Morningstar Ups Safe Starting Retirement Withdrawal Rate to 4%

Morningstar Inc.’s base case ‘safe’ withdrawal rate for retirement savers has crept up for the third consecutive year since the firm started the analysis, returning to what had long been held as the common benchmark of starting retirement drawdown by withdrawing 4% of assets per year, adjusting each year thereafter to account for inflation.

The investment services firm made news in 2021 when it issued its first report of a recommended starting retirement withdrawal rate of 3.3% for a balanced savings portfolio over a 30-year retirement. That time now feels like another world, back when interest rates were low and inflation had only recently started rising.

By 2022, the picture had changed dramatically, and Morningstar moved to recommending a 3.8% withdrawal rate based on higher interest rates and lower equity valuations. In its latest analysis released Monday, the firm moved to a 4% starting withdrawal rate for a portfolio starting with a balance of $1 million and a conservative portfolio of 20% to 40% in equities and the remainder in cash and fixed income.

That starting withdrawal rate would yield a 90% probability of having funds remaining at the end of a 30-year period, assuming the retiree would adjust for inflation each year either by adjusting the withdrawal rate or by using inflation-protected savings strategies.

Long-term Treasury yields that recently were hovering at a decades-long high were the key driver of the boost, says John Rekenthaler, Morningstar’s director of research. “The bond estimates went up fairly aggressively, because long-term bond returns tend to be what the current yield on the 30-year Treasury is—they don’t range that far away.”

Morningstar noted that Treasury inflation-protected securities, or TIPS, were yielding 4.6% at the time of publication and are guaranteed.

If Treasury yields drop dramatically over the next 12 months, that may change the ‘safe’ base case once again, Rekenthaler says. But there also may be other factors coming into play, such as a more bullish stock market valuation, so it will depend on the larger market environment to determine next year’s figure.

The lower inflation adjustments, though a factor, were not as dramatic, Rekenthaler says, with Morningstar basing the models on a 2.42% inflation rate this year, as compared with a 2.84% rate in 2022.

The withdrawal rate recommendation is slightly lower, 3.9%, for a portfolio with 50% equities and 50% bonds and cash, Morningstar noted, due to equities potentially having more volatile returns.

Looking Forward

The ‘right’ withdrawal rate by the firm takes into account three key variables: “the market environment that prevails over a retiree’s drawdown period, the length of the drawdown period, and the portfolio’s asset allocation.”

Unlike other withdrawal rate analysis that looks backward at historical outcomes, Morningstar’s report uses forward-looking forecasts created by Morningstar Investment Management. In the base case assumption, most savers will end up with money left over after 30 years. But fixed-income-heavy modelling is not a recommendation of how to invest, Rekenthaler notes.

“When we recommend 20-40% equity, we’re saying that when we run the numbers, that gets you to safe withdrawal rate,” he says. But the 3.9% in a 50/50 portfolio is “very close to 4% and may yield a higher balance at the end of the term.”

The reason for considering a more conservative drawdown scenario is, in part, because when withdrawing from a portfolio, “volatility is quite dangerous,” Rekenthaler says. “It doesn’t matter if you’re investing in a portfolio from a buy-and-hold perspective … but it’s another thing when you are pulling money out of a portfolio.”

Guaranteed Returns

Morningstar’s new report also ran analysis of guaranteed income options for the first time, considering an income option to supplement savings and Social Security.

The impetus for that analysis was to consider how retirement savers can set themselves to meet fixed or set needs via guaranteed income options, Rekenthaler says. Another reason was the 100% guaranteed rate TIPS are generating now, as opposed to in the past.

“If the yields on TIPS are sufficiently attractive, their safe withdrawal rates can exceed those provided by other investment portfolios,” Morningstar’s researchers wrote in the report.

If a retirement saver implemented a solely TIPS-based investment strategy, it would bump a ‘safe’ starting withdrawal rate up to 4.6% but would leave no assets remaining after 30 years, according to the analysis.

Other strategies for boosting guaranteed income would be delaying Social Security distributions to maximize payout or adding retirement income annuities. Morningstar’s report did not analyze the use of annuities but noted it plans to include them in future analyses.