View more on these topics

Richard Parkin: The dangers of conservative sustainable drawdown rates

Taking a sustainable withdrawal rate at face value could mean clients missing out on the retirement they saved so hard for

A colleague in Japan has sent me Morningstar’s research on sustainable withdrawal rates for the Japanese market. It is a rework of the analysis it did for the UK market a couple of years ago and I am sure it will be applying it to other markets soon if it has not already done so.

It is a decent piece of research but, as I read it, I am reminded how uncomfortable I am with the idea of sustainable withdrawal rates altogether. I have not yet got as far into the maths as others but there are some more fundamental challenges I have with the concept.

I am getting more worried about these as we learn the FCA is becoming more focused on the drawdown market and, in particular, how we talk to our clients about sustainability.

The landscape has shifted

First, we see few customers looking to just take regular income for a lifetime. It is generally accepted (though perhaps not well researched) that people have a greater need for money earlier in their retirement. As they get older and less active, the need for cash reduces but may increase later in life as care costs need to be funded.

This suggests a reverse-J or U-shaped income requirement rather than the gradually increasing linear requirement sustainable withdrawal rates tend to assume. Essential expenses may have this shape but, in many cases, these will be (or should be) covered by guaranteed income.

In fact, pension freedoms mean many are not looking for any sort of regular income, preferring to withdraw lump sums on an ad hoc basis or even take nothing at all. Again, this makes the idea of a sustainable withdrawal rate much less relevant.

But let us assume we are faced with a client who is looking to use an investment portfolio to provide a growing income for life. What relevance does the sustainable withdrawal rate have here? On paper, it seems to make sense but what concerns me is how taking the sustainable withdrawal rate at face value might lead to an overly conservative approach that will have clients missing out on the retirement they saved so hard for.

Pension freedoms mean many are not looking for any sort of regular income, preferring to withdraw lump sums on an ad hoc basis or even take nothing at all.

In it for the long run?

Many sustainable withdrawal rates will be calculated at 90 per cent or 95 per cent confidence. But what does 90 per cent confidence mean? The positive interpretation is that there is only a one in 10 chance of the client running out of money before they die.

That is great but flip it around and we conclude there is a nine in 10 chance that when they die there will still be money left in their pension pot. In many cases, this will be a non-trivial amount and, in some scenarios, the client will actually have more in their pot when they die than when they started.

Some may say this is no bad thing but I would argue it is. Every pound left in my pension pot on death is a pound I did not get to spend while I was alive. My heirs might be grateful but if it means I did not get the retirement I wanted, then I would say it is a bad outcome. What is the point of saving all your life, only to be too afraid to spend it in retirement?

The usual response to this challenge is to say people can reassess their income and increase it if the markets do well. They can but then this just gives them even more income in later life when we have established that, in most cases, they are likely to need less.

In addition, this approach still leaves a lot on the table as it is always aiming for a high level of confidence that the money will not run out over the rest of the client’s lifetime.

Every pound left in my pension pot on death is a pound I did not get to spend while I was alive.

In summary, then: using sustainable withdrawal rates in practice reduces the risk of not running out of money in retirement but increases the risk of not getting the most from your retirement. While they provide a useful benchmark, it seems we need to consider more practical approaches to managing income in retirement.

At the heart of this is building withdrawal strategies that are managed dynamically, adjusting income and asset allocation as market conditions develop. This might allow us to start with a lower confidence level but with the understanding that, if markets failed to deliver, then the “cost” of this would be reduced income in the future.

The adviser and client can work together to decide what balance needs to be struck between maximising certainty and maximising income. Those who can be more flexible in their income requirements can aim for higher initial withdrawals. Those who need more certainty will have to accept lower initial income levels.

This is the reality of drawdown. Aiming for safety by setting a very conservative withdrawal rate will mean people do not get the retirement they saved for. By accepting the risk of having to take a reduced income if markets fall, then drawdown can be made much more efficient. And if clients cannot accept that risk, maybe they should not be in drawdown at all.

Richard Parkin is head of pensions policy at Fidelity International



Gregg McClymont: Income drawdown’s phoney war

I spent last week out and about speaking to advisers. As usual, the conversations were full of fascinating insights into the practical day-to-day reality of managing clients’ wealth. The focus was on income drawdown and the challenges posed in getting it right. The shadow looming over the discussions was, of course, pension freedoms. In asset management, […]

Pensions-savings-retirement-piggy bank

Why are advisers put off by guaranteed drawdown?

Advisers remain split over the benefits of guaranteed drawdown after a report argued many are unfairly dismissing the products as too expensive or complex. Last week’s report by consultancy The Lang Cat says guaranteed drawdown products – often called unit-linked guarantees which combine drawdown with assured levels of income – faced a perception barrier amongst […]


How much are advisers charging for pension transfers?

Defined benefit pension transfer charges are being put under the microscope again as the regulator turns over more potential conflicts of interest. With the British Steel Pension Scheme the latest to dominate headlines and the FCA ready to interrogate further as it extends its review to include all firms authorised to give pension transfer advice, […]

Planning now for the residence nil-rate band

Graeme Robb, senior technical manager at Prudential, writes about the residence nil-rate band and the advice opportunities it presents for you when tax year-end planning with your clients. On our Planning Matters hub, we considered a widow, Margaret, and a married couple, John and Anne, for whom the residence nil-rate band (RNRB) is influencing planning […]


News and expert analysis straight to your inbox

Sign up


There are 4 comments at the moment, we would love to hear your opinion too.

  1. William Burrows 31st May 2017 at 3:13 pm

    This reminds me of the joke “live life to the full and spend your money. Your last cheque should be to the undertaker and it should bounce”!

    On a more serious note I agree with a lot of Richard’s points and I wonder if it really matters if someone takes 3.5% or 4% or even a bit more if they follow one of the basic rules of drawdown which is to have other sources of income to fall back on if need be.

  2. Duncan Gafney 31st May 2017 at 3:35 pm

    I would observe Richard that you would be very unusual for a typical client. Most clients worry about two primary things. Having the income they want and not running out of money. Many find this a difficult act to balance and bury their heads in the sand, choosing to keep taking too much, or too little, despite advice they are being given.

    However that is people, most either chose not to worry and rush from 1 financial crisis to another, or they are so cautious they worry that they will run out of money, when even if they spent vastly more than they currently do there is zero chance of that happening.

  3. At the recent Science of Retirement Conference, Bill Bengen suggested that perhaps higher rates could be tolerated and that a higher allocation to smaller companies would be appropriate. Not sure how many FCA or FOS employees were in attendance to hear this but it certainly suggests a rethink of the “perceived wisdom” especially now that we are also considering inter-generational planning now in addition to drawdown. Obviouisly not an all-for-one approach but certainly we shouldn’t be constrained on our thinking.

  4. Jonathan Wileman 31st May 2017 at 4:09 pm

    This is exactly the problem that has been experienced in the Australian market. Drawdown data suggests people generally withdraw less than they would have got if they had purchased an annuity for fear of running out of money. As a result, Australia is currently on a path in the opposite direction from the UK – away from drawdown and towards annuities.

Leave a comment