Under Flexi Access Drawdown, it is possible to take an income level of your choosing, with no upper limit. Whilst this sounds great in theory, it is of importance for us as advisers to give our clients reassurance that the income level they have selected is not one that will leave them in danger of their pension fund running out in later years.
Therefore arguably the most commonly asked question we receive is ‘How much can I afford to take out as an income?’.
There is no set answer to this, and there are many different theories is to what is a reasonable level of income to take, some more complicated than others, but our approach is a fairly straightforward one, and it involves quite simply what we refer to as the ‘6 and 4’ approach.
The underlying premise of this approach is a very simple one: that if you take an income withdrawal of 6% of your fund, and you received an investment return of 4%, then your fund would fall by 2% per annum. If this were to be replicated over the longer term, then your fund would last comfortably in excess of 40 years.
Similarly if you were to take an income of 7% per annum from your fund, and you received an investment return of 4%, then your fund would reduce in value by 3% per annum and would last over 30 years.
It is important to emphasise at this stage that investment returns cannot be guaranteed, and can be subject to short term volatility, and that if an investment return of 4% per annum were not to be achieved over the longer term, then this would potentially reduce the amount of income that could be taken in later years. That said however, historical evidence suggests that an investment return of 4% per annum in a reasonable one to assume.
In addition, as Flexi Access Drawdown allows the flexibility to change levels of income whenever an individual wishes, it is possible to change income levels according to changing life circumstances. For example, some people may wish to take a higher level of income in the earlier years of their retirement, as they may wish to reduce their income level when they start to receive State Pension.
Alternatively, they may wish to receive a higher level of income initially as they may be receiving an inheritance in future years, and again this in our opinion would make it reasonable to withdraw a higher level of income earlier on, in the expectation of income levels reducing in later years.
It is also worth pointing out that for many people, their expectation is that their level of expenditure will drop in later years, particularly as people reach their eighties, simply by virtue of them going out less, and certainly going on less holidays.
It is possible for us to adopt a cash flow modelling programme that allows for this reduction in expenditure in later years and generally shows that a higher level of income is perfectly reasonable in earlier years if it is accompanied by a lower income level later on.
Finally, it is also fair to say that life and circumstances change for all of us as we get older, and an amount of expenditure that we perceive now to be realistic for 10 years hence can change significantly 10 years later, either upwards or downwards, and it is therefore vital to have an ongoing review process that addresses both the performance of the fund and also any changes in personal circumstances.
However, in summary, the best way an individual can utilise their pension fund is the one that suits their circumstances the best, with the assumption that they do not take levels of withdrawal that are so high that it is inevitable their fund will run out.
And in this context, the simple 6 and 4 rule is a very good starting point!
