4% Withdrawal Rule Squeezed by Low Returns

“Determining the optimal amount to take out of a portfolio annually without prematurely depleting one’s assets is a question that vexes professional financial advisers and institutions nearly as much as it does individual investors,” according to the authors of a Morningstar research report.

They note in “The State of Retirement Income: Safe Withdrawal Rates” that a 4% withdrawal rate with annual inflation adjustments has been considered a safe withdrawal rate for years. It became the standard when financial planner Bill Bengen first demonstrated in 1994 that the 4% withdrawal rule had succeeded over most 30-year periods in modern market history.

Christine Benz, director of personal finance and retirement planning; Jeffrey Ptak, chief ratings officer; and John Rekenthaler, director of research, at Morningstar, set out to determine if the 4% withdrawal rule was still relevant today. Using forward-looking estimates for investment performance and inflation, they found that a 50% stock/50% bond portfolio should support a starting fixed real withdrawal rate of about 3.3% per year, assuming fixed real withdrawals over a 30-year time horizon and a 90% probability of success. This is because bond yields are low and stock valuations are high.

The authors say their research should not be interpreted as recommending a withdrawal rate of 3.3%, because their assumptions are conservative and some adjustments could result in a meaningful increase in starting withdrawal rates.

For example, lowering the success rate to 85%—meaning there’s a 15% chance of running out of money in retirement—would result in retirees being able to take 3.7% of a balanced portfolio initially, and lowering the success rate to 80% would result in a 3.9% starting withdrawal rate. Delaying retirement could also bump up the starting withdrawal rate. If someone delays retirement by five years, a safe starting withdrawal amount would be 4.1%, according to the researchers’ other assumptions.

The researchers add that flexibility in spending patterns could also help retirees consume their portfolios more efficiently. For example, retirees could forego inflation adjustments to the initial withdrawal rate in the beginning years of retirement, or they could spend less when their portfolio balance has declined and more when it has increased. Annuitizing part of their portfolio could also increase retirees’ sustainable withdrawal rates.

“There is little question that current conditions demand greater forethought and planning than in the past, when lower valuations and loftier yields paved the way to higher future returns,” the authors of the study report say. “Given this, many of today’s retirees will have to be more resourceful to support their income needs.”