I am thinking of starting to withdraw an income from my SIPP later this year. I have heard something about a 4% rule I should apply when working out how much to take from my SIPP.

What is this, and is it something I should be following?

Kamal

Rachel Vahey, AJ Bell Head of Public Policy, says:

Over our working life, our focus is on building up our savings and investments so that we can have the money to enjoy our financial later life.

Once we reach that magical point when we decide we want to flip the focus and start taking money then we encounter what has been called the ‘nastiest hardest problem in finance’ – decumulation. This is just a jargon word for working out how much money to take from which investment or saving, at what rate, and when.

You can access your pension pot from the age of 55 (rising to age 57 from 2028). You can take up to 25% of the amount you take as tax-free cash and then take the remainder as a taxed lump sum, use it to buy an annuity (a guaranteed income for life), or move it into drawdown.

DRAWDOWN OPTIONS

If you decide on drawdown, you can set the income you take from the pot. This is completely flexible. You can decide on any figure you want, and you have the flexibility to change it at any time. You don’t have to take a regular income – it could be ad-hoc, or you could decide to stop or start at any time.

Often people decide they want to use their pension pot to give them an income to last a particular amount of time, sometimes up to their death. The challenge then is deciding on the right rate to make sure the pot doesn’t run out of money before you reach the ‘end date’.

The ‘4% rule’ is one theory people have adopted to achieve this. It suggests people can withdraw up to 4% of their drawdown pot each year, adjusted for inflation, and still expect their money to last 30 years.

This is a simple and easy rule to understand to estimate how much income you may want to take from your retirement savings. But of course, it’s not guaranteed to work, and landing on the right answer to the tricky question of how much money should I take is far more complicated.

OTHER CONSIDERATIONS

As a starter, here are a few other things to consider.

The first thing to work out is how much money you need from your pension. This will depend on the other assets you have built up – such as ISAs and other savings, and when you plan on taking an income from them. It will also depend upon how much money you need in retirement and when. For example, you may anticipate a child’s wedding or helping them onto the property ladder.

But it’s not just about setting an amount. Inflation will erode the real value of your income over time so factor in increases over time.

You also have to work out how long you need your money to last, and that will depend on your general health, life expectancy, and whether you want to leave any of your pot to pass onto other people, such as a partner or adult children.

You can also factor in market volatility. There are various tools around that can help you test what would happen to your savings if there were a market event – such as a significant fall.

A final thought. Whatever strategy and final figure you decide on, don’t ‘set and forget’. Instead, you will need to review this on a regular basis to take account of not only market changes to your remaining savings and investments, but also factors changing your income needs such as inflation and changes in personal circumstances.

As you can see there are many things to consider. A regulated financial adviser can help you understand your choices and can put together a financial plan for you based on cash-flow modelling to work out the best way to take your money over retirement.

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to askrachel@ajbell.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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