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What's the Right Way to Approach Withdrawal Rates?

What's the Right Way to Approach Withdrawal Rates?

Christine Benz: Hi, I'm Christine Benz for Morningstar. Many retirees or soon-to-be retirees have heard the admonition about being conservative about their in-retirement withdrawal rates. Joining me to discuss that topic is David Blanchett. He is head of Retirement Research for Morningstar Investment Management.

David, thank you so much for being here.

David Blanchett: Thanks for having me.

Benz: David, you have researched withdrawal rates extensively. Let's just start with a basic question. Many investors have heard about the 4% guideline for in-retirement portfolio withdrawals. Do you think that's still a good starting point?

Blanchett: I do. So, I guess, we can go way back and define all the terms. And so, the 4% rule was something that Bill Bengen and others, kind of, came up with about 25 years ago, or maybe more than that now. And what it suggests is that when you first retire, you can take out 4% from your portfolio and then increase that amount every year for inflation, and it will last for about 30 years. "4%" actually isn't the best name for it because the 4% is only the first year of income. After that, it's a fixed amount. I think 1 divided 4% is 25 times. Like, you need 25 times your income goal when you first retire. That's what the rule says.

I mean, I'm a big fan of the early research. I thought it was groundbreaking. It's still widely cited. There are some kind of issues that people have with it. It didn't include fees initially, and it was based upon historical U.S. returns. And by any metric the U.S. has had really good returns historically versus any other country in the world. And there's also questions of, you know, are they relevant today, right? The long-term average yield on U.S. government bonds is close to 5%. For those of you that are aware of the current market conditions, we're not close to a 5% yield today on 10-year government bonds. And so, if you rerun the numbers using Bengen's original approach or others, you get a much more conservative initial withdrawal rate, say, 3%.

That being said, I think it's important to recognize that a lot of the assumptions that's used in this research are really conservative. It assumes that failure occurs if you cannot achieve the same amount of income in today's dollars every year for 30 years. If you fall $1 short, it says that you fail. I mean, it fails to kind of acknowledge that people can change their mind, they can change their withdrawal rate, might have other sources of guaranteed income. So, I still like 4% as a starting place for the discussion. However, it really is personalized, and it's based upon kind of each retiree's facts and situation.

Benz: So, speaking of that, one other potential sort of limitation to the 4% guideline is that many retirees are further along in their retirement careers, and they're seeking a check on whether what they're spending is a sustainable amount. How would you suggest they approach kind of checking up on whether they're taking out too much, too little, and so forth?

Blanchett: So, like, my favorite rule of thumb for retirees, and this is actually like incredibly efficient, is similar to what you do for required minimum distributions, right? So, you just take one and you say, well, how many years do I want to plan for retirement, my retirement to last? And let's say, you say, I want to plan for 20 more years. Well, then 5%--1 divided by 20 is 5%--is actually a pretty good starting place for what you should be withdrawing from that portfolio. Now, it isn't perfect. But if you're planning your retirement to last 30 years, and you're taking out 8%, that's not going to be within the kind of margin of safety that would be suggested by that rule.

Benz: You have done extensive research on withdrawal rates and you've already discussed how sensitive advisable withdrawal rates are to what's going on with current yields. Yields have begun to come up a little bit in 2021. Does that affect the prognosis? Could retirees potentially take more if yields get significantly better?

Blanchett: Don't jinx it, Christine. We could go back to below 1%. It, kind of, does, right? And so, I think that the one thing that is kind of wrong with a lot of financial plans is that they assume that you make a decision when you retire, and then you follow that path with really not changing it for 30 years. And the answer is yes. If yields do rise, that would suggest you can take more income. But at the same time, we don't know what will happen with life expectancies, with the stock market, and everything else. And so, the fact that yields are rising for the most part, it's good news for retirees. However, we just don't know how long it's going to last and what else happens. And so, it is good news. But if you're in retirement, you still could have 20 or 30 years to go. So, I wouldn't celebrate too much just yet.

Benz: So, if there's a common thread among the retirement research that's been done over the past few decades, it's that flexibility is really valuable. If retirees can be somewhat flexible in terms of how much they take out of their portfolio, that can go a long way toward making sure that their portfolios last and specifically, if they can take less when the market is down. A lot of the sort-of guidelines related to flexible withdrawals get really complicated. Are there any more simplified ways that you like? You referenced the RMD method. Are there any other ways that retirees can approach tethering their withdrawals to what's going on with their portfolios?

Blanchett: Yeah, so you mentioned flexibility, and to be honest, that's like one of the, the most important thing I would say might drive that withdrawal rate. Because if you're someone that needs a certain amount of income every year increased for inflation or whatever without fail, 2.5% or 3% could be your withdrawal rate today. But if you're like most Americans, and you say, hey, you know, I got a decent amount of money from Social Security, I can cut back if I need to, then 4% or 5% works. And there's probably almost two decades now of research on what are called "dynamic withdrawal strategies," how do you adjust the withdrawal rate as you move through retirement. And to your point, a lot of these are really, really complex and they don't necessarily do a very good job of incorporating nonconstant cash flows and everything else. And so, I think that for most people, unless you have access to like a really advanced financial planning software tool, some kind of RMD-type strategy where you are thinking okay, I want to plan this to last X number of years, 1 divided by that number is the base withdrawal rate--that's a really good place to start.

Benz: And the other advantage is that you can update it based on what you anticipate will be your life expectancy, so you can potentially take more as you age?

Blanchett: Right. And obviously, it should--the amount adjusts as your balance changes. And people would say, well, if the market goes down by 30% or whatever, do I have to take out 30% less? No. You can smooth things over time but just be aware of, hey, you know, if you're following this same path and the markets start going down or something were to happen, you need to be aware of kind of where you're trending in terms of the overall likelihood that your strategy will last as long as you need it to.

Benz: David, it's always great to get your perspective. Thank you so much for being here.

Blanchett: Sure thing.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.

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About the Authors

David Blanchett

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David M. Blanchett, Ph.D., CFA, CFP®, is head of retirement research for Morningstar’s Investment Management group. In this role, he works to enhance the group’s consulting and investment services. He conducts research primarily in the areas of financial and tax planning, annuities, and retirement plans. Blanchett also serves as the chairman of the Advice Methodologies subcommittee, which is the group responsible for developing and maintaining all methodologies relating to wealth forecasting, general financial planning, automated investment selection, and portfolio assignment for Investment Management. Before joining Morningstar in 2011, he was director of consulting and investment research for Unified Trust Company’s retirement plan consulting group.

Blanchett’s research has been published in a variety of academic and industry journals, such as Financial Analysts Journal, Journal of Financial Planning, The Journal of Portfolio Management, Journal of Retirement, and The Journal of Wealth Management. He has also been featured in a variety of media outlets and publications, including InvestmentNews, MarketWatch, Money, The New York Times, PLANSPONSOR, and The Wall Street Journal. His research has won a number of awards, most recently the Journal of Financial Planning’s 2014 and 2015 Montgomery-Warschauer Awards, the Financial Analysts Journal 2015 Graham & Dodd Scroll Award, and the CFP Board Center for Financial Planning 2017 Academic Research Colloquium Best Investments Paper Award.

In 2014, InvestmentNews included him in their inaugural 40 under 40 list as a “visionary” for the financial planning industry, and in 2014, Money named him one of the brightest minds in retirement planning. He is a RetireMentor for MarketWatch and an expert retirement panelist for The Wall Street Journal. Blanchett is also on the executive committee for the Defined Contribution Institutional Investment Association (DCIIA) and serves on the editorial boards of Morningstar Magazine and the Journal of Retirement.

Blanchett holds a bachelor’s degree in finance and economics from the University of Kentucky, a master’s degree in financial services from The American College, a master’s degree in business administration from the University of Chicago Booth School of Business, and a doctorate in personal financial planning from Texas Tech University. Blanchett holds the Chartered Financial Analyst®, Certified Financial Planner™, Chartered Life Underwriter (CLU®), Chartered Financial Consultant (ChFC), and Accredited Investment Fiduciary Analyst™ designations.

Christine Benz

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Christine Benz is director of personal finance and retirement planning for Morningstar, Inc. In that role, she focuses on retirement and portfolio planning for individual investors. She also co-hosts a podcast for Morningstar, The Long View, which features in-depth interviews with thought leaders in investing and personal finance.

Benz joined Morningstar in 1993. Before assuming her current role she served as a mutual fund analyst and headed up Morningstar’s team of fund researchers in the U.S. She also served as editor of Morningstar Mutual Funds and Morningstar FundInvestor.

She is a frequent public speaker and is widely quoted in the media, including The New York Times, The Wall Street Journal, Barron’s, CNBC, and PBS. In 2020, Barron’s named her to its inaugural list of the 100 most influential women in finance; she appeared on the 2021 list as well. In 2021, Barron’s named her as one of the 10 most influential women in wealth management.

She holds a bachelor’s degree in political science and Russian language from the University of Illinois at Urbana-Champaign.

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