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Sustainable income

Sustainable income withdrawals from drawdown

One of the important most important questions for drawdown investors is “how much income should be withdrawn each year”. Take too much income and there is a risk that you will run out of money but take too little and you will have lost out on income you could have spent during your retirement.

An annuity solves this problems problem and academics call this the optimum distribution of income throughout your life. Personally, I prefer the rather dark maxim “live your life to the full, spend all of your money and the last cheque you write should be to the undertaker, and it should bounce”

If you don’t want to withdraw too much or too little you will need to work out what is a sustainable level of income.

There are two elements to consider;

  • Sustainable income in terms of not running out of money
  • sustainable income by maintaining its spending power i.e. keep up with inflation.

There has been a lot of academic research on this subject, mainly in the United States. In the US, the benchmark withdrawal rate for ‘systematic withdrawals’ is normally taken to be 4% per annum based on research using a portfolio of equities invested over a 30-year period. This level of sustainable income allows for annual increases in line with inflation.

However, research in the UK suggests that the sustainable level of income (increasing with inflation) is now much lower and could be in the range of 2.5% to 3.5% depending on assumptions. Other research suggests that 4% income is an acceptable level of withdrawals.

Our view is the income from an annuity should be used as a starting point or benchmark for deciding how much income to withdraw. Although it might be tempting to use the level annuity as the benchmark, the income from an inflation linked (or fixed escalation) is a better benchmark for the obvious reason it allows for income increases to offset the effects of inflation.

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If you want to make the most of pension freedoms you should start planning ahead and make sure your financial affairs are in good shape in the years running up to retirement.

William Burrows

William Burrows

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