The 4% rule is no more!
It has ceased to be! It has expired and gone to meet its maker!
Unlike Monty Python’s more famous and much funnier parrot, the 4% rule has never been alive in the UK.
This blog has featured a few posts about why the rule doesn’t work in the UK, and never has done.
But actuaries are now claiming that the 4% has been killed off.
This month, Lane Clark & Peacock announced the death of the rule (they claim that it was once alive in the UK, but that Quantitative Easing put the final nail in its theoretical coffin).
Actuaries like statistics about death, but I think it is unlikely that something that wasn’t alive can be killed off. But that’s not the point of this post.
What’s the 4% rule?
Back in the 1990s, US investment guru Bill Bengen worked out that, if you invested in a balanced portfolio of shares and fixed interest stock, you could withdraw 4% of the initial amount invested, increase the withdrawals by inflation, and have no risk of running out of money over a retirement lasting 30 years.
This is a nice, simple rule. But, it only applies to a balanced portfolio of US stocks and bonds, and it uses US inflation data.
Furthermore, it assumes that you don’t pay any charges for your portfolio!
So, whilst it may be a nice, simple rule, it’s not much use to the typical UK investor who won’t invest solely in US stocks and bonds, will be concerned by the UK inflation rate and will pay charges.
Is there a better rule?
Bill Bengen’s rules have been adapted to the UK; if you use UK data and assume typical charges for a UK portfolio, you end up with the 3% rule.
This initial withdrawal rate of 3% can be improved upon – particularly if your retirement portfolio is being used to pay for non-essential expenditure, so you can afford for the withdrawals not to keep up with inflation every year (e.g. in a bad year, you might decide to have one holiday, not two).
Lane Clark and Peacock’s new research adds to UK research about retirement planning; in particular, where it demonstrates the positive impact of deferring retirement.
This is unlikely to win them many votes in a retirement advisers’ popularity contest. But their research does confirm what we probably all knew intuitively – if you retire later, you can spend more every year once you have stopped work.
LCP also demonstrated the importance of keeping charges low in the retirement period. We hope that, as a result of their research, the government might ask regulators to reduce the amount which consumers pay them, directly and indirectly, in order to make it easier to fund retirement.
LCP also showed that, over a typical retirement period, making use of assets that are traditionally considered to be risky (like shares and property) can reduce the risk of running out of money in retirement.
LCP ignored the fundamental difference between essential and discretionary expenditure in their work, and they ignored the impact of the state pension and other forms of guaranteed retirement income (the majority of our clients still have some entitlement to a defined benefit pension when they retire).
They also paid no attention to the difference that good tax planning can make to the net returns an investor receives.
Some of LCP’s assumptions are questionable (e.g. they assume that whilst investment returns will stay low, inflation will be unchanged). Some of their research doesn’t apply in the UK (e.g. they assume that healthcare costs will increase sharply in later life in the UK, as they do in the USA; whilst we still have an NHS, this is unlikely!).
We are still grateful that Lane Clark and Peacock produced their report
Whilst Lane Clark and Peacock and Informed Choice might disagree about whether the 4% rule was ever alive in the first place, and some of LCP’s research might have been a bit sloppy, there is still good reason to be pleased that they have produced the report.
LCP are actuaries, and actuaries are good at maths. Influential people, including those in government and regulators, don’t question actuaries’ maths.
We can hope that the government and regulators might listen to LCP and recognise that the 4% rule shouldn’t be used in the UK.
Combined with the Retirement Living Standards, the government might use the new rules to guide people to work out how much they will need to save up to be able to afford to retire.