New research published today from Morningstar suggests that safe starting withdrawal rates for retirement are at their highest level in three years—and the “4% Rule” is back.
In The State of Retirement Income, Morningstar’s modeling found that a starting withdrawal rate of 4.0% is once again safe for a balanced portfolio, up from 3.8% in 2022 and owing largely to higher fixed-income yields and a lower long-term inflation estimate.
Back in Nov. 2021, Morningstar notably reported that the long-held standard rule of thumb made famous by financial advisor William Bengen in 1994 should be lowered to 3.3% from 4% based upon forward-looking estimates (at the time) for investment performance and inflation.
Today’s report—from authors Christine Benz, director of personal finance and retirement planning, Amy Arnott, portfolio strategist, and John Rekenthaler, director of research—compares six retirement withdrawal strategies that can extend an investor’s retirement income.
This year’s return to 4.0%, assuming a 90% probability of still having funds remaining after a 30-year time horizon, is the highest starting safe withdrawal percentage since Morningstar began creating this research in 2021.
“The 4% rule may finally hold true as a safe starting withdrawal rate when considering a 30-year time horizon,” writes Arnott in an article posted today on Morningstar.
The highest starting safe withdrawal percentage comes from portfolios that hold between 20% and 40% in equities and the remainder in bonds and cash. In compensation, portfolios with higher equity weightings provide higher median residual balances at the end of the 30-year period than do bond-heavy portfolios.
Additional key takeaways from the report:
- Dynamic withdrawal strategies may help retirees consume their portfolios more efficiently, factoring in both portfolio performance and spending. However, they also add variability to cash flows, which not all retirees will find acceptable.
- Based on studies of actual spending during retirement, retirees often decrease their inflation-adjusted spending over time, a pattern that can also lead to considerably higher safe withdrawal rates.
- The highest starting safe withdrawal percentage comes from portfolios that hold between 20% and 40% in equities and the remainder in bonds and cash. Portfolios with different equity allocations than 20% to 40% have slightly lower starting safe withdrawal rates. In compensation, portfolios with higher equity weightings provide higher median residual balances at the end of the 30-year period than do bond-heavy portfolios.
- Another approach for achieving a higher withdrawal rate than the base case of 4.0% is to build a ladder of Treasury Inflation-Protected Securities, or TIPS. Doing so provided a 4.6% withdrawal rate, with a 100% probability of success, at the time of the new paper’s publication. However, using that strategy also liquidates the portfolio by Year 30, under all conditions.
Arnott wrote that the reason for being back up to 4% is that as yields on bonds and cash have increased, the forward-looking prospects for portfolio returns—and in turn the amounts that new retirees can safely withdraw from those portfolios over a 30-year horizon—have continued to edge up since last year’s report. A more moderate inflation outlook has also helped: Arnott noted they used a 2.42% long-term inflation forecast this year, versus 2.84% in 2022.
She added that retirees who are willing to employ more-flexible strategies or make other modifications to a basic approach of using 4% as a starting point for withdrawals and then adjusting that dollar amount each year for inflation can enjoy even higher starting withdrawals, assuming they’re willing to accept other trade-offs, such as fluctuating year-to-year real cash flows and the possibility of fewer leftover assets at the end of a 30-year period.
Based on studies of actual spending during retirement, the paper notes that retirees often decrease their inflation-adjusted spending over time, a pattern that can also lead to considerably higher safe withdrawal rates.
The right level of flexibility in a retiree’s spending system will depend on the individual’s situation, including the extent to which fixed expenses are covered by nonportfolio income sources.
• READ THE FULL MORNINGSTAR REPORT HERE.
SEE ALSO:
• 3.3% Safe Withdrawal Rate is the New 4%: Morningstar
• IRI Expert Weighs in On Morningstar Update to 4% Rule
Veteran financial services industry journalist Brian Anderson joined 401(k) Specialist as Managing Editor in January 2019. He has led editorial content for a variety of well-known properties including Insurance Forums, Life Insurance Selling, National Underwriter Life & Health, and Senior Market Advisor. He has always maintained a focus on providing readers with timely, useful information intended to help them build their business.