How to Approach Retirement Portfolio Withdrawals in 2021

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. What adjustments should retirees consider making to their withdrawal rates in 2021? Here with me to discuss the topic is Christine Benz. Christine is Morningstar's director of personal finance.

Hi, Christine. Thanks for being here today.

Christine Benz: Hi, Susan. It's great to be here.

Dziubinski: Now, let's start with talking about why should retirees sort of revisit and perhaps recalibrate their withdrawal rates as their retirement goes on?

Benz: Well, there are a few reasons. One is simply that we know from examining retirement spending patterns that spending in retirement isn't a flat line. People's spending tends to fluctuate based on what they have going on in their lives. So, for a lot of retirees, a lot of all of us, 2020 was a year of very light spending. Going forward, they may spend more, they may spend less. So, spending naturally fluctuates based on what you have going on in your life.

And then, you also want to think about your withdrawal rate with respect to your age. So, as we age and are taking from our portfolios in retirement, we can generally take a higher withdrawal percentage as the years go by as our life expectancy declines. And finally, you want to give some thought to your portfolio, its value as well as valuations and the returns that you might expect from your portfolio going forward. If your portfolio is enlarged, that means that you can take perhaps a higher dollar withdrawal. But if valuations have shrunk or have increased, that may also affect your withdrawal rate. A lot of different considerations might affect how much you take out from year to year.

Dziubinski: Let's unpack those a little bit, maybe starting with spending. You say the first step is to sort of determine what you think your spending will look like in the coming year. How do you go about doing that?

Benz: Well, really map it out, and you might use last year's spending as a baseline. But as I said, it was somewhat anomalous whether spending patterns in 2021 look the same is an open question, kind of depending on what happens with this virus. But use that as a starting point because certainly your baseline expenses--your property taxes, your utilities, your food outlays--may not change a lot in 2021. So, use that as a starting point. And then, think through any changes that you might expect to see in your spending. So, think through what your travel plans are perhaps for later this year, think through any extraordinary outlays that you expect to have, whether big home repairs, or maybe you need a new car that you plan to purchase in 2021. Really map out those things and think about what your needs will be, what your wants will be, and how your spending might change.

Dziubinski: How do you take your age into consideration if you're re-examining your withdrawal rate?

Benz: It's a really important question, Susan. And as I said earlier, you do want to think about taking potentially a higher percentage of your portfolio as you age. Our colleague David Blanchett, who does retirement research for Morningstar Investment Management, has argued that the RMD system, the required minimum distribution system, is actually a decent starting point for people thinking about withdrawals in retirement because it does factor in age. So, withdrawals scale up as people get older. And so, I think you maybe want to look at those RMD tables as kind of a baseline to determine how much you take out and to know that you can safely take more as you get further on into your retirement.

Dziubinski: Let's pivot over now to the part about the portfolio. So, as you noted, despite 2020 being a very odd and interesting year, stocks and bonds and most other asset classes did reasonably well last year. So, retirees could be looking at a really nice return on their overall portfolios for the year. How should that impact or color how they think about withdrawals in 2021?

Benz: So, there's good news and bad news here. The good news is that portfolios are generally enlarged because, as you said, Susan, almost no matter what you invested in in 2020, you had some good results. So, we had really strong-performing stock market obviously, but bonds actually did pretty well as well. And so, investors who are retired have these enlarged balances. On the flip side, though, the return potential of both stocks and bonds is constrained in part because we did have such great results, not just in 2020 but 2019 as well. You want to factor that into how much you can take out as a percentage of your portfolio. Your portfolio balance is higher--that's a plus. But you probably want to think about taking a lower percentage withdrawal going forward because returns are likely to be constrained from stocks and bonds over the next decade.

Dziubinski: And lastly, why is it especially important for newer retirees to be very careful with calculating what that withdrawal rate should be, especially after we've seen stocks go up so much the past couple of years and we're in still kind of an uncertain economic environment. Why is that so important?

Benz: It's really important for younger retirees to stay attuned to their withdrawals because there's this concern in retirement planning about what's called sequencing risk or sequence-of-return risk. And that basically means that if early in your retirement you encounter a really bad market either for stocks or bonds, or maybe both, and you're overspending from your portfolio during that time period, that leaves less of your portfolio in place to recover when the markets eventually do. So, a lot of great research has been done on withdrawal rates over the past decade. Much of it comes back to if people can be somewhat flexible and take less during those periods of market duress, that really improves a portfolio's sustainability over the totality of the retiree's time horizon. So, for a 25- or 30-year time horizon, you can be really mindful and potentially reduce your withdrawals during those periods and that can really improve a portfolio's sustainability potential. So, if you're a new retiree, I think you want to be mindful of that research, be prepared to take less if a weak market environment materializes early on in your retirement. For older retirees, this is less important.

Dziubinski: Well, Christine, thank you so much for your time today. A lot of great food for thought when it comes to withdrawal rates.

Benz: Thank you, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thank you for tuning in.