That is why pension experts invented the 4 per cent rule, to stop people from spending their nest egg too soon. The rule states that if you withdraw no more than 4 per cent of your pension each year, your pot should never run out.
However, experts say the rule no longer works, because of rising life expectancy and record low interest rates. So how much dare you draw from your retirement savings each year?
When pension freedom rules allowing the over-55s to cash in their entire pots were introduced in April 2015, annuity sales plunged.
Billy Burrows, director of pension planning specialists Retirement IQ, says that annuities have the benefi t of paying a guaranteed income for life, no matter how long you live: “However, many people are reluctant to tie into an annuity, especially at today’s rock-bottom rates.”
If you leave your pension invested instead through income drawdown, you can take 25 per cent of your pension pot tax-free, then draw income from the rest.
Burrows says this gives you much more flexibility, but also leaves you facing a tricky question: how much income should you draw?
Take too much and you could run out of money, take too little and you may not enjoy your retirement to the full,” he says.
That is where the 4 per cent rule comes in. “A financial expert in the US worked out that if people took 4 per cent of their pot as income and kept the rest invested they would probably never run out of money.”
Unfortunately, rules are made to be broken.
As people live longer, their pension pots have to stretch further.
That is not easy, as rock-bottom interest rates make it harder to generate the income you need to get by.
The other challenge is that to be sustainable, your income has to keep pace with inflation.
Burrows says this trio of factors means that 4 per cent a year may be too high: “The sensible withdrawal rate may be closer to 3 or 3.5 per cent a year.”
Currently, a 65-year-old with a £50,000 pension pot could buy a level annuity paying £2,549 a year, equivalent to 5.1 per cent per annum.
If they opted for income drawdown and withdrew 4 per cent a year, they would get just £2,000. Why put up with that?
Burrows says there are three reasons: “Drawdown is more fl exible, as you take control of your money.
Also, when you die you can leave your pension pot to your children.
Finally, your fund will increase if stock markets rise, so your 4 per cent withdrawal should give you higher income over time.”
Quick on the Draw
Andrew Tully, pensions technical director at Retirement Advantage, says drawdown is complex and the big danger is that people take too much too soon.
“Our research shows that most people think it is safe to withdraw 7 per cent a year from a £100,000 pension pot without fear of running out of money early, but that is a risky strategy,” he warns.
Tully suggests the safe withdrawal rate could be as low as 2.5 per cent: “More people now choose drawdown over annuities but if they get their sums wrong they risk retirement ruin.”
While 4 per cent can still work as a handy rule of thumb, how much you can take depends on personal factors such as the size of your pot, how your investments perform and your other sources of income.
Tully says that the new breed of retirement accounts allow you to combine the security of an annuity with the flexibility of drawdown, giving you the best of both worlds.
You may need to take financial advice to find the right one for you, but at least you will avoid the dangers of working to the 4 per cent rule.