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Christine Benz

Retirement Planning > Spending in Retirement > Income Planning

'Safe' Retirement Spending Rate Rises in 2023: Morningstar

By John Manganaro

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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.

“The results vary widely, though,” she warns.

Portfolios with 100% equity weightings delivered the highest starting safe withdrawal percentage over any 30-year period in history, at 6.9%. But in less-forgiving environments, even a 2% starting withdrawal rate could have been dangerous.

Fixed vs. Dynamic Withdrawal Strategies

As the report details, the consideration of 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.

“Variable strategies do entail trade-offs — specifically, the tension between a higher lifetime withdrawal rate afforded by periodic withdrawal adjustments and the volatility those adjustments create in the retiree’s cash flows, which may also subject retirees to swings in their standards of living,” the report explains.

Consequently, some retirees may find flexible schemes unacceptable. For example, taking a fixed percentage withdrawal — such as 4% of the portfolio balance per year — essentially solves the problem of running out of money but does so at the expense of the retiree’s standard of living being buffeted by changes in portfolio value.

“Also, should the markets perform particularly badly, the withdrawal amount could end up being trivially low,” Benz warns.

At the opposite extreme, the fixed real withdrawal system that serves as the paper’s base case “nicely addresses a retiree’s desire to have stable portfolio cash flows,” Benz says, much like a paycheck in retirement.

“But taking fixed real withdrawals can be inefficient because it does not link consumption to portfolio values,” the report continues. “If the starting withdrawal is too low and the portfolio outperforms expectations, the retiree will leave behind a large sum, which may not be a goal. If, on the other hand, the initial withdrawal is too high, the retiree will consume too much too early and risk running out prematurely or having to engage in dramatic belt-tightening later in life.”

The full paper offers an in-depth examination of four dynamic withdrawal strategies, showing how each comes along with both attractive and potentially concerning features that will need to be weighed by each individual retiree.

Big Conclusions

Ultimately, the paper finds the guardrails system — which uses flexible withdrawals with upper and lower limits that prevent withdrawals from being either too high or too low in any given year — does the best job of enlarging payouts in a safe and livable way.

For those seeking a simpler approach that provides more predictable withdrawal amounts, however, a fixed real withdrawal system that forgoes inflation adjustments after a losing year moderately increases lifetime withdrawals, without greatly increasing cash flow volatility.

“It is also straightforward to implement,” Benz points out.

Alternatively, retirees who believe that their spending needs will not keep up with inflation over their drawdown period — an assumption borne out by the data on how retirees actually spend — might consider making slight reductions to their annual spending over time.

Pictured: Christine Benz

John Manganaro

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