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Retirement Planning > Spending in Retirement > Income Planning

Here's the New 'Safe' Withdrawal Rate: Morningstar

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What You Need to Know

  • A starting withdrawal rate of 3.8% is “safe” in Morningstar’s model over a 30-year time horizon, meaning it brings a 90% likelihood of not running out of funds.
  • Dynamic withdrawal strategies may help retirees consume their portfolios more efficiently, factoring in both portfolio performance and spending.
  • However, dynamic strategies bring their own challenges, including significant swings in annual income.

Investors hoping to utilize a “safe” fixed real withdrawal strategy for managing their retirement income can plan to withdraw 3.8% of their portfolio’s value in the first year, according to Morningstar’s newly published report, “The State of Retirement Income: 2022.”

In the newly published analysis, the analysts found that a starting withdrawal rate of 3.8% delivers a 90% success rate (defined here as a 90% likelihood of not running out of funds) over a 30-year time horizon. The analysis assumes a balanced portfolio of 50% stocks and 50% bonds.

While lower than the traditional 4% withdrawal assumption commonly cited by media pundits and financial planners, the new figure is appreciably higher than the 2021 figure, which was 3.3% for a balanced portfolio with a 90% projected success rate.

Taking a Page From Market History

As the Morningstar team explains, history demonstrates that the “right” or “safe” withdrawal rate depends on three key variables: the asset allocation of the portfolio; the market environment that prevails over a retiree’s drawdown period; and the length of the drawdown period. Looking at all of the rolling 30-year periods from 1930 through 2019, the safe rate ranges from 3.7% for the worst period to 6% for the best.

In general, according to Morningstar, portfolios that maintained balanced or more equity-heavy asset allocations delivered higher returns and, in turn, higher withdrawals than those with more-conservative positioning.

That said, in less-forgiving environments, such as the one that prevailed in the second half of the 1960s and early 1970s, investors with excess equities stood a high chance of exhausting their portfolios by the end of the retirement period if they made annual withdrawals of even 4%.

Overall, according to the analysis, employing a more aggressive equity allocation does not meaningfully improve safe starting withdrawal rates. In fact, investors with shorter time horizons of 10 to 15 years can actually employ a higher withdrawal rate if they’re using a more conservative portfolio mix relative to an equity-heavy one.

This is the case because their returns are smoother and subject to meaningfully less sequence of returns risk.

Do Dynamic Withdrawals Help?

Given the relatively low “safe” fixed withdrawal rate identified by the report, Morningstar’s analysts ask whether utilizing a dynamic income approach may help retirees improve their standard of living without raising the risk of poor outcomes.

The report considers a set of distinct dynamic withdrawal methods, including forgoing inflation adjustments following annual portfolio loss, withdrawing only the required minimum distributions and setting income guardrails. These guardrails incorporate some variability based on market performance while setting an upper boundary on how much comes out in good markets and a lower boundary around withdrawals in down markets.

According to the report, of the dynamic strategies tested, the guardrails system does the best overall job of balancing higher withdrawals alongside cash flow volatility considerations. In general, the right level of flexibility in a retiree’s spending system will depend on the individual’s situation, especially the extent to which fixed expenses are covered by non-portfolio income sources.

Morningstar finds the guardrails approach is highly efficient, as the periodic course corrections help the retiree consume more of the portfolio in up markets but not too much in bad ones. The trade-off of that efficiency, however, is a lower median ending balance.

“Although the strategy resulted in more leftovers at year 30 than was the case with the RMD method, especially for more equity-heavy portfolios, the guardrails system would tend to be most appropriate for retirees who prioritize maximizing spending over leaving a bequest to family or charity,” the report concludes.

“While cash flow volatility is certainly higher than with a fixed real withdrawal approach or the two strategies that involve taking less after a losing year, it is substantially lower than the RMD method,” it explains.

(Image: Adobe Stock) 


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