Could you spend more in early retirement?

If an individual could know in advance how their portfolio would perform over the course of their retirement, they could be assured in drawing down their portfolio in such a way that they would not exhaust their investments, pensions, and other retirement resources. However, in the real world, retirees face the spectre of “sequence of return risk”, where poor portfolio returns during the first decade or so of a retirement can lead to a shortfall in assets to support their remaining years. Where there is a risk, there is a potential reward, and strong returns early in retirement could lead to significant potential to increase spending later on.

A financial planner can help you determine how much you can afford to sustainably spend throughout your retirement. One of the most widely known ‘rules of thumb’ for determining how much an individual can spend in retirement is the “4% Rule” developed by Bill Bengen, which suggests that (based on historical market data) you could spend a starting amount of 4% per year of the value of your portfolio, and increase that in line with inflation throughout a 30 year retirement, without the risk of exhausting the portfolio.

As we have mentioned in previous blog posts, this rule doesn’t apply for UK clients – the 4% rule is based on US returns and inflation data, and assumes that no charges or taxes will apply. The equivalent rule for UK retirees is more like the 3.25% rule – this means that a person who withdrew 3.25% of their portfolio’s value during their first year of retirement, then withdrew the same amount in Pounds and Pence adjusted for inflation in each subsequent year, would never run out of money by the end of a 30-year time horizon – even in the worst case sequence of returns or inflation ever experienced in the historical UK data.

Notably, the “3.25% Rule” (or the US’s 4% rule) represents a static approach, in that spending adjustments (other than for inflation) are not made throughout retirement (beyond annual adjustments for inflation). However, it is possible to opt for a more dynamic approach to retirement spending, where the level of spending adjusts to changes in your portfolio’s value. For example, under a “guardrails” approach, you would have an initial withdrawal rate that is subject to change depending on portfolio performance; so retirees increase the amount they withdraw when the markets have done well but rein in their spending when the markets haven’t. Using this strategy, strong portfolio returns would allow you to spend more, while poor performance would require a reduction in spending. The key is that if you were willing to trim your spending back when times are bad, you could start out spending more in the first place, with guardrails strategies often starting at a baseline initial withdrawal rate of 1%, or more, than the conventional 3.25% rule. Morningstar’s latest safe withdrawal report dedicated nine pages to research looking at how an effective guardrails system can support higher safe withdrawal rates at the beginning of retirement, result in higher lifetime withdrawal rates, and still leave some assets for bequests.

My anecdotal experience is that this sounds great in theory, but I am not convinced that it is what UK retirees would want. I’ve yet to meet the client who waits to meet with me, before deciding on their plans for the year to come. Clients do often ask me how they may be affected if they go ahead with a certain item of expenditure, but the annual financial planning meeting isn’t what determines what sort of holiday they have for the year to come.

However, whilst it may not make sense to vary your spending annually, according to how your investments and pensions have returned, it is advisable to consider this every few years. If your investments have produced better than expected returns, it can give you scope to spend or give away more money. The alternative is to simply build up more assets that don’t get used during your lifetime – that’s good for the taxman, but probably not what you would want!

As people age, they spend their retirement resources differently; spending in the early “go go” years of retirement is often higher than it is in later years, with discretionary spending closely linked to how healthy and energetic you feel. Added to that, most people’s experience of inflation will differ, depending on what they spend their money on.

So, the “3.25%” rule has its weaknesses, though it is still a useful starting point to help us decide how much our investment and pension portfolios we can spend when we stop work. It can also help us to determine the value of annuities – is it worth giving up the chance of leaving some of our pension funds to our children, in order to have a secure income from an insurance company? Guardrails also have their place, but in my view, that approach should be used carefully, and less frequently than annually, and combined with the other retirement spending approaches; however, they do demonstrate that you may be able to spend more at the start of retirement… as long as you accept that, sometimes, your spending will have to be curtailed after an extended period of poor returns for investments.

Philip Wise | philip@sussexretirement.co.uk

Managing Director and Chartered Financial Planner


This guide is for information purposes and does not constitute financial advice, which should be based on your individual circumstances.
Past performance is not a reliable indicator of future performance.
A pension is a long-term investment, the value of your investment and the income from it may go down as well as up. Your eventual income may depend upon the size of the fund at retirement, future interest rates and tax legislation.
Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.

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