Falling inflation and higher fixed-income yields have increased retirees’ ability to withdraw more, according to a new report by Morningstar on the state of retirement income.
Morningstar’s modeling found that the starting withdrawal rate increased from 3.8 percent in 2022 to 4 percent in 2023. In 2021, the highest starting safe withdrawal rate was calculated at just 3.3 percent, the first year Morningstar conducted this research.
While not a huge increase, Amy Arnott, portfolio strategist at Morningstar, said that for someone with a million-dollar portfolio, even a small increase could mean an improvement in quality of life like a nice vacation or eating out more frequently.
She sees Morningstar’s starting rate not as a hardline but as a jumping-off point for investors and advisors.
“We’re not saying that every single investor who is embarking on retirement should start out with a 4 percent withdrawal rate and never change,” Arnott said. “If you’re an individual or an advisor working with a client, you can think about do those assumptions apply to you.”
The ‘right’ withdrawal rate depends on three things, according to Morningstar. It depends on the market environment during a retiree’s drawdown, the length of the period of the drawdown, and the portfolio’s asset allocation.
Morningstar found that portfolios with higher equity weightings had a higher median residual balance at the end of the 30 years than bond-heavy portfolios. Conservative portfolio allocations improve the safe withdrawal rate but it does so at the cost of potential future wealth.
Morningstar’s starting safe rate is modeled on portfolios that hold between 20 percent and 40 percent in equities with the remainder in bonds and cash with a 30-year horizon and with a 90 percent probability of success.
According to the report, portfolios with equity weights between 20 percent and 40 percent had the highest starting safe withdrawal percentage but they had a lower median balance at year 30 than did portfolios with more equity exposure.
Falling inflation had one of the biggest impacts on increasing the safe withdrawal rate this year.
Last year, Morningstar ran the forecast with a 2.84 percent inflation rate compared to 2.46 in 2023. Higher fixed income yield also played a major role in increasing withdrawal conditions, said Arnott.
Many aspects affect an individual investor’s withdrawal rate, including their spending.
According to research by the Employee Benefits Research Institute that looked at actual retiree spending, spending tends to level off in the middle to later years of retirement. When Morningstar factored this into the model, it found that the safe withdrawal rate actually increased to 5 percent.
Knowing a client’s real spending habits could help advisors more accurately plan.
David Caviness, founder of Caviness Wealth Management, an RIA serving about 125 households with 50 million in AUM with most of his clients in the pre-retirement planning or retirement drawdown phase, said it’s all about creating a plan that is realistic and sustainable.
This requires advisors to have detailed conversations about spending, financial needs, asset allocation and risk tolerance, financial legacy requirements, and life expectancy from the very beginning.
“When [clients are] concerned about the market being down 20 percent, those conversations center back to our plan, our investment strategy, and then what investments we own,” said Caviness.
