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How should I manage withdrawals in the drawdown phase?

It is essential to have a plan to ensure that you do not run out of money before the end of your life
How should I manage withdrawals in the drawdown phase?
  • How much you can safely withdraw from your assets in retirement depends on factors including the value of your assets and the age at which you start to draw from them, health and life expectancy
  • Try to get an idea of how much income you will need each year in retirement for essential spending and how much you will want for discretionary spending

Everyone has a different lifespan, lifestyle, value of assets and sources of income, so a one-size-fits-all solution is not going to be right for everyone. The amount you can safely withdraw each year depends on factors including the value of your assets and the age at which you start to draw from them, health, life expectancy, and whether you have dependents to provide for.

This means that it is essential to have a plan to ensure that you can take what you need without risking that your money runs out before the end of your life. Not having a long-term plan and investment strategy can lead to withdrawing too much too soon, so that difficult adjustments must be made or you run out of money before the end of your life. Or you might be too cautious and go without things you could afford.

Think about what age you want to retire and how much you might need for your retirement funds to last till the end of your life. You can make estimates based on your life expectancy which you can get from online calculators such as Aviva’s at https://www.direct.aviva.co.uk/myfuture/LifeExpectancy/AboutYou or the Office for National Statistics’ at https://www.ons.gov.uk/peoplepopulationandcommunity/healthandsocialcare/healthandlifeexpectancies/articles/lifeexpectancycalculator/2019-06-07.

But you might live more or less than this. “For someone retiring at 60, the drawdown fund may have to last 30 to 40 years or more, so sustainability is key,” points out Kay Ingram, chartered financial planner at LEBC Group.

Try to get an idea of how much income you will need each year in retirement for essential spending and how much you will want for discretionary spending. “Understand how much income is needed to meet a minimum acceptable retirement lifestyle and how much extra is wanted to support your desired lifestyle,” suggests Ingram. “Ideally, the former should be guaranteed as much as possible, with only the latter dependent on investment returns. For example, a person wants to retire aged 62 but their occupational and state pensions will not start until 65 and 66 respectively. Taking larger withdrawals for the four year gap period and then reducing these from year three onwards could be feasible."

Your retirement funds are not necessarily just your pension – investments held in individual savings accounts (Isas) and general investment accounts can also be a part of this.

Buying an annuity with some of the money and increasing your sources of guaranteed income while leaving the rest of the money to potentially grow could be a good option. Rates are currently very poor so this is a reason not to annuitise your entire pot.

Ingram suggests dividing your retirement savings into different buckets to manage investment risk. For example, you could take no investment risk on the money that will be needed to fund withdrawals in the first three years of retirement and minimal risk with the money that will fund the three years’ after that. But you could expose money earmarked for income over the longer term to more risk so that it has the potential to beat inflation. Online pensions calculators can help to estimate how much your retirement money pots might generate. You can find ones at https://www.unbiased.co.uk/tools/pension-calculator or https://www.moneyadviceservice.org.uk/en/tools/pension-calculator.

“Dividends and gains made in years of good investment returns could be gradually moved into the lower risk spectrum of the portfolio so that liquidity can be maintained during market shocks, without the investor becoming a forced seller to generate income,” she adds.

This will help to build up a cash buffer to draw from during market volatility. It is a good idea not to draw from investments when their value has fallen because you will deplete their size even more and make it harder for them to recoup the losses they have experienced. Ingram suggests holding enough cash to cover around three years net income, inflation adjusted, although cautious investors may wish to hold more. “It also depends on how much of the overall income needs are being met from drawdown,” she adds.

If the withdrawals are for non-essential spending that can wait, you could delay them until the investments have recovered their value.

If your investments are properly diversified it could mitigate the effect of a sharp fall in equity markets on the value of your overall assets. Diversifiers could include bond funds, property and cash. The extent to which you diversify depends on what other assets you have, according to Clare Julian, wealth planner at JM Finn. For example, if your pension is your only source of retirement income you should probably diversify it and remove some risk. 

But if your pension is part of a range of sources, including some lower risk ones, this is not as essential. And if it is the portion of your retirement savings that you are drawing on last, meaning that it has a longer-term investment horizon, it could be worth focusing it on higher-risk growth investments. The biggest risk of going into drawdown rather than buying an annuity is that you will run out of money before the end of your life. 

If you wish to pass on assets after your death it can make sense to draw on your pensions last as they do not form part of your taxable estate, whereas Isas and general investment accounts do. Michael Lapham, director of financial planning at Mercer & Hole, suggests first drawing on unwrapped investments, using allowances including those for capital gains, income and dividends to offset tax. For example, you could sell portions of unwrapped investments which have done well and offset the gains up to the value of your annual capital gains tax (CGT) allowance, which for the 2021/2022 tax year is £12,300.

You could then draw from your Isas as withdrawals from them are tax free whereas with pensions, after you have taken the 25 per cent tax-free entitlement, withdrawals are taxed at your marginal income tax rate.

The less you lose to taxation, the further the money you take out will go, meaning that you have to draw less, helping your retirement funds to last longer. “Careful management of the tax liability on income withdrawn can enhance the net income received by between 20 and 55 per cent, and is an important contributor to income sustainability,” says Ingram.

Review your plans and estimates regularly so you can factor in changes such as a deterioration in your health or the death of a partner. “An annual review enables changes to the asset allocation and withdrawal patterns to be made incrementally, giving the plan a better chance of achieving its long term sustainability goal,” says Ingram.

When you are retired and drawing you should still conduct an annual review because income needs in retirement are likely to change over time.