Retirement Income and Safe Withdrawal Rates in 2023

Key Takeaways

• People retiring today can reasonably take a higher withdrawal percentage than they would have been able to in the past.
• Even though safe starting withdrawal percentages are higher for retirees in 2023, that might not actually translate into a higher payout for most of them.
• On average, spending tends to decline by about a percentage point less than the inflation rate, which translated into a nice uptick in spending early on in retirement.

Susan Dziubinski: Hi, I’m Susan Dziubinski from Morningstar. Stocks and bonds both lost money in 2022, while inflation rose dramatically. Joining me to discuss implications for safe withdrawal rates in retirement is Christine Benz. Christine is co-author of a recent research report on this topic.

Christine, nice to see you today.

Christine Benz: Hi, Susan. It’s great to see you.

Dziubinski: You and your co-authors, John Rekenthaler and Jeff Ptak, concluded that people retiring today can reasonably take a higher withdrawal percentage than they would have been able to, say, a year ago. Talk a little bit about how you arrived at that conclusion.

Benz: Right. We used what are called Monte Carlo simulations to figure out what someone could safely take out of their portfolio as a percentage in Year One of their retirement using a balanced portfolio and have a 90% success rate—so, a 90% chance of not running out of funds over that 30-year horizon. And we assumed a fixed real withdrawal system for those retirement withdrawals. So, we’re assuming that someone is taking X percentage in Year One of retirement, and then inflation-adjusting that dollar amount thereafter, and that’s kind of a convention in talking about and thinking about safe withdrawal rates.

When we used the inputs that we received from our colleagues in Morningstar Investment Management for expected stock returns, expected bond returns, expected inflation over that 30-year horizon, what we saw is a little bump up in safe withdrawal rates in 2022 versus what they were in 2021. So, when we ran this study in 2021, we came out with a fairly low number, kind of a worrisome number, a 3.3% safe withdrawal rate for that 30-year horizon starting at the beginning of 2022. Thanks to increasing bond yields as well as lower equity valuations, we came out with a 3.8% number in 2022. That’s because the team in Morningstar Investment Management expects that stock returns will be higher over the next 30 years and bond returns will also be higher.

Dziubinski: Now, inflation also rose quite a bit last year. How did that factor into your analysis?

Benz: Yeah. Super good question. Inflation is all top of mind for all of us today. But the fact is, we’re planning for a 30-year time horizon. So, there are periodic blips in inflation, but the team in Morningstar Investment Management makes an estimate of what they think inflation will be over that 30-year horizon. Their estimate that they’re using is 2.8% as of late 2022. So, over that 30-year horizon, the expectation is that inflation will be elevated a little bit for the next couple of years but then will level off to a more normal level going forward. When we ran this study in 2021, the forecast that we were using was 2.2%. So, it’s a little bit elevated but not a lot elevated. It’s nowhere near the 7% inflation level that we’ve had over the past year in the U.S.

Dziubinski: Christine, you say in the research that it’s important to note that even though safe starting withdrawal percentages are higher for retirees this year, that might not actually translate into a higher payout for most retirees. Unpack that for us.

Benz: Yeah, I think that’s such an important point, Susan. People care about their dollar withdrawals. They don’t care about the percentage. So, a higher percentage, say, 3.8% on a shriveled-up portfolio may translate into a lower payout. So, what matters at the end of the day is how much you’re able to spend in dollars and cents, not the percentage. And the fact is many retirees, many of us, have seen significant declines in our balances over the past year because stocks have declined and bonds have declined simultaneously.

Dziubinski: Christine, who is this research really for? Is it mostly for people who are just about to retire and who are thinking about what their optimal portfolio withdrawal rate might be? Or is this useful research for those who are already in retirement and tapping into their portfolios?

Benz: It’s mainly relevant for people who are on the cusp of retirement or just starting retirement, but I do think there are some takeaways in this research, especially in the broad white paper that we wrote, where we look at various time horizons and what would be safe withdrawal rates for various time horizons. We take it all the way down to 10 years, a 10-year time horizon. That would be someone who has been retired for a long time or for whatever reason thinks that they will just have a 10-year time horizon for that portfolio. What you see quite intuitively is that as the time horizon shrinks—so, if you’re an older adult, and maybe you’ve already been retired for 10 years and you think, maybe “Well, I think I’ll live another 20 years” or whatever it might be—as that time horizon shrinks, the payouts that are supported are higher. So, when we look at a 20-year time horizon, for example, you can see that with a balanced portfolio and a 90% success rate, you can actually take over 5% today. If you have a 15-year time horizon, you could take over 6%. So, definitely, it can be a check for people who are further on in their retirement. It’s not just for retirement newbies.

Dziubinski: In your paper, Christine, you and your team explore how flexible withdrawal strategies can help elevate those starting safe withdrawal amounts. Let’s dive a little bit into these flexible strategies. How are they able to do that, and what are the trade-offs with a flexible approach?

Benz: Sure. This is an element of the paper that frankly I wish had gotten more attention. Because when we look at all of the retirement research that’s been done over the past couple of decades by people like Wade Pfau or our former colleague David Blanchett, our research points to the value of being flexible in terms of your withdrawals. If you’re willing to vary them a little bit based on how your portfolio has performed, maybe even based on that time horizon, how long you’ve been retired, you can very likely take a higher withdrawal amount. So, in our paper, in our research, we tested five different dynamic withdrawal strategies ranging from really simple tweaks on the old 4% style, fixed real withdrawal guideline to things that are a little bit more radical in terms of making adjustments. What we found is that starting safe withdrawal rates increased and lifetime safe withdrawal rates—so how much you could pull from the portfolio over your whole retirement time horizon—also increased. So, my hope is that people will explore some of these dynamic strategies because I think they can be really powerful. They can translate into higher spending, higher quality of life. The trade-off, though, is more variability. That you have to be willing to put up with some changes in your paycheck from year to year. They can be modest changes, but they’re changes all the same.

And the other point I would make is that for some of the strategies—especially what’s called the guardrails strategy, which was developed by Jonathan Guyton, a financial planner, and William Klinger, a computer scientist—strategies like guardrails or an RMD, required minimum distribution type strategy, they basically get you consuming more of your portfolio throughout your retirement. Some of us might say, “Well, that’s exactly what I want. I want to enjoy the fruits of my labors.” Some people might say, “Well, for me, having a bequest, money left over at the end is a really important goal, too.” So, bear that in mind as you evaluate these flexible strategies. If you’re bequest-minded, you might want to lean more toward just the modest tweaks. Whereas if you’re very consumption-oriented, you want to really enjoy what you’ve managed to save, you might look at a guardrails type strategy, for example.

Dziubinski: And then, lastly, Christine, your research also looked at how retirees actually spend, which is specifically the tendency of retirees to spend less as they age. How does that affect the safe withdrawal amounts?

Benz: Right. This is some research that was prompted by, again, David Blanchett’s research on how retirees actually spend. And what he found in surveying retiree spending habits is that retirees do tend to spend less as they move on in their retirement. So, in the middle to later years of retirement, spending trends down. It’s higher early on in those pent up, go-go years and then trends down in the middle to later years of retirement. So, we decided to model that in. We consulted with David on how best to do that, and he suggested to simply reduce the inflation adjustment that we were giving retirees each year throughout their retirement. So, he found that, on average, spending tends to decline by about a percentage point less than the inflation rate. So, if we’re assuming a 2.8% inflation rate for the purpose of modeling, we used a 1.8% inflation rate. What we found is that that translated into a nice uptick in spending early on in retirement. So, a retiree could spend more in those early go-go years, but the trade-off, of course, is the assumption that spending is going to level down, that spending won’t necessarily increase in line with inflation. But I think it was an attempt to reflect how retirees do indeed actually spend in aggregate.

Dziubinski: Thank you for your time, Christine, today. As we know, withdrawing from a portfolio in retirement can be a very challenging and frustrating experience, and we appreciate your new insights today in light of what happened in the market last year.

Benz: Thanks, Susan.

Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.

Watch “Can the 60/40 Portfolio Bounce Back in 2023?” from Susan Dziubinski and Jason Kephart.