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Is it time to retire the 4 percent rule?

Are charges impacting sensible levels of retirement income?

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Ian Millward
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How much of your hard-earned nest egg can you afford to spend each year in retirement without running out of money?

It is a really important question, and for a very long time, the generally accepted figure has been 4% a year. It is not a figure plucked from thin air and is based on testing and data suggesting a sensibly invested pot should last at least 30 years and, for many people, far longer.

But with inflation running at over 10%, and many investment portfolios down 10%, is it still realistic today?

Crashes, corrections and calamities are nothing new and are reflected in the data. 4% was never a guarantee, simply a reasonable assumption. If you don’t need that much then, of course, it helps to take a little less, but life doesn’t always work like that, and we remain comfortable with withdrawals of up to 4% a year.

Which is why I was quite intrigued by a comment I read in last weekend’s Financial Times.

Last week one of our clients volunteered to be a ‘case study’ for an FT article addressing the challenges of managing your pension via income drawdown. It was an excellent article, but a comment that caught my eye was another advice firm suggesting that 4% was now too aggressive saying ‘we are more comfortable with 3 per cent and the ability of a portfolio to grow’.

It struck me as a little glib. Why a conveniently round 1% drop to 3%? Why not 3.8%, or 3.6% or even 2.9%? And let’s not kid ourselves that the drop is anything but vast.

Just imagine rocking up for work one day and being told to take a 25% cut in pay! Because that is exactly what cutting your income from 4% a year to 3% a year is. These are life changing differences, wrapped up in a seemingly innocuous 1% pay cut.

And the real reason for the cut has nothing to do with new analysis and assumptions. It is something much, much simpler: charges. The 4% assumption never factored in total annual costs of 2% a year and yet somehow that seems to have become the de facto figure for total costs via an adviser.

I couldn’t verify it for the advice firm in question. Their website referred to an ongoing advice fee of ‘just 0.9%’ but, despite having a page devoted to ‘Investment Charges’, with helpful headings like ‘What is the charge?’, ‘Platform costs’ and ‘Portfolio fee’, no actual charges were forthcoming.

But forget this other adviser, this is an industry issue. Total fees of 2% a year (and above) are now the norm and, when that is the case, withdrawing a 3% a year is a much more realistic figure.

It really is as simple as that. The stock market doesn’t recognise what you pay your adviser, fund manager or platform and decide to compensate you if you pay more. Investment performance does vary but there is no evidence to support expensive propositions doing anything other than make more money for those offering them.

Cutting fees by 1% means increasing income by 1%. And by the way, increasing your income from 3% to 4% a year is a 33% pay rise! And if you don’t actually need to draw that extra money, even better as it compounds and grows making the difference even greater over time.

And our clients do often pay total annual fees of less than 1% a year. The fees typically range from 0.8% to 1.2% a year (depending on the amounts involved) but our average overall cost is under 0.9% a year. That includes advice, platform and investment and please note no use of the word ‘just’ 0.9%. There is nothing ‘just’, in any sense of that word, about a 0.9% ongoing cost. But I don’t expect other advisers to match us on cost. There are reasons we can do what we do, such as working remotely, operating on tight margins, being very efficient and making cost core to the fabric of our business.

Nevertheless, we have to stop kidding ourselves that total costs of 2% a year (and don’t forget many people pay a lot more than this) are remotely fair or reasonable. Carefully controlling costs is equivalent to a lifestyle upgrade for you and your family.

It is not time to retire the 4% rule, but it may be time to make fees of 2% a year redundant.

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