According to a new report from Morningstar, 3.3% is the new 4%.
When it comes to determining a safe initial withdrawal rate for retirees, that’s what Christine Benz, Director of Personal Finance and Retirement Planning at Morningstar and co-authors Jeffrey Ptak, Chief Ratings Officer, and Director of Research John Rekenthaler estimate in a new report released on Nov. 11, titled “The State of Retirement Income: Safe Withdrawal Rates.”
“Using forward-looking estimates for investment performance and inflation, Morningstar estimates that the standard rule of thumb should be lowered to 3.3% from 4%.”
While stressing that this should not be interpreted as recommending a withdrawal rate of 3.3%, paper’s introduction states: “Using forward-looking estimates for investment performance and inflation, Morningstar estimates that the standard rule of thumb should be lowered to 3.3% from 4%.”
Using conservative assumptions, the research finds that a 50% stock/50% bond portfolio should support a starting fixed real withdrawal rate of around 3.3% per year.
That would mean a retiree with a $1 million portfolio would only be able to withdraw $33,000 in the first year of retirement instead of $40,000 under the 4% rule. The difference would be even more pronounced later in retirement, when accounting for inflation: $75,399 vs. $62,205, respectively, in the 30th year, according to a CNBC analysis that assumes a 2.21% annual rate of inflation, the average projected by Morningstar over the next three decades.
The paper acknowledges that a 4% starting withdrawal rate, with annual inflation adjustments to that initial dollar amount thereafter, has generally been considered an appropriate level for retirees since 1994. That’s when financial planner William Bengen demonstrated that over every rolling 30-year time horizon since 1926, retirees holding a portfolio that consisted 50% of stocks and 50% of fixed-income securities could have safely withdrawn an annual amount equal to 4% of their original assets, adjusted for inflation.
“Under those same assumptions, a 4% withdrawal rate may no longer be feasible. Because of the confluence of low starting yields on bonds and equity valuations that are high relative to historical norms, retirees are unlikely to receive returns that match those of the past,” the paper states.
However, there are various factors that could affect this percentage, resulting in the retiree withdrawing a significantly higher amount.
The report explores ways that retirees can make their savings last longer without compromising their standard of living, and the tradeoffs that some of those techniques entail.
Among the techniques? Adjusting one or more of the levers behind the conservative assumptions that underlie the withdrawal rate calculations current retirees can safely withdraw a significantly higher amount that the 3.3%.
Those assumptions: 1) a time horizon that exceeds most retirees’ expected life spans; 2) fully adjusting all withdrawals for the effect of inflation; 3) a fixed withdrawal schedule that does not react to changes in the investment markets; and 4) a high projected success rate for the plan (90% probability that retirees won’t run out of money over a 30-year retirement).
Properly adjusting one or more of those levers can allow current retirees to safely withdraw a significantly higher amount than the 3.3%.
“By relaxing these assumptions or adopting a more flexible spending approach, our analysis finds retirees can safely sustain higher withdrawals, with a 4.5% starting real withdrawal rate achievable under some scenarios,” the paper states.
Various ways of doing so are covered extensively in the 59-page paper.
Morningstar Research said it will be updating this research annually to incorporate changing market conditions: return expectations for the major asset classes as well as inflation. Future research will also explore additional strategies for enlarging lifetime withdrawals and better aligning them with retirees’ own spending needs.
“While our safe initial starting withdrawal rate is fairly low today—just a 3.3%-3.4% initial withdrawal rate for balanced portfolios—retirees who are willing to depart from a fixed real withdrawal system should be able to obtain a higher level of cash flows from their portfolios,” the report concludes.
SEE ALSO:
• 6 Retirement Rules of Thumb Most Americans Get Wrong: Slideshow
• Most Retirees Wait Until RMDs to Tap Retirement Accounts
• Episode 36: Morningstar’s Christine Benz Defends TDFs from Recent Attack
• Market Volatility, Low Interest Rates Threaten Retirement Income: Cerulli