Recent retirees haven’t had an easy time lately. When stock and bond prices both plummeted in 2022, many retirees saw a significant drop in the value of their portfolios. A typical portfolio consisting of 50% stocks and 50% bonds will result in annual losses of approximately 16%. Although market conditions improved slightly in 2023, as of October 31, 2023, the balanced portfolio had not recovered all of its 2022 losses. To make matters worse, rising inflation is reducing the value of portfolios and forcing many retirees to withdraw larger amounts. .
But for those who are about to retire, the outlook for retirement income is a little brighter. In a newly published research paper, “The State of Retirement Income in 2023,” co-authors Christine Benz, John Rekenthaler, and I find that retirees who are withdrawing income from their investment portfolios are currently We estimate that you can afford to withdraw 4.0% of your pension amount. The initial expenditure rate assuming that the probability that the funds will remain after the 30-year period is 90%. This number is the highest safe withdrawal rate since Morningstar began producing this research in 2021 (the highest starting safe withdrawal rate based on similar assumptions would be 3.3% in 2021 and 3.3% in 2022). 3.8%).
reason? As bond and cash yields rise, the future outlook for portfolio returns, and by extension the amount a new retiree can safely withdraw from those portfolios over his 30 years, has also changed a bit since we last covered this topic. It continues to rise gradually. Year. A more benign inflation outlook also helped. The long-term inflation forecast for this year was 2.42%, while for 2022 it was 2.84%.
Retirees who wish to adopt a more flexible strategy or make other changes to the basic approach of using 4% as a starting point for withdrawals and adjusting that amount annually for inflation, If you’re willing, you can enjoy even higher withdrawal starts. Other trade-offs must be accepted, such as real cash flows that vary from year to year and the possibility of reduced residual assets at the end of the 30-year period.
Research Details: Safe Withdrawal Rate Analysis
Similar to last year’s study, we employed a “base case” to test safe starting withdrawal rates. Specifically, we assumed a new retiree with a 30-year forecast period and a desire to not outlive his money 90% of the time. We assumed that retirees use a fixed real withdrawal system. With this system, you set a starting withdrawal amount and then each year that dollar amount is adjusted for inflation.
While we have stabilized these key inputs over the past year, our overall portfolio return assumptions have increased based on capital market assumptions compiled by our colleagues at Morningstar Investment Management. This year’s study found that the expected 30-year return on stocks was slightly lower than last year, with the expected return on an all-stock portfolio dropping slightly from 9.88% to 9.41% in 2022. -Income return (including cash) increased from 4.44% to 4.81% in 2022. As mentioned earlier, more benign inflation assumptions were also positive. The 30-year inflation forecast has been lowered from 2.84% to 2.42% in 2022.
With two of our three key assumptions trending positively, our study suggests that people heading into retirement today could reasonably qualify for higher retirement entry rates than indicated last year. I am. As shown in the table below, a new retiree planning a 30-year time horizon can safely withdraw up to his 4% of the portfolio value, with a starting safe withdrawal rate for a portfolio with an equity weight of his 40%. It is estimated that it is possible. We find that the same numbers hold true for portfolios with lower equity weights, around 20%, as bonds offer more attractive yields.
Investors may expect that a higher weighting in stocks will lead to a higher safe withdrawal rate, but this is not necessarily the case. Our return assumptions still assume that stocks have significantly better long-term returns than bonds or cash. As a result, equity-heavy portfolios typically end up with more money left over at the end of a 30-year period. However, stocks also require very high levels of volatility, making the results of all withdrawal rates tested inherently uncertain. We also aimed for a relatively high success rate of 90%. This also tended to tip the scales in favor of less volatile assets such as bonds and cash.
Additionally, for retirees with both shorter and longer time horizons than 30 years, portfolios with 20% to 40% stocks have higher exit rates than portfolios with higher stocks. As shown in the table above, retirees with shorter time horizons can safely withdraw significantly more than the 30-year baseline assumption, while retirees with longer time horizons can safely withdraw significantly more than the 30-year baseline assumption. gradually declined at a slower pace.
How dynamic withdrawal strategies can help
Similar to last year’s paper, we tested a variety of additional flexible withdrawal systems. They range from simple adjustments, such as forgoing inflation adjustments after a portfolio has lost value in the previous year, to adjustments such as the “guardrail” approach originally developed by financial planner Jonathan Guyton and computer scientist William Klinger. This ranges from even more complex systems. This year, we also tested a strategy that incorporates the average reduction in spending that occurs over the retirement lifecycle, based on empirical data. All these systems allowed us to start with a safe withdrawal rate compared to the fixed real spending rate we used as our base case.
However, all of these strategies involve tradeoffs, as shown in the table above. For example, both guardrail laws and withdrawals in line with required minimum distributions allowed for higher starting safe withdrawal rates, but at the cost of significantly greater fluctuations in cash flows from year to year. If you gradually reduce your actual spending over time, your initial withdrawal rate will be higher, but your lifetime withdrawal rate will be lower.
Another tradeoff involves how much money you have left at the end of the spending period. In extreme cases, the base case and actual spending practices typically result in the highest balance at the end of the 30-year period. This metric is relevant for retirees who want to preserve (or grow) their assets in order to leave something for their heirs or charity. On the other hand, with Guardrail and his RMD method, both typically end up with a lower balance due to higher withdrawals in good markets. These methods, like his TIPS Ladder method described below, are useful for retirees who want maximum consumption (including gifts to loved ones and philanthropy) over their lifetime rather than leaving something behind. Perfect for.
The role of income guarantee
In addition to the dynamic withdrawal strategies described above, retirees can use guaranteed income sources such as Social Security, insurance company-sold annuity contracts, or inflation-indexed Treasury securities to manage their retirement spending. You can also support
There are several ways to maximize the value of Social Security. The best thing to do is to wait until the official full retirement age (currently he is 67 if born after 1960) to claim full benefits. Delay filing until age 70 to receive higher monthly payments. Or you can defer Social Security and wait to tap into your retirement portfolio. This means working longer and continuing to contribute to your retirement savings.
Fixed annuities (immediate or deferred) are another way to generate a guaranteed income stream (primarily consisting of a return over time on the initial amount of capital purchased). Fixed annuities spread the risk of death among a wide range of policyholders by continuing to make monthly payments throughout the retiree’s life.
TIPS ladders, which are self-liquidating portfolios created to support spending over a specific period of time, can also be an attractive way to generate guaranteed income. The principal value and yield of TIPS both adjust to changes in inflation, so they not only provide a stable source of income, but also act as a built-in hedge against unexpected inflation. Creating a TIPS ladder involves purchasing TIPS of various maturities over a spending period (in this case 30 years) and using the bond proceeds (and ongoing coupon payments) depending on maturity to cover your spending needs. Includes: over time.
Current TIPS yields are more attractive than in the past, making TIPS ladder strategies particularly attractive in this year’s study. As of September 30, 2023, we estimate that his 30-year TIPS ladder supports a withdrawal rate of 4.6%. Not only is this higher than most other strategies we’ve tested, it’s 100% guaranteed. On the downside, in contrast to the portfolio spending strategy discussed in the previous section, if a retiree uses her TIPS earnings for spending, there is no chance of accruing a balance.
Retirement planning strategies remain one of the most difficult areas in all of finance. But fortunately, retirees have many options. The appropriate level of flexibility in a retiree’s spending system ultimately depends on whether the person wants to prioritize stable income over a long period of time, maximize withdrawal rates, or leave funds for bequest purposes. , depends on several different factors, including how much fixed costs are covered. From sources of income other than the portfolio.
Christine Benz and John Rekenthaler contributed to this article.