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Tap your super, but how much? - Eureka Report Article

February 18, 2008

Tap your super, but how much?
By Scott Francis



PORTFOLIO POINT: Two US studies offer a guide to the rate super can be tapped, to maintain an income during retirement.

One of the most profound questions we face in planning our financial future relates to how we turn a lump sum (such as our superannuation balance) into an income stream. For people at, or close to, retirement this is significant because it is how much of their future life will be funded. For people thinking ahead to retirement this is also crucial because it builds a picture of how much is needed for retirement - or for stopping work early and living off their assets.

The Government has been kind to people planning the process - judicious use of superannuation means that most people can ignore tax because at retirement the income stream from a superannuation fund is tax-free (if over 60 and, in practice, for the majority of people over 55).

That means we can ignore tax consequences, but it does not help us calculate the rate at which we withdraw money. The research on withdrawal rates shows that the rate at which we can withdraw money from a lump sum is related to the mix of assets we have: more growth assets (shares and listed property) mean a higher expected return, which allows a slightly higher drawdown rate. (The drawdown rate is the percentage withdrawn from a portfolio each year - a 4% drawdown on a $1 million portfolio is $40,000 a year. Throughout this article the drawdown rate also assumes that drawings increase each year with inflation).

Among the best work done in this are is two research papers, both from the United States; they offer very interesting thoughts on the drawdown process. It is important to consider this issue of drawing from a portfolio in an Australian context, which is subtly different from the American experience, and we finish by looking at this.

The first paper, Asset Allocation and Long Term Returns, by Stephen Coggeshall and Guowei Wu of Morgan Stanley, was published in July 2005 by the Social Science Research Network.

What is the best mix of stocks and bonds to use as an asset allocation for a portfolio that is being drawn from? Bear in mind that Coggeshall and Wu's article is US-based. It uses data from a period of almost 80 years - 1926 to 2004.

It starts by looking at the returns from holding shares for different periods of time, and holding periods started in each year of the study. For example, in looking at the 20-year returns, it looked at periods starting in 1926, 1927 and so on. It found that although the average annual return from shares was just over 11% for the period of the study, the period of time shares were held was crucial in managing the volatility of a portfolio.
  • Over one year share returns ranged from - 44% to 61%.
  • Over five years, - 14% to 28%.
  • Over 10 years, - 3% to 20%.
  • Over 15 years, 0.5% to 19%.
  • Over 30 years, 8.3% to 14%

The study then looked at the returns from bonds, the proxy for fixed interest investments. It considered only high-quality fixed interest investments, rated AAA and AA.

Bonds had a significantly lower return - 5% over the period studied. When bond returns were compared to stock returns there was a 90% probability over any five-year period stocks would outperform bonds. Over 10 year periods that increased to 95%. Over 15 years it was 99% certain that stocks would outperform bonds, based on the author's data. This led them to state, "Bonds are riskier than stocks for holding periods of about 15 years or greater."

It also raised the question of asset allocation: how much of a portfolio in stocks and how much in bonds (high quality fixed interest)? For shorter-term needs - up to 10 years - bonds are favoured. However, for the part of the portfolio that has a timeframe of more than 10 years, where you can be confident at the 90% level that stocks will outperform bonds, then stocks are favoured. Given that many people are looking at 30, 40 and 50 year retirements, then a strong allocation to stocks is implied.

The second article, Guidelines for Withdrawal Rates and Portfolio Safety During Retirement, by John J Spitzer, Jeffrey C Strieter and Sandeep Singh of the State University of New York, appeared in the US Journal of Financial Planning in October 2007.

This paper was similar to that by Coggeshall and Wu in acknowledging that asset allocation - particularly the amount of the portfolio exposed to growth assets - was important in determining how long a portfolio could fund retirement.

In this case, a 30-year retirement was assumed - which is probably reasonable for someone thinking about retiring at age 60 and living to age 90.

The paper looked at various asset allocations between stocks and bonds (high-quality fixed interest investments). It then expressed as a percentage your chances of running out of funds prior to the end of the 30 year period. It found:

For a portfolio with 30% exposure to growth assets:

  • Almost 0% chance of running out of assets if you drew on them at 3% a year.
  • 5% chance of running out of assets at 4% a year.
  • 25% chance of running out of assets at 5% a year.
  • 40% chance of running out of assets at 5.5% a year.

For a portfolio with a 60% exposure to growth assets:

  • Almost 0% chance of running out of assets at 3% a year.
  • 7.5% chance of running out of assets at 4% a year.
  • 18% chance of running out of assets at 5% a year.
  • 27.5% chance of running out of assets at 5.5% a year.

For a portfolio with a 90% exposure to growth assets:

  • 3% chance of running out of assets at 3% a year.
  • 10% chance of running out of assets at 4% a year.
  • 20% chance of running out of assets at 5% a year.
  • 25% chance of running out of assets at 5.5% a year.

It is interesting to note that there is actually a small increase in the chances of running out of money in portfolios where the withdrawal rate is small when the exposure to growth assets is increased. This is because if you start with a high exposure to growth assets, and there is a strong collapse in the value of growth assets, this will negatively affect your portfolio value.

The Australian context and income

I see two practical differences between the Australian and the US markets (where these papers were written). Although the returns from markets have been very similar, the makeup of returns is different. Australia has the benefit of franking credits, which allow the tax-effective payments of dividends. While the yield of the sharemarket is currently 3.6%, add to that franking credits and the gross yield increases to 5% a year.

We also have a well-developed listed property market segment, which is characterised by the payment of strong income - even if the income is not as strong as it has been historically. Currently the income is 6% a year.

A portfolio made up of cash (now yielding 6.25%), fixed interest investments (6.75%), Australian shares (5% gross) and listed property (6%) means that the income of the portfolio would allow a drawing rate of about 5.5% - without having to touch any capital.

The only risk to this income stream would be a decrease in interest rates, and therefore lower interest being received from the cash and fixed interest investments.

An advantage of the Australian situation is the generous access to the age pension. People with less than $839,500 can receive some part-age pension under the more generous asset test that came into force in September last year. For many people this many act as a "safety net", were they to receive very poor investment returns for a period (such as a repeat of the 1987 sharemarket crash or a period of very poor returns like the early 1970s). This may encourage people to be more aggressive in their asset allocation in pursuit of higher returns, with the knowledge that there is a safety net under them.


When thinking about how to draw money from a portfolio, this cannot be done in isolation from the asset allocation of the portfolio. A drawing rate of up to 5.5%, increasing with inflation, seems to be achievable, provided the portfolio value is monitored over time. (Remember, the minimum withdrawal rate from a fund in pension phase is 4%.)

The Australian situation, which is different from the US, may see more people focus on the income from their portfolio as a way of working how much money to draw from their portfolio.