The Effect of Defined Benefit Pensions on Income Survivability and ‘Safe’ Withdrawal Rates in Retirement
By Alan Stocker
Income from a Defined Benefit (DB) pension with various levels of inflation protection (no protection, and inflation caps of 2.5% and 5%) was combined with the income from an investment portfolio to provide a total required income, IR that was constant in inflation adjusted terms. Results of backtesting are presented for retirees in the UK and USA using historical asset returns and inflation. For a value of IR close to the maximum safe withdrawal rate (MSWR) for the portfolio alone (approximately 3% and 4% for the UK and USA, respectively), the addition of income from a DB pension without inflation protection equal to 2% of the initial portfolio value was sufficient to increase the period over which the retirement income survived by more than 15 years (from just under 30 years to over 45 years). Furthermore, the results indicate that the MSWR increased by approximately 0.6 (for a DB pension with no inflation protection), 0.7 (with 2.5% inflation cap), and 0.8 (with 5% inflation cap) percentage points for each percentage point of DB pension income.
Source @SSRN
