How do I cash out my pension over 30 years?

The answer, according to the Hitchhiker’s Guide to the Galaxy, is 42 - the joke being that it is absurd to seek simple solutions to complex, existential questions. I was reminded of this when I embarked on some personal retirement planning focused on one number, 30, and quickly found myself heading down a rabbit hole full of others. When it comes to pensions there really are no one-number answers.

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I started with 30 for three reasons. Playing online Bridge with my dad this week made me realise that there is a reasonable chance that, like him, I might still be here, compos mentis, at the age of 92. That is still 30 years away.

Second, I have just read William Bengen’s new book, A Richer Return, his latest discussion of the ‘4% rule’ he invented. It is not really a rule, as such, but a guide to how much you can safely take out of your pension pot and still assume it will last you out. Bengen’s definition of this, for the purposes of a retiree in their early sixties, is also 30 years.

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Then, this week, I came across Schroders’ annual forecast of investment returns for, you guessed it, the next 30 years. It felt like I was being led somewhere.

So, I took Schroders’ estimates for equity, bond, cash, property and commodity returns, and their forecast for inflation, and played around with them to see what the next three decades might look like for me from a financial perspective.

The answer, as ever when you start thinking about financing your retirement, is that it depends. There are too many unknowns. Will I last as long as my parents? Does Schroders know any more than the rest of us about what the markets will deliver? How much will I want, or need, to spend over that period? How much or little will I be comfortable with at the end? Did I mention tax and inflation? It is no wonder people buy annuities.

Still, there is only one thing worse than having a plan that will need revising. And that is not having one at all. So here goes.

Let us start with Schroders’ crystal ball. And let us not worry how they arrived at their forecasts. I don’t have the space; I suspect you might not have the interest.

They think shares will deliver 6.6% a year between now and 2055, the annual return from UK gilts will be 4.7%, corporate bonds will offer 5.1%, UK commercial property 6.8%, precious metals 6.2% and cash here in the UK 4%. No-one knows, but these seem plausible.

Now, we need to decide in what proportion we might hold these different assets. Again, there is no right answer. The more money you start with, the less you need to chase those higher equity and property returns and the more you can relax into cash and bonds. Because the time scale we are talking about here is long, I am going to swallow the volatility of shares in pursuit of an inflation-beating return - 70% shares, 10% cash, and 5% each for gilts, corporate bonds, real estate and gold.

On a weighted basis, that means I am looking at an investment return of 6.16%. That sounds good until you consider what Schroders is expecting in terms of inflation. It thinks the average over the next 30 years will be 2.6%. That is comfortably ahead of both the Bank of England’s and the Fed’s targets. As I have written before, inflation makes a big difference.

Let us set some other guardrails. A common refrain among financial advisers is how hard it is persuading their clients to shed their saver’s mindset and start spending their money. This reluctance is totally understandable, and one of the least understood consequences of the death of final salary pensions. Most of us will end up with a big pile of unused savings because we cannot face the prospect of spending our way into penury.

My bare minimum, therefore, is to still have half my starting pot intact at the age of 92. Let us say, for argument’s sake, that I start with a million pounds. I will still want to have at least £500,000 in thirty years’ time. Not efficient, maybe, but I will sleep at night.

I am going to make an assumption about tax too. Again, this is largely a factor of how much money we start with. But sticking with that notional million-pound pension pot, it should be possible, for most of the 30 years, to keep under the £100,000 income level at which an effective 60% tax rate kicks in. With judicious use of ISAs and the tax-free cash from a pension and the personal allowance, I think we can assume an average tax rate of 20%. If you start with more, or have less tax-sheltered cash, you will be paying more than this, I’m afraid.

So, we have a starting amount, we have forecast our investment return and guessed the inflation rate. We will assume we take the state pension from 67. And we think we know roughly how much we need to set aside for the tax man. We have decided we do not want to go lower than half our starting capital. What is the equivalent of Douglas Adams’s 42? What is the amount we can safely take from our pension pot and still be solvent in 2055?

The answer, hedged around by a pile of caveats, is 4.7%. Plugging in all of the above, I calculate that, in year one, I can take £47,000 after tax from a £1m pension pot, increase it by inflation every year, and still have £461,000 in 30 years’ time, having taken out a smidge over £2m along the way.

Coming up with the number is not as hard as finding the answer to the Hitchhiker’s ‘ultimate question of life, the universe, and everything’. But it is dependent on a bunch of other numbers playing ball - which they almost certainly will not.

The government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.moneyhelper.org.uk or over the telephone on 0800 138 3944.

Our team of retirement specialists can also provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.

This article was originally published in The Telegraph.

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