The best (and worst) years to retire: how timing affects your income

MOVING from saving for your retirement to using investments to provide an income brings a whole new challenge for investors. 

You simply don’t know in advance how long you need your money to last, or the rate of investment return you’ll get along the way. That makes knowing how much you can safely withdraw as income difficult. 

If investments rose in a smooth and predictable way the task would be much easier - but they don’t. The long-run return from investment assets may well be ample to provide the income you’re looking for but the sequence in which those returns come through makes a huge difference to your outcome.

If you suffer large market falls in the early years of retirement - when your pot of invested assets is still large - this will cause lasting damage to the value of your fund, even if prices rebound after that. That’s because you’ll need to sell more assets in the early years to raise the income you need, leaving fewer to recover later. In investing jargon it’s known as ‘sequencing risk’.

We wanted to examine exactly how much difference sequencing can make to your retirement prospects, as well as putting a common method of ensuring safe withdrawals - the ‘4% rule’ - to the test. 

It meant looking back through recent history to uncover what the best - and worst - moments to retire in recent history have been. Here’s what we learned.

The 4% rule - why it works, why it doesn’t

A lot of thought has gone into working out a sustainable level of withdrawals from investments. Perhaps the most widely used measure is the ‘4% rule’ which says investors should be able to take 4% of the value of their fund in the first year of withdrawals - while escalating that amount each year by the rate of inflation - and expect their money to last 30 years, reflecting the length of a full retirement.¹

To establish it, academics ran numerous simulations of market returns going back several decades to work out the likelihood of an investment fund running out within 30 years. Based on these historical scenarios, 4% withdrawals have been very unlikely to exhaust an investment fund.

That makes the 4% rule a great starting point if you want your money to last. However, it also creates a high likelihood that you will be left with an excess at the end of 30 years. In the most favourable scenarios this excess could dwarf the original size of the pot.

That’s a good problem to have but less than ideal if you want to maximise your retirement fund for income throughout your retirement.

Running the numbers

We wanted to see how the 4% has stood up in the recent past. To do that we used market data going back almost three decades - 29 years to be precise - to build a series of overlapping scenarios, each starting one year apart. Our first scenario began on 1^st January 1994, the second a year later in 1995, the third in 1996, and so on.

In each scenario a 4% annual withdrawal was taken from a £100,000 pot invested in a 60/40 blended portfolio of shares and bonds. Withdrawals then escalated by 2% each year to represent inflation.

The chart below shows the value of the pots 10 years after withdrawals began. The final scenario for which 10 years of returns were available began in 2013.

You can see that even after 10 years the range of pot sizes is substantial, with the worst performing scenario leaving around £81,000 and the best around £177,000. And remember - these scenarios share the same starting value and the same level of withdrawals.²

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.