The New 'Safe' Retirement Spending Rate? It's Not 4%

Likewise, they oberve, most retirees won’t want or need to follow such a strict spending framework. Instead, they can embrace flexible spending strategies that respond to actual spending and annual market movements to ensure that their long-term prospects of financial solvency remain under control.

It's worth noting that the research does not consider Social Security payments in setting the safe spending limit, so real-world retirees could opt to spend more in anticipation of access to benefits as a form of insurance against destitution.

“These numbers aren’t meant to imply that people who are already retired should shift their spending up or down from year to year,” the authors emphasize. “Rather, they represent our best estimate of the starting safe withdrawal rate for a person currently embarking on retirement.”

Guardrails and Guarantees

For those willing to tolerate some spending fluctuations, a safe starting rate of withdrawal is closer to 6%.

The researchers benchmark some widely used flexible strategies against a system of fixed real withdrawals. Each method supports a higher initial safe withdrawal rate than the base case of fixed real withdrawal method.

The “constant percentage” and “endowment methods” support the highest starting safe withdrawal rates across most asset allocations. The constant percentage method applies a static percentage withdrawal to each year’s portfolio balance, while the endowment method takes a percentage of the portfolio’s average value over a 10-year period.

Both approaches support higher initial withdrawals by making potentially significant year-to-year adjustments, ratcheting down spending when the portfolio value is down.

“The right level of flexibility in a retiree’s spending system will depend on the individual’s tolerance for spending changes, including the extent to which fixed expenses are covered by nonportfolio income sources,” Arnott, Benz and Kephart note.

To help illustrate the interplay between portfolio spending and income from other sources, the researchers offer several scenarios involving Social Security and annuities. They show that decisions to enlarge income from other sources — like delaying Social Security — pair well with flexible withdrawal strategies.

At the same time, a consistent finding is that enlarging lifetime income generally reduces the amount available for bequests. As such, the authors emphasize, it is critical for retirees to examine their individual goals and make spending and investing decisions accordingly.

Key Portfolio Considerations

The Morningstar researchers derived the 3.9% safe spending rate from an assumed portfolio with an equity weighting of between 30% and 50%.

“Because of the higher volatility associated with higher equity weightings, boosting stocks detracts from the starting safe withdrawal percentage rather than adds to it,” they explain.

A table in the analysis demonstrates the connection between time horizon, asset allocation and safe withdrawal rates, indicating that older retirees can reasonably spend substantially more than the 3.9% in the 30-year horizon base case.

Finally, in this year’s research, the authors explore the role of market, inflationary pressures and spending shocks such as early retirement. They find that retirees who encountered poor returns in the first five years of retirement and didn’t adjust their spending downward were much more likely to exhaust their savings than those who came through the first five years with positive returns.

“Similarly, we concluded that retirees who encountered high inflation early in retirement were also more likely to prematurely run out of funds unless they took steps to adjust their savings,” the authors warn.