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November 13, 2023 at 07:00 AM
What You Need to Know
- Stronger fixed income returns have boosted the starting safe withdrawal percentage to its highest level in three years.
- History demonstrates that the “right” withdrawal rate for any given retiree depends on three key variables.
- While fixed spending is easier to manage, dynamic withdrawal strategies may help retirees consume their portfolios more efficiently.
New retirees hoping to use a “safe” fixed real withdrawal strategy for managing their retirement income can plan to withdraw 4% of their portfolio’s value in the first year of retirement, according to Morningstar’s newly published report, “The State of Retirement Income: 2023.”
In the analysis, a trio of Morningstar researchers including Christine Benz, director of personal finance and retirement planning, find that a starting withdrawal rate of 4% delivers a 90% success rate over a 30-year time horizon.
As Benz recently told ThinkAdvisor while previewing the results, the analysis assumes a balanced portfolio of 50% stocks and 50% bonds, and the 90% “success rate” here is defined as a 90% likelihood of not running out of funds over the 30-year period.
“That figure is the highest starting safe withdrawal percentage since Morningstar began creating this research in 2021,” Benz says.
Specifically, the starting safe withdrawal rate for a 30-year horizon with a 90% probability of success was 3.3% in 2021 and 3.8% in 2022, Benz notes, meaning the outlook for retirees has been steadily improving despite persistent market volatility and worries about inflation.
The key tailwind for retirees, Benz explains, is higher interest rates.
“The increase in the withdrawal percentage since 2022 owes largely to higher fixed income yields, along with a lower long-term inflation estimate,” Benz says.
Some Surprising Results
According to Benz, this year’s analysis included some “interesting and somewhat surprising findings” compared with the first two iterations of the safe spending report.
“One thing that surprised me this year is that the highest starting safe withdrawal percentage comes from portfolios that hold between 20% and 40% in equities, with the remainder in bonds and cash,” Benz says.
While improvements are seen across different portfolio approaches, portfolios with different equity allocations than 20% to 40% have slightly lower starting safe withdrawal rates. By comparison, portfolios with higher equity weightings do provide higher median residual balances at the end of the 30-year period than do bond-heavy portfolios.
These mixed results, Benz explains, underscore the dynamic nature of the income planning question and the way that relatively simple success metrics and averages can mask substantial complexity.
As the analysis explores, history demonstrates that the “right” withdrawal rate for any given retiree depends on three key variables: the market environment that prevails over a retiree’s drawdown period, the length of the drawdown period and the portfolio’s asset allocation.
As shown in the report, the starting safe withdrawal rate for 50% stock and 50% fixed income portfolios during rolling 30-year periods from 1926 through 1993 ranged from 3.4% for the worst 30-year period to 6.7% for the best.
In general, Benz explains, portfolios that had higher equity asset allocations delivered superior returns and, in turn, higher withdrawal rates than those with more conservative positioning.
