Drawing an income from a portfolio

Building a portfolio and drawing on one are different problems, and the transition between them is where most retirement planning attention should be.

Why decumulation is harder

Several reasons.

Sequence risk becomes relevant: the order of returns matters when withdrawing, and a poor sequence early does disproportionate damage.

Longevity is unknown, which means the required duration of the income is unknown.

Flexibility is lower, since returning to work may not be possible.

Inflation compounds over a potentially very long retirement.

And the decisions are largely irreversible.

Which means the accumulation approach — hold a diversified portfolio, contribute, ignore it — does not simply continue.

The withdrawal rate question

Where the debate sits.

Rules suggesting a sustainable initial withdrawal in the region of three to four per cent of the starting balance, increased annually with inflation, derive from historical simulation.

Their limitations are substantial: they depend on the historical period and market examined; assume a fixed retirement length; generally exclude costs and taxes; and assume rigid withdrawals regardless of circumstances.

Lower rates have been suggested for lower expected return environments and longer retirements.

Which means these are a framework for thinking rather than a rule, and any specific plan should be modelled with your own numbers.

Flexible withdrawal approaches

Which improve sustainability substantially.

Reducing withdrawals in poor years and increasing them in good ones, which modelling consistently finds improves the probability of the money lasting.

Guardrail approaches, which define upper and lower bounds and adjust when breached.

Percentage-of-portfolio withdrawals, which never run out and produce variable income.

And required-minimum style approaches based on remaining life expectancy.

Each trades income stability against portfolio sustainability, and the right balance depends on how much of the spending is essential.

The bucket approach

A structure many people find intuitive.

Short-term bucket: one to three years of withdrawals in cash, which funds spending without selling investments.

Medium-term bucket: bonds and lower-volatility assets covering the following years.

Long-term bucket: equities for growth over the remaining decades.

Refilled periodically from the longer buckets when markets permit.

Its main benefit is behavioural and mechanical rather than mathematical: it prevents selling equities during a decline and makes the plan comprehensible.

Guaranteed income

Which addresses the risks directly.

State pensions and defined benefit pensions provide inflation-linked guaranteed income in many systems.

Annuities convert capital into guaranteed income for life, transferring longevity and sequence risk to the insurer.

Covering essential spending with guaranteed income means market outcomes affect discretionary spending only, which changes the entire risk picture.

A combination of guaranteed income for essentials and a portfolio for the rest is what many practitioners recommend, and it addresses the main risks while retaining flexibility.

Order of withdrawal

Which affects tax and outcome.

Which accounts to draw from first depends on tax treatment, and the answer differs by jurisdiction.

General considerations: preserving tax-advantaged growth where possible; managing taxable income to stay within lower bands; considering the treatment of each account on death, since some pass more favourably than others; and the interaction with means-tested support.

This is one of the clearest cases where professional advice earns its cost, since the amounts involved are substantial and the rules are complex.

Inflation over a long retirement

Frequently underestimated.

A retirement lasting thirty years faces substantial cumulative inflation even at moderate rates.

Which means a fixed nominal income loses a large proportion of its purchasing power over the period.

Level annuities are cheaper initially and produce this outcome; increasing annuities cost more initially and protect against it.

And a portfolio drawn on must grow enough to sustain increasing withdrawals, which requires maintaining growth assets rather than de-risking entirely.

Spending patterns in retirement

Which are not flat.

Research on retirement spending generally finds higher spending in the early active years, declining in the middle years, and potentially rising again with care costs.

Which means planning a constant inflation-linked income may overstate the requirement in the middle period and understate it at the end.

And which is an argument for flexibility and for considering care costs separately.

The practical checklist

Before drawing.

Know your guaranteed income and what essential spending it covers.

Build the cash buffer before you need it.

Decide the withdrawal approach and write it down.

Model a poor sequence in the first five years.

Understand the tax consequences of each account.

Use free guidance services and consider regulated advice, given the irreversibility.

And be alert to scams, which cluster around people accessing pension savings.

General information only, not investment advice. Retirement income decisions are largely irreversible — use free guidance services and consult a regulated financial adviser.