Rules of Thumb for decumulation or draw down

A simple tool to get people thinking about how to take money from retirement savings – a new approach from New Zealand.

As previously blogged here and here, decumulation is proving a puzzle in countries which have a generation retiring about now with more retirement savings in private sector defined contribution (DC) funds than used to be the case.

Retirees must navigate inflation, investment and longevity risks when they ask the question How can I best organise my retirement savings for income in later life?

They could go to a financial adviser, but we know that not everyone will.  Whether they do or not, it may still be helpful to have another independent, trusted source of information which suggests options and gives an easy-to-understand general steer.  In recent Financial Markets Authority (FMA) research, 48 per cent of people at the point of retirement asked which types of information or tools would be helpful when making decisions about retirement chose tools to help me understand different financial options and 47 per cent chose simple guidelines about making the most from my money.

But there isn’t much available. If instead there were many sources of such information, offering slightly different takes on the ‘best’ options, this could be more confusing than helpful.  The Retirement Interest Income Group (RIIG) of the New Zealand Society of Actuaries (NZSA) spotted this problem – and offers a solution.

The NZSA has published Decumulation Options in the New Zealand Market: How Rules of Thumb can help to explain.  Here is the full paper, and here a summary. I’m a member of RIIG and co-author of the paper.

The key points are:

  • A set of four Rules of Thumb is proposed to be integrated into the different ways retirees in New Zealand receive information on how to take income from their retirement fund. The four Rules of Thumb are:
    • 6% Rule: Each year, take 6 per cent of the starting value of your retirement savings.
    • Inflated 4% Rule: Take 4 per cent of the starting value of your retirement savings, then increase that amount each year with inflation.
    • Fixed Date Rule: Run your retirement savings down over the period to a set date – each year take out the current value of your retirement savings divided by the number of years left to that date.
    • Life Expectancy Rule: Each year take out the current value of your retirement savings divided by the average remaining life expectancy at that time.
  • The four Rules of Thumb have been tested to be relevant to people approaching or at retirement with modest savings in the current (2017) New Zealand investment, longevity and superannuation environment.
  • The four Rules fit with different profiles of consumer preferences about retirement income, and each Rule is described by who each is “suitable for”. These descriptions cover the risks that people need to think about, and their preferences for taking income.
    • 6% Rule: Suitable for people who want more income at the start of their retirement, to “front-load” their spending, and are not concerned with inheritance.
    • Inflated 4% Rule: Suitable for people worried about running out of money in retirement or who want to leave an inheritance.
    • Fixed Date Rule: Suitable for people comfortable with living on other income (for example New Zealand Superannuation) after the set date. Those wanting to maximise income throughout life, not concerned with inheritance.
    • Life Expectancy Rule: Suitable for those wanting to maximise income throughout life, not concerned with inheritance.
  • A single set of Rules would be “approved” (not necessarily formally in the sense of being mandatory) by a relevant body, perhaps the regulator (FMA in New Zealand). This set would be available to be integrated into messages from providers, distributors, commentators and others who communicate with New Zealanders on decumulation matters.
  • The presentation of the Rules would be different in different situations. For example:
    • An information website might simply describe the Rules, and perhaps show something like the “suitable for” descriptions.
    • Educational literature might illustrate potential income profiles for a couple of examples as an invitation to more personalised advice.
    • A robo-advice website might give access to a calculator which generates income profiles from the Rules based on user-input parameters.
  • These Rules need not be a complete solution; they are simple and add to rather than replace other sources of advice or guidance. They can be used with suitable recommendations for when to seek independent financial advice. The aim is a useful and reliable steer which engages retirees of modest means.

The Rules themselves may not be right for other countries.  A typical retiree is likely to have different priorities, preferences, amount of savings and level of public pension than in New Zealand.  Tax and regulation will be different. Unique conditions of NZ include:

  • Extremely limited annuity market – no guaranteed annuities and only one variable annuity available on the open market.
  • Relatively low retirement savings – average KiwiSaver balance for near-retirees around NZD15,000.
  • Tax-free KiwiSaver withdrawals after age 65.
  • The public pension, New Zealand Superannuation, is practically universal and relatively generous.

This means that in a country other than New Zealand, the same process to derive a single set of Rules can be followed, but the testing will be carried out using different assumptions.

Wherever decumulation is a puzzle, a set of Rules of Thumb to help retirees think through their options is likely to be a useful part of the solution.

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