• The State of Retirement Income: 2024
• 5 Ways to Boost Retirement Income
• The Creator of the 4% Rule Doesn’t Follow It
• Why Most Retirees Will Never Spend Down Their Portfolio
• Estimating the True Cost of Retirement
• How Spending Changes in Retirement
• Planning for Spending Volatility in Retirement
• Retirement Guardrails: The Guyton-Klinger Paper

Morningstar recently published its annual State of Retirement Income Research Report. This year’s report concludes that the highest safe starting withdrawal rate for retirees is 3.7% over a 30-year timeframe.

In other words, if you have a $1 million nest egg, the report suggests that you could safely begin withdrawing $37,000 per year, and then adjust it annually for inflation throughout your retirement.

This safe withdrawal rate number is slightly down from 4% in last year’s report, primarily due to higher equity valuations and lower fixed income yields, which have reduced Morningstar’s expected returns for stocks, bonds, and cash over the next three decades.

If a 3.7% withdrawal rate seems unreasonably low, you’re not alone. In fact, the creator of the famous 4% rule is on record saying that his own rule is likely too conservative and personally adjusted his withdrawal rate to 4.7%. So what is an appropriate withdrawal rate? How do you determine what’s best for you? And what if an investor needs more income than what the popular rules allow for?

Welcome to the Stay Wealthy Podcast. I’m your host, Taylor Schulte, and today I’m diving into retirement withdrawal rates, sharing key takeaways from the recent Morningstar report, and providing three strategies for boosting your retirement income.

To view the research and articles supporting today’s episode, just head over to youstaywealthy.com/238.

To set the stage, let’s dissect Morningstar’s 3.7% safe withdrawal rate number. If you dive into the fine print of the report, you’ll find that this 3.7% figure comes from an ultra-conservative planning approach, combined with somewhat muted expectations for US stock returns over the next decade. It also assumes an investor has a conservative portfolio with a range of 20% to 50% allocated to stocks and the remainder in bonds and cash.

So, this 3.7% withdrawal rate is essentially a worst-case scenario planning number, and the report does acknowledge that while it is a safe number, it might actually lead to underspending in retirement.

In fact, the median ending balance after 30 years for the scenarios tested is quite substantial, suggesting that many retirees could potentially enjoy a higher standard of living and commit to a higher starting withdrawal rate. And this finding is nothing new.

Research published by Michael Kitces nearly 10 years ago concluded that the 4% retirement rule has quintupled wealth more often than depleting it at the end of the 30-year time periods measured.

In addition, he found that nearly two-thirds of all scenarios ended with more than double their starting wealth in retirement. Nearly 7 out of every 10 hypothetical person ended life with 2 times the amount that they started with.

In other words, a 4% withdrawal rate historically has led to the majority of rule followers dying with a lot of money left over. So what is a retirement saver to do if most experts, including the creator of the 4% rule, agree that a 4% withdrawal rate is too conservative? How can investors boost their retirement income and enjoy the money that they worked so hard to save without putting their plan at risk of failure?

There are dozens of effective ways to create a custom withdrawal strategy that maximizes income and mitigates failure, and today, I’m going to share three of them with you.

The first one to share with you is the simplest, which is to create a laddered portfolio of Treasury Inflation Protected Securities, or TIPS. If implemented for a 30-year time horizon, this strategy could provide a withdrawal rate closer to 4.4% with a 100% probability of success, according to Morningstar. However, just know that the portfolio would be completely exhausted by the end of 30 years in this scenario.

What if you’re okay ending life with zero dollars with exhausting your portfolio, but you aren’t really interested in the ongoing management of a laddered TIPS portfolio? Aside from hiring a professional to implement it for you, you could consider an immediate annuity with an inflation rider. The exact rate that you receive from the insurance company will depend on a number of unique factors, and many policies do have maximum purchase limits, but the income percentage likely gets most people in the same ballpark as a laddered TIPS portfolio.

Also, while most immediate annuities require you to choose a term to receive income for, like 10 or 20 or 30 years, some of them known as lifetime annuities remove the need to guess how long your retirement will last. They simply pay your guaranteed income amount until end of life.

As you can imagine, your annual payout rate will be smaller as a result because the insurance company is accepting a little more risk here, the risk that you live longer than the average person. While immediate annuities often look attractive, most successful retirement savers struggle to pursue this route primarily because it requires you to write a single lump sum check to the insurance company in return for guaranteed income.

In other words, if you buy a $1 million immediate annuity, you’ll wave goodbye to that $1 million forever. And most people I work with want to retain flexibility with their retirement nest egg knowing that life is fluid and their needs and goals could change, and they may not need the same amount of guaranteed income forever.

So creating their own withdrawal strategy through a laddered bond portfolio or a diversified portfolio paired with a systematic distribution process ends up being more attractive to them. Speaking of life being fluid, the second thing you can do to boost your withdrawal rate is to plan on spending less money in the future, i.e. you might need or want to spend more money in the early years of retirement, your Go-Go years, and then commit to spending less money in the later years when you start to slow down.

Several academic studies have confirmed that this spending pattern is common, that retiree households of all net worth levels do tend to spend less as they get older, not because they’re worried about running out of money, but because they just don’t need as much.

If this resonates with you, you’ll be glad to hear that according to Morningstar’s report, assuming a 2% reduction in spending each year over a 30-year retirement results in a starting, safe withdrawal rate of 4.8% on a balanced portfolio of 50% stocks and 50% bonds.

However, and you might already be thinking this, it’s important to note that while you do have control over your spending and could tighten the belt each year as needed to follow the systematic approach, you don’t have control over one major unexpected retirement expense, healthcare.

So if you commit to a spending decline strategy to boost your starting withdrawal rate, it would be wise to earmark a bucket of money specifically for potential future long-term care needs or purchase a long-term care insurance policy.

Okay, the third strategy to boost retirement income is, in my personal opinion, the most practical and the most appealing. It also is one of the best to address the million-dollar question that most retirees are asking. How do I boost retirement income while ensuring I don’t run out of money and also don’t leave a pile of it behind?

This strategy is often referred to as a flexible or dynamic withdrawal strategy. You see, the 3.7% withdrawal rate shared earlier and the popular 4% rule are known as static withdrawal strategies.

In other words, the withdrawal percentage doesn’t change. The dollar amount of the withdrawal can change year to year due to inflation adjustments, but your initial starting withdrawal rate calculation essentially dictates your lifetime of retirement spending.

And that likely seems a little silly knowing that a lot of unique things are going to happen throughout a 30 year or 40 year retirement that nobody would be able to accurately predict. So why anchor ourselves to a static withdrawal rate when our lives, the markets, and the economy are so fluid and ever-changing?

Why not establish some rules and guardrails on day one of retirement allowing us to adapt to different market environments and adjust our retirement income based on our needs and goals, our desired level of risk, and the actual performance of our portfolio?

I’ve done a deep dive on this topic before here on the show, which I’ll link to in the show notes. So I’ll only cover the basics here today.

But this strategy I personally implement from my clients is commonly referred to as the guardrail strategy, which was developed by financial planner Jonathan Guyton and a computer scientist named William Klinger.

The primary goal of this dynamic approach is to help retirees maximize the income from their nest egg without running out of money before end of life. It’s also designed to protect against sequence of return risk during the first 10 years of retirement.

In short, during good times when the portfolio grows by a certain amount and crosses what’s referred to as the upper guardrail, the strategy allows you to take a pay raise and increase your withdrawal rate. But in difficult times when the portfolio value drops below the lower guardrail, the rules force you to take a pay cut until the investments recover. Because the strategy is dynamic and the withdrawal rate can change year to year, the research supports an attractive starting withdrawal percentage on day one of retirement.

For example, the updated paper from Guyton Klinger states that a retiree with 65% in global stocks, 25% in treasury bonds, and 10% in cash can use an initial withdrawal rate of up to 5.9% while still achieving a success rate of 98% over a 30 year time period. If an investor was willing to take more risk and allocated 80% to global stocks, their initial withdrawal rate could be as high as 6.5%.

A 5.5% or even 6.5% withdrawal rate is probably starting to sound pretty good compared to the boring, overly conservative 4% rule, and it certainly sounds better than the 3.7% that I led with in today’s discussion. But in addition to understanding all the rules and nuances associated with the guardrails approach, there are two major downsides to consider.

First, it requires on-going management. Unlike a static rule like the 4% rule where all that’s required are annual inflation adjustments, a dynamic strategy like guardrails requires intra-year monitoring and management. Markets can move quickly, especially when falling.

If a retiree’s portfolio crosses below the lower guardrail, adjustments to spending and withdrawals need to be made in a timely manner, or the long-term system begins to break down and create a higher chance of failure. And, unfortunately, the math behind these adjustments isn’t very simple. You’ll need a fairly robust spreadsheet or professional planning software to help monitor and manage this approach on an ongoing basis.

Second, it’s not easy for everyone to make quick downward adjustments to their spending. A guardrails approach that begins with a high starting withdrawal rate might feel a little bit like lifestyle creep, where you get used to living a certain lifestyle and spending a certain amount of money, and then find it difficult if not impossible to spend less when it’s needed.

Those who adopt a dynamic withdrawal strategy need to have control over their spending to be able to easily adapt to potential changes to their withdrawal rates. Historically and on average, withdrawal rate percentage cuts are few and far between over the 30 and 40 year time periods measured in the Guyton-Klinger study.

But it’s of course impossible for anyone to know exactly what their personal 30 year time period will look like. The next 30 years could be wildly challenging and require dramatically more cuts to spending than the average of all scenarios and time periods evaluated in their research.

We just don’t know, so it would be important to confirm that you are willing and able to make adjustments as needed before implementing a guardrails or flexible spending approach.

If you prefer a more stable, predictable retirement paycheck, you might just need to accept a lower starting withdrawal rate, something closer to four or four and a half percent, or part ways with your nest egg and go ahead and buy that insurance policy.

Okay, I know I said that I had three strategies for you today, but Morningstar did reference something important in their annual State of Retirement Income report that can boost your withdrawal rate, and I think it’s worth calling out.

So unlike the Guyton-Klinger research study and the 4% rule and many others, which use historical return data in their scenarios, Morningstar uses its proprietary, forward-looking return market forecasts to arrive at their safe withdrawal rate figures. And because their forecasts are expecting low returns for US stocks over the next 10 years, their safe withdrawal rate percentages are going to be much lower than if you used historical returns instead.

In fact, using actual historical return data, Morningstar stated that their starting, safe withdrawal rate on a balanced portfolio of 50% stocks and 50% bonds over a 30-year time period would be 5.5%, significantly higher than the initial 3.7% that was established in their baseline scenarios.

Now, 5.5% is more attractive than 3.7% and certainly more in line with the guardrails research, but it’s important to know that it’s still a static withdrawal percentage in Morningstar’s study and not intended to be dynamic or flexible. This means that if the historical return data doesn’t prove to be a good indicator of future returns over the next 30 years, a 5.5% static withdrawal rate could potentially put your plan in jeopardy.

I’ll be the first to admit that using historical data, even 100 years of historical data that we have access to, is not bulletproof. The next 100 years could look wildly different than the previous. At the same time, I’m also not convinced that anyone can accurately model and predict the future with market forecasts.

Yes, US equity valuations are high and it’s reasonable to expect lower future returns, but nothing says that they can’t go higher and if they do, it would completely derail Morningstar’s conclusions in their latest retirement income report. As Mark Twain said, “History does not repeat itself, but it often rhymes.”

So personally, when it comes to creating a sustainable retirement income plan, I prefer to couple actual long-term historical data with a dynamic, flexible withdrawal approach like guardrails to put clients in the best possible position for success.

If the next hundred years of market returns are wildly different than the previous, the dynamic nature of a flexible withdrawal strategy will help us course correct and avoid overspending or even underspending in retirement.

Lastly, before we part ways, there are two final things worth mentioning that are important to factor in when creating a retirement income plan.

Number one, other retirement income sources, and number two, your retirement time horizon or life expectancy. To elaborate, withdrawals from your retirement nest egg might just be one of many sources contributing to your retirement paycheck. In addition to Social Security, you may have part-time employment, a pension, or even other investments like rental real estate that generate consistent cash flow.

Factoring these other income sources into the picture will certainly influence how you invest your traditional retirement savings and the exact withdrawal strategy that you implement. They will also influence your retirement time horizon.

For example, if you have other income sources that support your expense needs for, let’s say, the first 10 years of retirement, the time horizon for taking consistent withdrawals from your nest egg might be 20 years instead of the 30 years that I’ve referenced throughout today’s episode.

On the other end of the spectrum, you might not have any other income beyond Social Security, and because you retired a little earlier than expected, you might have a 40-year time horizon for taking regular withdrawals. The longer your time horizon is, the lower your starting safe withdrawal rate will be. The opposite is also true.

In fact, the most recent Geithen Klinger paper, which I’ll link to in the show notes, documents both a 30-year and 40-year time horizon allowing you to see the difference in withdrawal rates. I hope it’s clear today that there is no one-size-fits-all answer.

Your ideal retirement income strategy depends on your individual circumstances, your risk tolerance, needs and goals, other income sources, desire to plan for long-term care, give to charity or leave a legacy for errors.

If you’re comfortable with a bit of variability, dynamic strategies like the guardrails approach could potentially be a great way to maximize income, protect against sequence risk and mitigate the chances that you outlive your money.

But if predictability is key for you, sticking with lower, fixed, inflation-adjusted withdrawals might be the better bet. And remember, incorporating guaranteed income, whether it’s through annuities or bond ladders, in addition to Social Security and pensions, can add an extra layer of security to your plan.

At the end of the day, retirement planning isn’t about finding a single magic number that works for everyone. It’s about understanding the trade-offs and choosing the approach that best aligns with your unique situation and priorities.

Once again, to grab the links and resources mentioned in today’s episode, just head over to youstaywealthy.com/238.

Thank you as always for listening and I’ll see you back here next week.