Morningstar Report Revives Debate On 4% Rule

A recent Morningstar report throwing shade on a rule of thumb for retirement fund withdrawals was hardly breaking news. But it revives debate about the old saw and may raise some valid reminders and areas of concern for retirees in the current economy.

At issue was the decades-old “4% rule,” a guideline for determining an annual withdrawal rate that in theory will provide sustainable income over a 30-year retirement period without depleting assets.

The rule, first introduced in 1994 by William Bengen, relied on historic data. It concluded that a portfolio allocation of 50% stocks and 50% bonds would generate sufficient returns to support a sustainable 4% withdrawal rate that would increase over time.

But with current interest rates at historic lows and equity markets at record highs, returns are expected to be lower in the future, according to the Morningstar paper. The report estimated that a 3.3% withdrawal rate was a more appropriate baseline for projections - an amount that could substantially lower a retiree’s proceeds.

“It seems 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 report’s authors wrote.

They also said one investment goal should be "to increase income from nonportfolio sources so as to reduce cash flow demands on the portfolio." It suggested that one way to accomplish this is through annuities.

“Nonportfolio strategies such as delaying retirement and annuitization will also increase the sustainable withdrawal rate,” the report said.

Financial advisors were quick to point out that the debate about the efficacy and reliability of the 4% rule is not new and has been going on pretty much since the moment it was proposed 27 years ago; it was never intended to be a hard and fast rule for every situation. In fact, cautions about the 4% rule are contained in the latest edition of the Best Broker Educational Sales & Training continuing education course. It includes an entire section debating the 4% rule with chapter headings like “Four percent rule not safe in a low-yield world,” based on a 2013 study of the same name.

Moreover, the Morningstar paper relies on pre-pandemic 2019 data and is primarily a marketing tool.

“People have been talking about this for a while; it is not cutting-edge,” said John J. Lanahan, a Certified Financial Planner with Ameriprise Financial.  “A simple Google search on the ‘4% rule’ will show you that it’s a popular talking point; all these different withdrawal methods based on equity allocation, and they go through all the examples of age, remaining life expectancy, etc.”

Lanahan, who referenced the 4% rule in his monthly newsletter as recently as last May, as well as other advisors stress that the rule is only a baseline guide for beginning the evaluation of one’s withdrawal strategy and that there are too many variables to simply adopt a one-rule-for-all notion.

“Revisiting the rule makes sense, especially with people living longer and economic conditions being what they are,” said Lanahan. “I get it, but I'm more of a realist and I try not to have preconceived notions of what may or may not be appropriate for my clients. Many financial principles need to be reviewed with those nearing retirement or currently in retirement to help clients feel more confident.”

Even Morningstar includes caveats about its 3.3% estimation.

“This should not be interpreted as recommending a withdrawal rate of 3.3%,” the paper states. “The conventions that underlie the withdrawal-rate calculations are conservative…by adjusting one or more [variables], current retirees can safely withdraw a significantly higher amount than the 3.3% initial projection might suggest.”

Doug Bailey is a journalist and freelance writer who lives outside of Boston. He can be reached at [email protected].

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