??
Thanks Mark!! 🙏🙏
Yes definitely, if you stuck to 4% of the value at any one time then absolutely the pot in theory would be more sustainable than assuming 4% at outset with inflationary increases. The issue that people face with sticking to 4% from the pot is the variability in the income from one year to the next. For example if the fund value drops by 20% so does your income. The key is to know what you are getting into and that the solution works for you.
I wanted to add: I am at pension age in a few months and I have decided for me two important things: the UK state pension will be very significant for me and I may very well delay drawing it - where else offers 5.8% salary raise a year? They say the UK pension is at least worth 300K£ considering average longevity. Do you agree Edmund? The second conclusion I came to is to stay in my my current job longer - some colleagues speculate working at "a shelf filling" kind of job when retired....i really can't see the point of taking a low minimum wage slave job if you have the chance to stay in your permanent job with all the benefits (life insurance, company discounts, company facilities, nice colleagues). The third thing : Covid has taught us that having a job, basic comforts and health is all you need to be happy. During Covid we lived so well with so little - exploring the local hills, walking a lot and working on our garden.
The maths doesn’t back up delaying the state pension anymore. If you intend to keep on working beyond retirement age (and therefore earning a salary), that gives you the opportunity of taking the state pension and putting it into a SIPP (until age 75). This way you get a significant tax refund by way of tax relief (especially if you’re a higher rate taxpayer) and, hopefully, you get growth on your contributions in the SIPP.
I can’t take credit for the above, by the way! See czcams.com/video/3tUFeEPjmhw/video.html
Great video and very informative as usual. Good idea about using an annuity to buffer from market volatility. Also worth mentioning that here in the UK we have another option which is shielded from the market ups and downs: the state pension. We should all ensure we can make enough NI contributions during our working lives to get maximum state pension from age 66/67/68 etc.
In addition, I would think that the early years of retirement, people spend more and then at a certain age, leisure and lifestyle expenses start to reduce.
The above should be all taken into account when working out retirement budgets and funding.
Whilst leisure expenses may well reduce as an individual ages, you did need to consider that medical and care expenses may well increase
@@robincandy7064 Well yes, but we have a national health service (whatever opinions one may have on that) which covers medical care costs. Care home fees is another consideration, but at that point, this is your last move and many people fund that by selling their properties. The final consideration would be what inheritance/legacy you wish to leave to family, friends etc.
Thanks so much Simon!! Really appreciate that and very true!! 👍👍
At age 51, with a reasonable company pension, I have realised its time to seriously look ahead at a retirement plan. At first glance it all seemed like a minefield full of jargon, but your videos have really helped clarify points that weren’t clear. Thanks Edmund, really appreciate your work here.
Thanks so much Rob thats incredibly kind of you to say!! 🙏🙏🙏
Great info. Volatility is my key concern when it comes to doing pension drawdown and drawing on my S&S ISA. At least I have a decent DB pension which will start paying out when I'm 65. I'm planning different drawdown scenarios to cope with volatility and hopefully to allow recovery should the markets fall including having years with no drawdown in adverse market conditions and 3% and 4% drawdown options.
Thanks Helena!! Having the DB scheme is such a nice addition to the other assets you mention there! That secure income is hugely useful during downturns and periods of high volatility. 👍👍
A bit late to the party I'm afraid.
I think the scenarios that you just went through, make a good argument for not taking a lump sum of 25%.
If you didn't, and there was a downturn, you could fall back on your tax-free amount, somewhat.
Maximise your tax free annual allowance first, then transfer more money to your crystallised pot, than you need. Then you can draw a larger tax free amount.
Eg. Crystallise 40k, collect 10k tax free, but only 12.5k taxable amount,
for a zero tax income of 22.5k, saving £875 tax. More if you have other income.
This would help to keep more money invested, instead of handing it to the treasury. Hopefully to tide you over until recovery.
This analysis does not isolate the effect of sequencing risk, as the comparison made is between steady return of 6.5% and the return of 6.5% following a drop of 15%+. To identify sequencing risk alone, you would have to compare the 6.5% with a similar 6.5% annual return over say 30 years with the early decline, which would imply a higher return once the recovery is under way. It is no surprise that the example given is so bad, as the total return is lower over the long term. Sequencing risk will still be detrimental, but not as severe as presented.
Thanks for another thought provoking video, Ed. It seems to illustrate perfectly two points made in a book have read recently...
"Planning your retirement income strategy is one of the hardest things you will ever do."
"If you get poor or even mediocre returns in the first decade of retirement, then technically speaking you're buggered!"
Abraham Okusanya 'Beyond the 4% Rule'
He also states that there is a 24% chance of one of a 65 year old couple living to be 100, suggesting that it is wise to withdraw a lower percentage of the retirement fund after the first 10 years of retirement, than in the first 10 years of retirement.
Thanks so much Mike!! Definitely agree with all of those points… and yes to go from a situation of a regular ‘secure’ salary to an asset from which an income is drawn is a big jump in both expectations and management… it’s so different than dealing with a secure defined benefit pension. The individual basically takes all the risk! 🤔🤔