Morningstar - Q1 2022 - 30

Spotlight: Withdrawal Rates
EXHIBIT 1
Withdrawal Trade-Offs Retirees who choose a variable method over a fixed method
can increase their starting withdrawal rates, but because their annual cash flow is
based on market conditions, amounts will be more volatile year to year.
Starting Safe Withdrawal Rate
5%
Forgo Inflation
10% Reduction
Fixed Real
Guardrails
Required Minimum Distribution
4
3
2
1
0%
Standard Deviation of Simulated Withdrawals in Year 30
10
20
Source: Morningstar Direct. Data as of 12/31/2020.
Asset Allocation
100% Stocks
75% Stocks/25% Bonds
50% Stocks/50% Bonds
25% Stocks/75% Bonds
100% Bonds
Mattress
Safe Withdrawal Rates (%)
Lowest
estimates that the standard rule of thumb
for starting withdrawal rates should be lowered
to 3.3% from 4%.
This should not be interpreted as a recommendation.
The conventions that underlie the withdrawal-rate
calculations are conservative. They presume:
3.2
3.6
3.7
3.2
2.4
1.4
1 A time horizon that exceeds most retirees'
expected life spans.
2 Fully adjusting all withdrawals for the effect
of inflation.
3 A fixed withdrawal schedule that does not react
to changes in the investment markets.
4 A 90% projected success rate for the plan.
Time Period
2 The annualized real returns of the Ibbotson SBBI Large Cap Stocks Index and Ibbotson SBBI Long-Term Government Bond Index were 7.9% and 5.1%, respectively, from 1991 to 2020;
they returned 5% and negative 1% annualized, respectively, from 1960 to 1989.
3 Bernicke, Ty. 2005. " Reality Retirement Planning: A New Paradigm for an Old Science. " Journal of Financial Planning. June.
1990-2019
1985-2014
1980-2009
1975-2004
1970-1999
1965-1994
1960-1989
1955-1984
1950-1979
1945-1974
1940-1969
1935-1964
1930-1959
By adjusting one or more of these levers, retirees
can safely withdraw a significantly higher amount
than the 3.3% initial projection might suggest.
That said, there is little question that current conditions
demand greater planning than in the past,
when lower valuations and loftier yields paved the
way to future returns. Given this, many of today's
retirees will have to be more resourceful to support
4.5
5.0
4.9
4.5
4.0
3.4
3.3
2.6
2.5
2.5
2.4
2.9
3.3
30
Morningstar Q1 2022
1
2
3
4
5
6
7
5.3
5.8
5.5
6.5
5.3
4.0
4.2
4.1
5.1
4.5
6.1
5.9
3.9
Safe Withdrawal Rates (%)
Lowest
Highest
30
40
50
60
The Withdrawal-Rate Problem
Unlike other financial goals that are either one
and done (home purchase) or finite (college),
the duration of retirement spending is unknowable.
Retirement could last just a few years for the
unlucky retiree or 30 or more years for people who
live long lives. With perfect foresight, the optimal
withdrawal rate for the retiree who dies young
would obviously be much higher than for the
retiree with a longer drawdown period. But there
is no perfect foresight into longevity.
Compounding the challenge is that it's impossible
to predict the market environment during each
retiree's time horizon. The past 30 years have been
exceptionally strong for both stocks and bonds,
supporting a high safe withdrawal rate. But
the 30-year period that preceded it was much less
robust, especially for bond investors.2
Highest
6.5
6.2
6.0
5.7
5.0
2.5
their income needs. With that in mind, we will
examine practical ways retirees can make their
savings last longer without compromising their
standard of living and explore the trade-offs some
of those techniques entail.
EXHIBIT 1 shows the starting safe withdrawal
rates of five withdrawal strategies that we tested
and compares those withdrawal rates with the
year-to-year variability of withdrawals under each
strategy. By safe, we mean the starting withdrawal
rate that has a high probability of the investor
successfully funding retirement. Some methods,
like the traditional fixed real withdrawal approach
(aka Bengen's 4% method), support lower starting
withdrawal rates but boast stable year-to-year
withdrawals. Flexible methods like the guardrails
spending approach support higher starting
withdrawal rates but have significant variability in
yearly withdrawals because these methods can
entail yearly spending adjustments depending on
market conditions. By tethering spending to
market conditions, such variable strategies lead to
more efficient portfolio consumption but lower
ending balances in many cases.
1
2
3
4
5
6
7
There is also the issue of retirees' spending
patterns. While much of the research on
withdrawal rates is anchored on the premise that
retirees seek a fixed real dollar amount from
their portfolios annually, the data points to
a large degree of variability in spending through
retirement. Using information from the U.S.
Bureau of Labor Statistics' Consumer Expenditure
Survey, financial advisor Ty Bernicke noted
that spending generally decreases throughout
retirement.3
That observation led Bernicke to
conclude that many retirees are underspending
because their withdrawal rates assume fixed
real consumption, when instead, consumption
patterns are more modest.
Research from David Blanchett, now head of
retirement research at PGIM and formerly head of
retirement research for Morningstar Investment
Management, similarly concluded that spending
tends to be uneven through retirement. Blanchett
identified a downward slope in spending from
the early to middle/middle-late years of retirement.
But Blanchett also noted an uptick in spending
toward the end of life, largely attributable to higher
healthcare and long-term-care outlays.

Morningstar - Q1 2022

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