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What is a “Safe” Drawdown Rate In Retirement?
27 July 2022

Written by Kris Wrenn

How much can I earn in retirement” is possibly one of the most commonly asked questions in the financial planning world, and one that is very difficult to answer. As with almost all financial planning issues, there is no ‘one size fits all’ and the answer is always specific to the individual/couple. However we can still consider the question generically, and how government legislation regarding “minimum drawdown %’s” for account-based pensions can question the sustainability for those over 65, and even more so for those aged over 75 and beyond.

In 1994 William Bengen produced a theory, based on drawing an income from a pension account for a minimum of 30 years, that a safe withdrawal rate was 4% in the first year, and then increasing this $ amount by the rate of inflation each year thereafter. This is commonly referred to as the 4% rule, or “the golden rule”. The general premise is that your funds (assuming a balanced portfolio) should return around 7%, 4% of which you draw 4% as an income, and 3% caters for inflation.

This obviously makes some big assumptions:

  • To me, the main assumption it makes is that people want to leave a significant amount of their Super to their children, rather than gradually run down the balance. E.g. If you start with $1,000,000, and return 7% p/a ($70,000) and draw $70,000 p/a), then in theory in 30 years (or any timeframe), you would still have your $1,000,000 balance. Albeit $1 mil in 30 years will likely be “worth” considerably less than in today’s world (due to inflation). The point being, the likelihood is you would “leave this world” with a sizeable retirement nest egg, which may not be what you want. The more common response I hear from my Hudson members is that “The Super is ours, the house is for the kids”.

Implication: This would suggest one could “safely” draw slightly more than 4%+inflation, and slowly run down the nominal balance.

  • Bengen’s theory in the simplistic sense also doesn’t take into account entitlements to the Age Pension. When your retirement assets fall past a certain point you become eligible to an entitlement known as The Age Pension, and from that point this entitlement rises as your assets fall.

Implication: As you head further into retirement, the amount you need to draw may decline. Furthermore, there is an argument to draw more earlier on in retirement, and less as your Age Pension entitlement rises.

  • Finally, it does not take into account how expenditure needs change through retirement. Put simply, the older you get the less you tend to spend. Earlier on in retirement people are far more active and get out and about more. They also tend to travel more, knowing they may not be able to later in life as health may not permit it.

Implication: Once again it suggests one should perhaps draw more earlier on in retirement and less as time progresses.

Government minimum drawdown rates for Pension accounts

As well as making assumptions, there is also Government legislation regarding how much you must draw from your pension each year. It works as follows:


Age Bracket Minimum Drawdown Rate
Under 65 4% (currently 2%)
65 – 74 5% (currently 2.5%)
75 – 79 6% (currently 3%)
80 – 84 7% (Currently 3.5%)
85 – 89 9% (Currently 4.5%)
90 – 94 11% (Currently 5.5%)
95 and Over 14% (Currently 7%)

 

The minimum drawdown amounts are currently lower due to recent legislation introduced after the covid-related market drop. They are anticipated to return to normal at some stage.

The above shows that under normal rules, those that retire after age 65 can’t actually draw 4% initially, as per the Golden Rule. Furthermore, it forces someone who is, say 85 years of age, to draw 9% of his or her pension. This individual may well live another 15 or 20 years, but they are forced to draw nearly 10% of their retirement funds each year. Of course, although you are forced to draw out of the Pension account you don’t have to spend the money!

Summary

As I stated initially, there really is no one-size fits all answer here, because a range of factors can influence how much you should draw from your Super/Pension funds; from estate planning considerations, Centrelink entitlements and expected expenditure needs. A simple solution could be draw the minimum the Government allows, and increase this when needs dictate, effectively playing it by ear, and then reassessing your position year-on-year to see how much you have drawn and to consider sustainability. Assuming you keep a cash balance outside Super, the balance of this account can be reviewed periodically.

 





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