insight

Myths and rules of thumb in retirement income

Evidence type: Insight i

Context
The study
Key findings
Points to consider

Context

Part of a series of research, this article builds on the findings from previous qualitative work that explored how individuals approaching retirement might use their Defined Contribution (DC) pension pots. The current research looks to qualify what makes a ‘rule of thumb’ rather than ‘received wisdom’ and how they might help retirees to think about and manage their DC pension under the new pension freedoms.

A rule of thumb is defined as: “A guideline that provides simplified advice regarding a particular subject. A rule of thumb is a general principle that provides practical instructions for accomplishing or approaching a certain task. Typically, rules of thumb develop as a result of practice and experience rather than scientific research or theory” (Echalier 2015).

Received wisdom is defined as: “A judgement that has been accepted as true or worth, especially without firsthand corroboration” (Echalier 2015).

The study

Comprising mainly of findings from a roundtable discussion, this report seeks to establish how rules of thumb could be helpful for retirees to think about and manage their DC pension pots.

The roundtable and report were sponsored by State Street Global Advisor and facilitated by PPI. Attendees included: Age UK, Citizens Advice, the Money Advice Service, NEST, The Pensions Advisory Service, The People’s Pension, TUC and Which?.

The report also draws on wider literature, data modelling and on qualitative findings from earlier research.

Key findings

To be classified as a rule of thumb, a piece of advice needs to partly or fully address the following criteria:

It addresses a specific situation
It is relatively easy to understand and apply
It is a tool that can work in a variety of ways
It offers a better course of action than not following it.

Two particular rules of thumb were found to be helpful in assisting people to think about their retirement planning, and more specifically, these two rules of thumb were deemed to provide outcomes that are better than if the rule is not used. These two ‘rules of thumb’ are:

4% withdrawal: to help DC pension pots last for a retiree’s lifetime, this rule of thumb encourages people in the 1st year of retirement to withdraw 4% from their DC pension pot. It then encourages them to withdraw this same amount indexed by inflation throughout the rest of retirement to achieve a sustainable level of withdrawal;
Secure a basic income to meet essential needs: findings from the first stage of research highlights that individuals estimate this basic income would fall between £10,000-£15,000K per year to cover essential needs.

Two further additives were discussed but were deemed to be ‘received wisdom’ rather than ‘rules of thumb’, because they fail to meet the following two criteria: ‘tools that can work in a variety of ways’ and ‘offers a better course of action than not following it’. These are:

Better returns can be achieved by investing in property
I can find somewhere ‘better’ or ‘safe’ for my money.

Overall, rules of thumb could help people to manage their pension pots, but they need to be carefully phrased and the language needs to be easy to understand.

Points to consider

Methodological limitations: These findings are based on a roundtable discussion by a group of experts. These theories have yet to be tested with actual pension savers or retirees.
Applicability: Based on the information provided, this research seems applicable for today’s savers and retirees. However, the authors acknowledge the ‘rules of thumb’ need to be phrased so they are easy to understand and apply.
Generalisability/ transferability: As part of this research, the authors discuss the transferability of the 4% rule of thumb from an USA to a UK context. The authors highlight how the 4% rule of thumb could be appropriate; however this might require further testing/discussion with the general public.