How much income can we take out of our retirement savings?
As you might imagine, this is a question we are asked almost every day.
It gets asked in a variety of different ways – “are we spending too much?”, “can we afford to give money to our children?”, “will we be comfortable in later retirement?” – but it often boils down to the same thing.
The answer is “it depends”, as it so often is in proper financial planning.
There are some rules of thumb you can use, if you’re happy to gamble the next 30 years’ happiness on an off the cuff soundbite, and I’ll deal with those next week.
So, what does it depend on?
What the money is for.
Most importantly, whether you can afford to withdraw less next year than this year, or whether you can put off withdrawals altogether in some years.
So, if the money is needed to pay for discretionary expenditure (like holidays), you can take more out of your fund than if the money is needed for unavoidable expenditure (like council tax).
Research shows that being able to adopt flexible spending increases the starting amount you can withdraw by as much as 1% of the starting capital value per year.
Whether you need to increase the amount you withdraw every year.
Studies have shown that, on average, people’s expenditure increases more slowly than inflation generally in retirement. But, of course, none of us are Mr and Mrs Average, and the national average hides some important figures.
Our essential expenditure tends to rise in line with inflation throughout retirement, but our discretionary expenditure doesn’t.
The nature of discretionary expenditure also changes as retirement continues – regular smaller items of expenditure are typically replaced by less frequent, but larger items.
It is logical to plan for essential and discretionary expenditure separately, having one fund for essential expenditure and another for discretionary spending.
How old you are.
The older you are, the more you can withdraw from your savings, without running the risk of exhausting your funds. And, sadly, vice-versa.
This may seem obvious, but very few advisers will be aware of this, as most academic research into the rate at which you can spend your retirement savings is based on a 30 year retirement.
If your retirement is only expected to last 20 years (or if you don’t care that you might have no savings left after 20 years), you can increase the amount you withdraw at outset by 1%; if you retire early (so you are expecting a 40 year retirement), you should reduce the starting amount you withdraw by 0.5%.
Market valuations when you start withdrawals.
Perhaps less obvious, but, if market valuations are high when you start withdrawing, then you should take out less money to start with (as a percentage of your retirement savings).
If market valuations are low, you can take out more. The difference in the starting withdrawal rate can be as much as 1% per year.
How much you pay in charges.
You should reduce the amount you can withdraw at outset by 50% of the amount you pay in charges.
Typical charges on a retirement savings fund in the UK are around 2% per year (of the portfolio value), with lower charge portfolios costing around 1.5% per year.
So, based on this, if you opt for a lower charge, you can increase the amount you spend when you first retire by 0.25% of the value of your retirement savings.
It may not sound like much, but I would need a good reason to be reducing the amount I could spend when I retire.
The impact of tax on the amount you can withdraw is important and recent changes to UK rules have made the impact of tax more difficult to calculate.
If, for example, your retirement savings are made up, entirely, of ISAs, then there is no tax to worry about; however, if you have the same investments in a taxable account (like a General Investment Account), you might have some tax to pay.
The amount of tax you have to pay on the General Investment Account will depend on a huge variety of factors, and you are likely to have to find the money towards the end of January every year; in this scenario, tax becomes part of your expenditure and you are left with less of your withdrawal to spend.
I’ve spent the last twenty years or so studying the research and helping people to generate enough income and capital to enjoy themselves once they have stopped work, so I know that it’s not easy to work out you can afford how much you can spend.
The simplest solution is to have a retirement income plan, which is constructed for you by an expert, and then maintained for the rest of your life.