Investment research firm Morningstar released its newest State of Retirement Income report in late 2022. The report, authored by Christine Benz, Jeffrey Ptak and John Rekenthaler, is backed by copious research and data modeling. The report assesses the current market environment to provide new retirees with a safe starting withdrawal rate of 3.8% to help ensure their savings will last 30 years.
History of the Safe Withdrawal Rate
In 1994, financial advisor William Bengen recommended a first-year withdrawal rate of 4% for new retirees. He theorized that starting at that rate, then adjusting the withdrawal rate for inflation each following year, would mean savings could last through 30 years of retirement. Morningstar revisits the 4% recommendation periodically to evaluate whether it is still sound.
In 2021, Morningstar noted that 3.3% was a more sustainable figure. By their calculations in 2022, the safe starting withdrawal rate rose to a more robust 3.8%.
2022 Report Findings
The Morningstar report asserts that asset allocation, the market conditions when withdrawals are made and the length of your retirement period are the three factors that most affect your safe starting withdrawal rate. Bond rates and stock valuations have shifted so rapidly that the historical data that provided the basis for the original 4% suggestion is not necessarily the best guide in the modern landscape.
Morningstar modeled 11 different asset allocation strategies over time to determine the optimal starting withdrawal rate. For an investment portfolio with a balanced allocation of 50% stocks and 50% bonds, 3.8% emerged as a safe and sustainable starting withdrawal amount.
The report also noted that while a stock-heavy portfolio is more adaptable than one weighted to fixed income savings, an asset allocation balanced 50/50 between equity and fixed-income investments will outperform a fixed-income portfolio over time.
Flexible Withdrawal Strategy
The report also suggests that retirees may benefit from moving away from a fixed withdrawal rate and instead adjusting their annual withdrawal percentage according to the market conditions of the day. This more flexible approach to withdrawal will help savings last longer. Choosing to withdraw less in years when market conditions are poor and more in years when market conditions are strong, they suggest, is a more sustainable long-term approach.
Suggestion for Long-Term Sustainability
New retirees are coping with three concurrent issues: high inflation, a sinking stock market and low bond yields. Nest eggs are shrinking as prices are rising, and the risk/return ratio is anything but guaranteed. Retirees who follow the original 4% recommendation run the risk of depleting their savings before the 30-year timeline runs out. But the Morningstar report recommends a strategy to offset that possibility.
The report suggests retirees lower their withdrawal rate by 10% in the year following a substantial decline in the market. For instance, if you were planning to withdraw $30,000 in the year after a steep market contraction, a safer and more sustainable long-term strategy would be to take $27,000 instead. Such a strategy may involve some near-term sacrifice, but it can substantially lengthen the life of your retirement savings.
Always speak to a trusted financial advisor for strategies and tips specific to your own situation and retirement portfolio.