How the pension freedom 'class of 2015' nearly doubled their money

Ed Monk is associate director at Fidelity International.

Markets have been kind to the first cohort retiring under pension freedoms introduced a decade ago.

Retirees who followed the ‘4 per cent rule’ and withdrew that percentage annually from a pension pot worth £100,000 would now have £189,000 remaining – nearly double their starting amount.

Pension freedoms launched in April 2015 allowed retirees to take control of their pension savings, shifting away from the obligation to purchase an annuity and moving towards flexible drawdown and investment options.

While this gave people the ability to tailor their retirement income, it also left them reliant on market conditions to generate income – and exposed to a potential downturn, particularly in the crucial early years of retirement.

Today, more and more retirees are navigating this challenge. By 2023/24, 2.6 million people had accessed their pension funds flexibly, using them as income while keeping a portion invested for the future.

The class of 2015: A decade of decumulation

To understand how these retirees have fared, let’s look at the journey of a hypothetical individual who retired on 6 April 2015, the first day pension freedoms came into effect, with £100,000 of invested pension savings.

Using historical market data, we can model how their pension pot would have performed over the decade, factoring in various levels of annual withdrawals and portfolio diversification.

The analysis started with a pot invested 100 per cent in global shares, with withdrawals set at 4 per cent a year and then rising annually by an amount to reflect inflation.

This is the ‘4 per cent rule’ – a long-standing principle that suggests this level of income is generally sustainable for 30 years or more.

The withdrawal rate was then remodelled for 5 per cent, 6 per cent, and 7 per cent withdrawals.

Income was taken once a year from the end of the first year onwards. The table below shows totals for what would remain after each level of withdrawal, along with cash figures for the total income take and the lowest balance hit during the period.

What jumps out immediately is just how well the class of 2015 have done, even if withdrawals were dialled up to 6 per cent or 7 per cent – above what most financial advisers would advise.

With a 4 per cent withdrawal rate, their pot grew to £189,000. Even at a 7 per cent withdrawal rate, they retained over £131,000, with 10 fewer years of retirement to fund.

So, retirees who relied on investments have benefited from favourable market conditions over the past decade.

However, this is only clear in hindsight, and there have been periods of high anxiety. For instance, those withdrawing 4 per cent saw their pot fall below £82,000 within 10 months of retirement, making it seem unlikely that it would last another 30 years.

Smoothing out the ride

Let’s also look at a diversified portfolio of 60 per cent shares and 40 per cent bonds.

While this approach reduced volatility and downside risk, it also slightly dampened overall returns.

The lowest pot value dropped to around £89,000 in the first year, and had a smoother ride thereafter.

Despite prolonged high inflation and interest rates, which usually hurt bond performance, 60/40 pots grew over the period, even with 7 per cent withdrawals.

The first cohort of retirees under pensions freedoms have seen quick recoveries from setbacks like the pandemic, and avoided having to make low-priced asset sales to maintain their income.

In 2015, those choosing market investments over annuities benefited more. A £100,000 annuity paid £5,304 annually, but market investments provided similar or higher income and often a larger remaining pot.

However, past performance doesn’t guarantee future results. Future retirees may not be as fortunate.

To mitigate risks, keep a cash reserve for two to three years of income to avoid selling investments during downturns.

But while it’s important to prevent running out of money, being overly cautious could also mean not making the most of your income.