Morningstar - Q1 2022 - 39

For retirees aiming to wring more from their
portfolios without radical adjustments to
their standards of living, the guardrails system
strikes a pleasing balance. While cash flow
volatility is certainly higher than with a fixed real
withdrawal approach, it is substantially lower
than the required minimum distribution method.
Because the approach resulted in smaller
amounts left over than most of the other strategies
(only the required minimum distribution method
had a lower average ending value), it will
tend to be less suitable for retirees with a strong
bequest motive. Finally, like all of the variable
systems, the guardrails system requires ongoing
calibration of the withdrawal amount; in
contrast with a fixed real withdrawal system,
it is not " set it and forget it. "
Method 4
10% Reductions After Losses
This method employs a baseline of fixed real
withdrawals, similar to the original Bengen
approach, but makes 10% downward adjustments
in years after losing years. For example,
if the initial withdrawal is $40,000 on a $1 million
portfolio in year 1 and the portfolio drops
to $700,000 at the beginning of year 2,
the year 2 withdrawal would be $36,000. The
guardrails approach, as well as variations
on it like Vanguard's " ceiling and floor "
method, can get complicated, so the goal of
stress-testing this method was to check
whether an ultrasimple downward adjustment
would help improve lifetime withdrawals
in a similar fashion.
Starting Safe
Withdrawal Rate
3.57%
Year 30 Cash Flow
Standard Deviation
8%
Average Lifetime Portfolio
Withdrawal Rate
3.42%
Average Ending Value
at Year 30
$1.4 million
While this approach is simple and easy to
implement, it underperforms the other simple
strategy we tested, forgoing inflation
adjustments, on safe withdrawal rates. However,
it does lead to larger ending values, on average.
As such, it may be appropriate for retirees
in search of a simple system that delivers a
higher withdrawal percentage than a fixed real
How to Identify the Right Withdrawal Method
Choosing the " right " withdrawal method is highly
dependent on the retiree's personal situation.
Here are some of the key considerations:
Age
Younger: More-Flexible Withdrawals
Older: Less-Flexible Withdrawals
Sequence-of-return risk is less of a factor if a
retiree encounters such a market environment
later in retirement, after making it through
the danger zone of the first 10 to 15 years,
with the portfolio needing to last for a shorter
period of time. For that reason, a variable
withdrawal system will tend to be most
appropriate for new retirees and may be less
necessary for people who have been
retired for many years.
Market Environment
High Equity Valuations and/or Low Bond Yields:
More-Flexible Withdrawals
Low Equity Valuations and/or High Bond Yields:
Less-Flexible Withdrawals
A fixed real dollar method is not inherently
problematic if a retiree embarks on retirement
in a period of high equity valuations and/or
low bond yields. But if these factors also lead to
lower market returns, the starting withdrawal
amount that is then inflation-adjusted throughout
retirement might need to be uncomfortably
low. Employing a flexible withdrawal
system allows for the possibility of higher
withdrawals during times when the market
environment is more rewarding.
Level of Wealth
More Wealth: More-Flexible Withdrawals
Less Wealth: Less-Flexible Withdrawals
A factor in whether a given withdrawal system
is " livable " is the extent to which changes
in the withdrawal rate might be a small nuisance
or begin to have a significant impact on
the retiree's quality of life. It is a good bet that
a 25% reduction in spending would have a
bigger impact on retirees with less wealth than
those who have more.
Coverage From Nonportfolio Income Sources
More Coverage: More-Flexible Withdrawals
Less Coverage: Less-Flexible Withdrawals
The retiree who can cover basic living expenses
using income from sources like Social
Security, a pension, rental income, or an annuity
will be better situated to absorb variations
in portfolio cash flows than a retiree who
is relying more heavily on the portfolio to cover
basic needs.
withdrawal system while also incorporating
bequests or building in a buffer for a longer-thanexpected
life span.
EXHIBIT 5 summarizes the above results.
Takeaways
Our research finds that a guardrails-type
system-flexible withdrawals with parameters,
or guardrails, around how high or low withdrawals
can go in a given year-does the best job
of enlarging payouts in a safe and livable way.
Meanwhile, a simple fixed real withdrawal system
that forgoes inflation adjustments after a
losing year does a decent job of enlarging lifetime
withdrawals versus a fixed real withdrawal
system and does so without a lot of cash flow
volatility on a year-to-year basis. It is also
straightforward and simple for individual investors
to implement. K
Christine Benz is director of personal finance and
retirement planning at Morningstar.
Jeffrey Ptak is chief ratings officer at Morningstar.
John Rekenthaler is director of research at Morningstar.
morningstar.com/products/magazine
39
https://www.morningstar.com/authors/30/christine-benz https://www.morningstar.com/authors/489/jeffrey-ptak https://www.morningstar.com/authors/208/john-rekenthaler http://www.morningstar.com/products/magazine
Morningstar - Q1 2022

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