3 Things to Retire Successfully with Pension Drawdown

3 Things to Retire Successfully with Pension Drawdown

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    If you’re approaching retirement and considering drawdown, yes this flexibility gives you loads of options and it can extremely powerful, but this freedom can be a poisoned chalice  if market returns are poor, you take too much income or you panic during a stock market crash.

    In this article I’m going to look at three things I would absolutely do with my clients in the build up to retirement to give your retirement the greatest chance of success and retire with confidence!

    For tailored pension guidance that prioritises your financial well-being, please contact the Heritage team today.

    1) Understand Your Portfolio’s Return and Risk Profile

    First up is understanding your portfolio and asset allocation. I am convinced that the sequence of returns risk is one of the biggest risk to the success of your retirement. This is the idea the timing of returns matter and to use a crude example, if you retire on the eve of a stock market crash, this has much more of a devasting effect on the chances of running out of money in retirement as not only are you now taking an income from your invested funds, but you are taking  it from a falling portfolio value.

    This goes hand in hand with knowing how your portfolio or asset allocation has done in the past as this can help you understand the expected returns or volatility your portfolio could experience in the future. I like to look at past bear markets or stock market crashes to understand how much a portfolio could go up or down in a really bad period.

    After all if your portfolio or asset allocation has gone down by 20%, 30% or even 40% or more in the past, although past performance is not a guide to the future, it is reasonable to expect your portfolio could see similar losses in the future, if not even greater losses!

    If you know to almost expect this and be cognisant of this risk, hopefully you wont panic and throw in the towel and sell your investments at the worst possible time which can have a devastating effect on your retirement. 

    As an IFA, the example I have seen first hand was during Covid when a retired brain surgeon sold his portfolio in April after the stock market was down 30%+. With his pension and investments valued at around £500k, believing the stock market had further to fall, he was adamant he wanted to sell despite our protests. Low and behold the stock market snapped back and not only did he crystallise paper losses up until that point, but to add further salt to the wounds, he bought back in at higher prices as financial markets recovered rapidly as you can see below.       

    That’s all well and good Alex, but how do I know how much my portfolio could go down by and how long can my portfolio take to recover. Well one way to do this is to use a website called portfolio visualizer. A word of warning, this is geared to US individuals, but its still quite useful. To show how this works we are going to demonstrate this with a typical 50% US stock portfolio and 50% US bond portfolio. I am not advocating this, it is simply to show you how a weighting of these asset classes has reacted in past stock market crashes.


    Starting with the drawdowns, we can see that since 1986, this asset allocation has lost 20% or more on four seperate occassions, with the worst drawdown over 25% during the banking crisis in 2008.

    Source: Portfolio Visualizer

    If you were planning to retire with this asset allocation as an example and the prospect of seeing your nest egg reduced by over 20% or more, then perhaps your risk tolerance is at odds with your investment strategy.

    By hopefully understanding how your portfolio has performed in the past, during future bear markets or periods of stress, if your portfolio does see similiar losses, this can hopefully give you comfort and prevent you throwing in the towel and selling your investments which can have a terrible effect on the success of your retirement as we could see in the example earlier.

    The Sequence of Returns Risk

    One of the biggest risks with drawdown and the success of your retirement is the sequence of returns risk. This is the idea that the timing of returns matter, and if you retire just before a stock market crash, this can a huge impact on the sustainability of your retirement funds as not only are you now taking an income from your pension, but you are taking an income from a falling portfolio.

    To protect against this risk, one option is to know how long it usually takes your portfolio to recover. Once you know this, you can try and mitigate this risk of taking an income from a falling portfolio by taking an income elsewhere and giving your pension time to recover such as funding your income from your cash deposits, delaying retirement or working part time etc:

    As you can see with the recovery and underwater period, if your portfolio has fallen significantly, if you are able to delay taking an income from your pension for a year or two, then historically at least, this would have given your portfolio time to recover all or at least some of the losses.

    2) Work Out How Much Income You Need To Retire

    The next thing I would encourage you to do in the lead up to retirement is to try and calculate what fund value or pension fund you should be aiming for. This can be a bit like how long is a piece of string, so I like to use a 3 step process.

    Step 1 – Work out what your expenses will be in retirement

    Firstly, work out what your expenses are likely to be in retirement. This could involve increasing or removing the expenses that you will no longer have to pay. If the house will be paid off by then, then remove the mortgage payment. The same would go for commuting costs if you won’t have to the dreaded commute every day.  

    Perhaps you are planning to treat yourself and planning more holidays when you retire. If that’s the case then increase your likely expenses for holidays. 

    If its hard to come up with a budget for retirement or it’s a long way away, then you could simply use a rule of thumb to try and estimate how much income you think you will need. One of which is to take 50-70% of your current income. The Retirement Living Standards also carry out a study which looks at how much retirees should need for a Basic, Moderate or Comfortable retirement and you can use these figures for your expected expenditure. If you are married or live with your partner, I’d always suggest doing this exercise together and combing your retirement assets and incomes. After all you probably split the bills now and likely will do so in retirement.   

    Step 2 – Deduct any other sources of income

    Once you have calculated what your expenses are likely to be in retirement, the next step is to deduct any other forms of income you may have such as state pensions, rental income and final salary pensions if you are luck enough to have one.

    Step 3 – Work out what fund value is needed to meet the shortfall

    Once you have deducted your other sources of income from your expenses, you then need to calculate what fund or pension value you would need to address this shortfall. One way to do this is to use the concept of a safe withdrawal rate, which is basically what income can you take as a percentage of your pension fund each year to hopefully not run out of money.

    4% of the starting pension fund is often seen as the poster child for safe withdrawal rates, whilst others would suggest 3% is more appropriate whilst others would say that you will be ok with 5%. The withdrawal rate you use is important, as a higher withdrawal rate will mean you need a lower fund value, although taking a higher amount of income increases the chance you will run your fund down.

    Let’s see the steps combined…

    Step 1 – Roy and Haley have worked out their expenses in retirement are likely to be a combined amount of £50,000.

    Step 2 – They should both receive their full state pensions which combined, come to £23,004. If we deduct this amount from their expenses of £50,000, this leaves them with a shortfall of £26,996 that they will have to plug from their private pensions.

    Step 3 – If we take this shortfall amount of £26,996 and divide it by 4%, Roy and Haley should be aiming for a combined retirement fund of £674,900.

    This of course assumes you take the flexible option from your pension known as drawdown. You could opt for an annuity which is a guaranteed income source.  Here you essentially buy a guaranteed income in exchange for your retirement fund. It’s worth highlighting that a ‘safe withdrawal rate’ doesn’t mean you wont run our of money as returns could be much worse in the future, or your expenses could surge in the future if you had care costs etc.

    It’s also worth highlighting this method doesn’t really fit if you plan on taking more income earlier in retirement, say for example you plan on taking more income earlier in retirement perhaps before the state pension kicks in and reducing it when you become eligible for this state pension. If this is you, if you don’t want to pay for a cashflow forecast, a spreadsheet can do a half decent job. 

    3) How Will You Take An Income Tax Efficiently

    I’ve discussed the difference between crystallised and uncrystallised funds in another post here.

    When it comes to your pension and drawdown, you may know that usually 25% of your uncrystallised pension is tax free, with the remaining crystallised funds taxable at your marginal rate of income tax. What you may not know is that it is possible to take a combination of your tax free cash and taxable income from your crystallised pension to provide a tax efficient or even tax free monthly income from your pension. This can allow you to take advantage of your personal allowance, in which the first £12,570 of your income is taxed at 0%.  Let’s see an example of how this would work.

    Nancy retired at age 63 and her private pension is uncrystallised and valued at £300,000. She has no other forms of income as she has not reached state pension age and she needs £30,000 as an income this year.  As she has no other income, she has all of his personal allowance remaining.

    Using a tax efficient income, Nancy can crystallise £69,720 of her pension, with £17,430 paid to her as a tax free lump sum. The remaining £52,290 are transferred internally within the pension to her crystallised side of her pension.

    She still needs £12,570 to meet the rest of her expenses, so she can then take the remaining £12,570 that she needs from the crystallised funds which if you recall are taxable however, as it is within her personal allowance, the effective tax rate would be a whopping zero percent on this withdrawal!  

    What About My Pension Tax Free Cash?

    As an Independent Financial Adviser, one thing I’ll often hear from clients approaching retirement is that they often want to take all of their tax free cash at once, even if they have no specific purpose for it and may just want to stick it in the bank. They’ll often think that if they only take a part of their tax free cash, or if they don’t take it at all, they will lose it.  

    This couldn’t be more wrong. It’s actually possible to take a series of smaller tax free lump sums or you can even take a monthly income made up entirely of your tax free cash only, which would result in you paying no income tax. The amount of tax free cash you have is usually 25% of the uncrystallised pension. Let’s see an example of how you can use your tax  free cash to create a tax efficient income.

    John has retired and has a pension worth £100,000 that is uncrystallised. He needs £4,000 to cover his expenditure and has turned to his private pension. He is a Basic Rate taxpayer as he gets the Teachers pension which comes to £20,000 a year so if he took any withdrawals from his crystallised pension, they would be subject to 20% income tax.

    John can take a monthly tax free cash withdrawal of £333 per month (£4,000 per year) to meet this shortfall. He will not be able to do this indefinitely, as he will eventually use up all of his 25% pension tax free cash.

    Seek pension advice from the specialists at Heritage Financial Planning

    If you are considering your retirement options and thinking about how to take your tax-free lump sum from your pension savings, it is wise to get professional, independent advice. Contact Heritage Financial Planning today to book a call with one of our knowledgeable and friendly financial advisers.

    Read more about how pension drawdown crystallisation works.

    The value of investments and any income from them can fall as well as rise, and you may not get back the original amount invested. HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen. The Financial Conduct Authority does not regulate tax planning

    Picture of Alex Norman-Jones​

    Alex Norman-Jones​

    I am one of the founders of Heritage and I am highly motivated to deliver bespoke financial planning solutions to my clients.

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