Is the 4% Rule Still Relevant for Pensions?

Retirement planning in the UK is a complex task, with many factors to consider. One of the most important decisions is how much you can safely withdraw from your pension each year without running out of money.

Historically, the 4% rule has been a popular guideline for this purpose, but its relevance in today’s economic climate has been the subject of much debate.

Here, we explore whether the 4% rule is viable in today’s day and age.

What is the 4% rule?

The 4% rule, which was popularised by financial adviser William Bengen in the 1990s, is a simple yet effective retirement withdrawal strategy that is often quoted in discussions about safe withdrawal rates.

Bengen’s theory suggests that you can theoretically withdraw 4% of your initial retirement savings each year, adjusting for inflation, to ensure your money lasts throughout your retirement.

The 4% rule in the current climate

While the 4% rule has been a reliable benchmark for many years, its validity in the recent economic climate has been questioned. Several factors have contributed to this uncertainty:

Underestimating life expectancy

Many Britons underestimate their life expectancy, which means they run the risk of depleting their pension savings too soon.

Rigidly following the 4% rule could compound this issue, leaving pensioners with a shortfall later in life.

We’re often told that people are living longer in the UK. In fact, life expectancy plateaued before the pandemic and has since been in decline. Despite this fact, the number of centenarians has more than doubled in the last 20 years.

One looming conundrum facing the Labour government is when to increase the State Pension age. The government has committed to an increase from 66 to 67 in 2026-28 and subsequently to 68 in 2044-46.

However, the latter uplift is in doubt after the International Longevity Centre this year suggested that the State Pension age would need to increase to 70 or 71 by 2050 to remain affordable.

The cost of living

The UK inflation rate, measured by the Consumer Prices Index (CPI), increased from less than 1% in early 2021 to a 40-year high of 11.1% in October 2022. Since then, inflation has declined to 2.2% as of August 2024.

From May 2021 to May 2024, food prices rose by 30.6%. Before that, it took 13 years for food prices to rise by the same amount.

Food and non-alcoholic drink price rises peaked at 19.1% in March 2023 – the highest since 1977.

Energy prices soared following the conflict in Ukraine and mortgage rates sky-rocketed in 2023 as a result of interest rate hikes designed to slow inflation. All of which combined made the price of living more expensive.

The good news is that inflation has slowed and wage growth continues to outpace inflation. However, it goes to show that economic crises like this will happen, making a flexible approach to pension withdrawals essential.

Is the 4% rule still viable?

Despite the recent economic gloom, research by Morningstar suggests the 4% rule could still be viable.

According to the authors of The State of Retirement Income 2023, “retirees drawing down income from an investment portfolio can now afford to withdraw as much as 4% as an initial spending rate, assuming a 90% probability of still having funds remaining after a 30-year time horizon.”

They posit that the combination of more moderate inflation and increasing yields on cash and bonds make this approach viable when exercised with a degree of flexibility.

However, it should be noted that their projections are based on a portfolio with an equity weighting of 20-40% among various other assumptions.

As such, although the 4% rule will work for some pension savers, it’s far from a blanket, one-size-fits-all approach.

Approach with caution and discuss your options with a financial adviser to ensure the best approach for you.

Alternatives to the 4% rule

Given that the 4% rule won’t be applicable to everyone, it’s essential to consider alternative strategies for retirement withdrawals. Here are just a few options you might like to consider:

Flexible withdrawal rates

Instead of sticking rigidly to the 4% rule, you can adjust your withdrawal rate based on market conditions. For example, if the market is performing poorly, you can reduce your withdrawals to preserve your capital.

Other income sources

In addition to your pension savings, you may have other sources of income, such as the State Pension and private pensions. These can supplement your retirement income and reduce reliance on your workplace pension.

Part-time work

The money purchase annual allowance (MPAA), which caps the amount you can pay into your pension once you have begun withdrawing an income, increased from £4,000 to £10,000 on 6 April 2023.

This makes a part-time return to work a much more enticing option, which can help to top up your savings in the longer term.

Get professional advice from Acumen

The 4% rule has served as a valuable guideline for retirement planning for many years. However, its relevance in today’s UK economic climate is far from straightforward and shouldn’t be taken as read.

Given the challenges posed by underestimating life expectancies and fluctuating living costs, it’s important to consider alternative strategies and seek professional financial advice to determine the best approach for you.

Remember, retirement planning is a personal journey, and there is no one-size-fits-all solution.

By carefully considering your unique situation and exploring various options, you can develop a retirement plan that helps you achieve your financial goals and enjoy a comfortable retirement.

Contact us today on 0151 520 4353 or email [email protected] today to book a free consultation and start taking control of your financial future.