In this guide
Once you retire and start an account-based pension from your super fund, you are required to withdraw a minimum amount each financial year.
Australia’s minimum pension withdrawal rates begin at 4% for retirees aged under 65 and rise gradually as you age to 14%. There’s nothing stopping you withdrawing more if you need to or can afford to, but there are financial penalties if you withdraw less.
Minimum withdrawal rates were halved during COVID-19 so retirees would not be forced to sell assets into a falling market to fund their pension. But even before the pandemic hit financial markets for six, there was debate in academic and financial planning circles about how much you can safely spend in retirement and be confident you won’t run out of money.
The 4% rule
While Australia’s minimum drawdowns were decided on advice from the Australian Government Actuary, they hark back to a rule of thumb known as Bengen’s 4% Rule.
In 1994, after testing historic market returns, US financial planner William Bengen settled on 4% as the initial withdrawal rate that would preserve the average retiree’s nest egg for 30 years with a high degree of safety.
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But the investment landscape Bengen was surveying has changed dramatically since 1994.
Reviewing the safe withdrawal rate
In a 2015 paper titled How Safe are Safe Withdrawal Rates in Retirement? An Australian Perspective, Griffith University academics Michael Drew and Adam Walk tested Bengen’s 4% Rule using Australian historic market returns.
Given that today’s retirees are living longer and life expectancy is likely to increase further, they looked at withdrawal rates that would provide various levels of safety over 30 years of retirement for different asset allocations.
For example, as you can see in the table below, someone with a 50:50 mix of shares and bonds and a 30-year retirement investment horizon could withdraw just under 3% of their initial portfolio and be 100% confident that their money wouldn’t run out. If they were prepared to accept a 10% chance of falling short (90% safety), a withdrawal rate of 3.62% was considered safe.
Withdrawal rate as a percentage of initial portfolio value
| Asset allocation (rebalance annually, 30 years) | 100% safety | 95% safety | 90% safety | 50% safety |
|---|---|---|---|---|
| 100% shares | 2.74 | 4.20 | 5.13 | 7.63 |
| 75% shares/25% bonds | 2.94 | 4.01 | 4.31 | 6.71 |
| 50% shares/50% bonds | 2.96 | 3.54 | 3.62 | 5.37 |
| 25% shares/25% bonds | 2.45 | 2.69 | 2.85 | 4.11 |
| 5% shares/95% bonds | 1.66 | 1.83 | 2.04 | 5.37 |
However, in Australia most retirees with a super pension are invested in their fund’s Balanced or Growth option comprising 60–80% growth investments. According to the calculations in the table above, a 4% withdrawal rate would have a 95% chance of lasting 30 years. In other words, even though it seems counterintuitive, ‘safety’ is increased by holding a meaningful amount in shares.
Note: For simplicity, the researchers assumed pension drawdowns are made each year on the initial portfolio value at the outset of retirement, which is the US practice. However, it should be noted that Australian super pension drawdowns are calculated on the account balance on 30 June each year. Drawdown rates are then increased as the retiree ages, rather than holding annual drawdowns at a constant 4% as in the US.
What withdrawal rates are safe for Australian retirees?
Index fund specialist Vanguard has also adapted US research for Australian conditions, caming up with a range of 3.5–5% as a safe withdrawal rate, depending on how conservative your portfolio is. They also recommend retirees take a flexible cap-and-floor approach to spending, pulling back in negative return years and spending more in good ones.
According to Vanguard Australia head of corporate affairs at the time of the research, Robin Bowerman: “Those people willing to be flexible in year-to-year spending dramatically increase their chances of not running out of money.
“In fact, a retiree who is willing to cut back spending in bad years by just 2.5% can lift their starting safe withdrawal rate as high as 5% of their savings – without increasing the chances of running out of money. The Vanguard numbers show the best result comes from capping spending increases each year at 5% – even if your portfolio grows faster than that.”
An argument for higher withdrawal rates
Despite evidence such as the studies outlined above that a 4% withdrawal rate is not only safe but many retirees could safely withdraw more income from their super, the message appears to be falling on deaf ears.
In its submission to the government’s Retirement Income Review, the Actuaries Institute said super fund members seem to be aware of the uncertainty they face around their life expectancy and are overly cautious as a result.
“Studies of retiree behaviour based on Centrelink data show that the median pensioner spends little of their assessable wealth (mainly financial) in retirement. The vast majority of their balances get paid as death benefits when they pass away. The reasons for this are likely to be:
1) A fear that reducing their balance could leave them short in later life.
2) A desire to leave money to children.
3) A need to have money set aside for large expenditures, particularly possible health care or aged care costs, which are likely to arise in retirement.”
In a report for the Actuaries Institute titled A framework to ‘maximise’ retirement income, senior actuaries Jim Hennington and Andrew Boal argued:
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“Drawing the minimum (mandated amount from an account-based super pension) generally results in an overall drawdown pattern (including the Age Pension) that increases during retirement rather than giving the member confidence to increase their total drawdown in the first 10–15 years of retirement while the person is healthier and likely to desire a more costly lifestyle.
“Most people who draw down the minimum amount will have at least some unused balance remaining on death and, in many cases, it will be quite material.”
Concerns about running out of money could be partially addressed by the introduction of more annuity-style pension products that offer income for life. Industry experts argue that these (along with any entitlement to the Age Pension) could be used to cover essential spending in retirement, in conjunction with account-based pensions for discretionary spending.
It was hoped the introduction of the government’s retirement income covenant, which came into effect on 1 July 2022, would hasten the development of more innovative pension products. This is happening, albeit slowly, as more super funds introduce pension products offering income for life.
In the meantime, a working group from the Actuaries Institute crunched the numbers a while back to test whether Australian retirees might confidently spend more than the current minimum drawdown rates. And if so, by how much.
They assumed a portfolio with 70% growth assets and an average annual real (after inflation) return of 3.5%, which is close to the returns benchmark used by most public offer super funds. The result was a new rule of thumb they called Spend Your Age.
By ‘spending their age’, it was found that retirees could safely withdraw a percentage amount beginning with the first number of their age and have confidence that their money would last around 30 years. That is, someone in their 60s could safely withdraw 6% of their super each year, while someone in their 70s could withdraw 7%. The rule breaks down for retirees aged 85+ when the statutory minimum rates are higher.
But what if the market tanks?
According to Chant West, Growth pension funds (61–80% growth assets) returned 7.9% per year on average in the 10 years to June 2024. Even Conservative investment options (21–40% growth) returned 4.8% on average.
So for the past decade, retirees have easily covered their minimum pension drawdown requirements without eating into their capital. But that’s looking back over an unusual period when bonds and shares were booming at the same time. While rising interest rates eventually burst the bond market bubble, shares carried on regardless.
What the past decade has taught us though, is that Australian super funds are well diversified and able to ride out periods of short-term volatility and economic uncertainty.
The bottom line
If history is any guide, an initial 4% safe rate may be simplistic, but it is not too far wide of the mark.
However, it’s important that minimum drawdown rates are not treated as default maximums. The development of annuity-style products offering income for life, in conjunction with access to a full or part Age Pension as super balances decrease over time, should give retirees the confidence they need to spend more in the early years of retirement when they are most able to enjoy it.
Debate about safe withdrawal rates is only likely to intensify as the super system matures and Australians have larger average retirement balances.
