4 retirement fund withdrawal strategies for your clients to consider

People spend their working lives saving for retirement. But they often don’t know how much they can withdraw safely from their retirement portfolio. What is the right percentage to start withdrawing and is it sustainable? Morningstar researchers examined this issue in their “State of Retirement Income: 2023” report and discussed their findings in a recent webinar.

Morningstar’s 2023 research suggests that 4.0% is the highest safe starting withdrawal rate for retirees spending from an investment portfolio, assuming a 90% probability of having funds remaining at the end of an assumed 30-year retirement period. That figure is the highest starting safe withdrawal percentage since Morningstar began creating this research in 2021. The highest 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.

The increase in the withdrawal percentage since 2022 is due largely to higher fixed-income yields, along with a lower long-term inflation estimate, Morningstar said.

But a 4% starting withdrawal rate might not be right for everyone, said John Rekenthaler, Morningstar vice president of research.

“If you start out taking 4% out of your nest egg the first year and then take out 4% the next year adjusted for the level of inflation – that’s the important part – throughout your retirement, which we modeled for being 30 years, we see a 90% probability of success.

“The point of the research is to get people to think about what’s a reasonable starting point for their withdrawal rate. There are various ways people can model that number. We think most people would want it to be higher. We show some ways it can be done.”

Although the 30-year time horizon is standard for Morningstar’s research, Rekenthaler said, that does not apply to all retirees.

“If you’re 84 years old, you probably aren’t planning for a 30-year time horizon. We have time horizons ranging from 10 to 40 years in our research and you run the numbers and you get different results. You have higher withdrawal rates that are permissible for someone who is looking at 10 or 15 years than you do for someone who is looking at a 30-year retirement.”

The highest starting safe withdrawal percentage comes from portfolios that hold between 20% and 40% in equities and the remainder in bonds and cash. Portfolios with different equity allocations than 20% to 40% have slightly lower starting safe withdrawal rates. However, portfolios with higher equity weightings provide higher median residual balances at the end of the 30-year period than do bond-heavy portfolios.

Four retirement portfolio withdrawal strategies

Morningstar’s research listed four withdrawal strategies that may help retirees consume their retirement portfolios more efficiently, factoring in both portfolio performance and spending. However, these strategies also add variability to cash flows, which not all retirees will find acceptable.

Amy Arnott, Morningstar portfolio strategist, described the four withdrawal strategies.

1. Forgo inflation method. When the portfolio value declined in the previous year, the retiree can skip the inflation adjustment to their withdrawal in the following year.

“So you keep the spending flat instead of giving yourself a raise to keep up with inflation,” Arnott said. “Even though that’s a small change in any given year, we found it is significant in terms of how much it can boost your sustainable withdrawal rate because you’re adjusting your withdrawals to meet market conditions and not taking as large of a withdrawal as you otherwise would when the portfolio value is down.”

2. Required minimum distribution method. This is a strategy for someone who has reached the age at which RMDs must be taken from accounts such as individual retirement accounts.

“The portfolio value is divided by your remaining life expectancy,” Arnott said. “It’s conservative in the sense that you’ll never spend the entire portfolio down to zero, but you still could get to a very low portfolio value toward the end of life. It also tends to lead to more volatile cash flows because you have two variables – the portfolio value and life expectancy, which are both changing every year.”

3. Guardrails method. Instead of withdrawing a stable dollar amount in real terms, the retiree adjusts that withdrawal for portfolio performance.

“After a bad year in the market, portfolio value is down, and you may be reducing your withdrawal rate,” Arnott said. “On the other side, if the market has a really strong year and portfolio value is up, you might be able to take a larger withdrawal.”

The guardrails refer to how you test for those adjustments, she said. “The idea is anytime you look at your planned withdrawal rate, divided by the portfolio value, that gives you the withdrawal rate number to test. Based on this method, if it’s more than 20% away from the original number, then you would ratchet your spending down. If it’s less than 20%, you would ratchet spending up.”

4. Spending method. This method is based on how retirees actually spend, Arnott said. The Employee Benefit Research Institute tracked a group of retirees over eight years, surveying them each year and breaking down their spending in various categories. From there, researchers were able to look at spending patterns over time during retirement. Arnott said the research found spending tends to decline significantly as you get older, with declines ranging from 1.5% to 1.9% each year.

Another approach for achieving a higher withdrawal rate than the base case of 4.0% is to build a ladder of Treasury Inflation-Protected Securities, or TIPS, Rekenthaler said. Doing so provided a 4.6% withdrawal rate, with a 100% probability of success, at the time of research’s publication. However, using that strategy also liquidates the portfolio by Year 30, under all conditions.

Based on studies of actual spending during retirement, retirees often decrease their inflation-adjusted spending over time, a pattern that can also lead to considerably higher safe withdrawal rates. The right level of flexibility in a retiree’s spending system will depend on the individual's situation, including the extent to which fixed expenses are covered by nonportfolio income sources, such as Social Security, pensions and annuities.

Susan Rupe is managing editor for InsuranceNewsNet. She formerly served as communications director for an insurance agents' association and was an award-winning newspaper reporter and editor. Contact her at [email protected]. Follow her on X @INNsusan.

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