Key Takeaways
- New Morningstar research shows that the 4% “safe withdrawal” rate is still a viable means of planning your retirement spending.
- Stock market volatility early in retirement can still damage a portfolio’s ability to sustain spending over time, however.
- Flexibility in how retirees draw down and spend allows for higher withdrawal rates, particularly given elevated inflation.
Ollie Smith: Now, with everything that’s going on in the world, retirees, or those approaching retirement, could be forgiven for feeling a little bit nervous about planning their portfolio withdrawal rates. It so happens that one of Morningstar’s star commentators, Christine Benz, is here to discuss just that.
Christine, thank you so much for your time today. So why is it important for retirees to stick to a safe withdrawal rate on their portfolios?
Christine Benz: Well, you’re calibrating your withdrawal rate over a number of unknowables. So, you don’t know how long you’ll live, obviously. You don’t know how the markets will behave. You don’t know what inflation will be over your spending horizon. So, you need to give some kind of a guess, some kind of an educated guess, ideally, about how much you can spend each year. So that’s why we do our research to help provide a starting point for retirees who are thinking about this problem.
Smith: Lots of commentators, economists have cited the 4% rule, the 4% safe withdrawal rule for portfolios. What does Morningstar’s research about that show?
Benz: So, it’s actually a pretty good ballpark estimate about how much you could withdraw annually. It’s important to know what we’re talking about when we talk about the 4% guideline—or in our research it was 4.1% as a starting withdrawal. The idea is that you would take 4.1% of your portfolio in year one of retirement and then you would just inflation adjust that number of pounds, that amount of pounds, over your entire time horizon. And so, it’s not like you’re taking 4.1% out of whatever your portfolio balance is per year. That’s probably going to be too volatile in terms of cash flows for most retirees. You’re taking more or less a fixed real withdrawal over the whole time horizon. And when we do our research we determined that 4.1% is a starting withdrawal percentage for people using that kind of system. It’s a pretty good place to start.
Inflation Can Hit Retirement Portfolios
Smith: I want to come on to the idea of trade-offs in a second because this is about balance between what people spend and what people refrain from spending, so to speak. But just on the topic of inflation: your research is sort of couched upon this 2.15% inflation rate. Inflation in the UK is currently running at 3.3%. So, what I want to know is how sensitive is this research to rising inflation and what impacts should retirees be considering?
Benz: Yeah, it’s an important question, Ollie. So, we receive our capital markets assumptions including the inflation projection from a team at Morningstar: 2.15% was their latest read. And the idea is that this would be over a whole 30-year time horizon. So, the expectation is that even though inflation is a little bit high relative to that level currently here in the UK, that it will come down to more of a 2% level over that whole 30-year time horizon. If inflation is in fact higher than that, a retiree’s best defense in that scenario is to take the base withdrawal percentage down because you expect that you may be needing to take bigger inflation adjustments as the years go by.
Smith: So, let’s talk trade-offs then. What kind of trade-offs do retirees need to be aware of in terms of their withdrawal rate and what they spend?
Benz: Yeah, so it’s important to note that if you use that kind of mechanistic retirement withdrawal system that I talked about where you’re basically like a robot putting blinders on to what’s going on with your portfolio, the trade-off is that, generally speaking, if you start low enough, that will be safe over the whole retirement time horizon. You’re very unlikely to run out of funds. And it’s also inherently a very stable source of cash flows that you’d know what to expect from year to year. The downside is that in many different market environments—because that 4.1% is kind of anchored on a worst-case scenario—in many market environments, it’s not a worst-case scenario and you’ll end up significantly underspending during your retirement time horizon and you’ll leave a big bequest at the end of your life.
Now that may be just fine. It may be what you want, but for some retiree households they are short-shrifting their own quality of life. And so those are some of the trade-offs that are in play. I think it’s important for retirees to really do a bit of introspection as they embark on this process to determine what they’re looking for from their retirement cash flows and how much of a bequest they have in mind, or maybe they don’t care about a bequest at all.
The 60/40 Portfolio and Higher Bond Yields
Smith: Sure. I want to turn to the topic of 60/40 portfolios because in recent months with the volatility that we’ve seen, 60/40 has been under renewed scrutiny. But I think some people who read your report might be surprised to see that the benchmark, so to speak, is couched in a 30% equity exposure. Why is that? And what would you say to retirees who actually are hungrier for more risk than that?
Benz: Right. So, we do use this base case scenario where we’re assuming that someone wants kind of a steady paycheck equivalent through retirement. Because of that, the Monte Carlo simulations that we do for this analysis gravitate to where they can find safe sources of cash flow hiding in plain sight. And today in the fixed income markets, given that yields have come up very nicely over the past few years, retirees who want that stable source of cash flow can lock a lot of it down by gravitating to a portfolio that’s heavily fixed income oriented. But they’re short-shrifting the ability to grow that portfolio.
So, for people who do want more growth potential in their portfolios, they can pursue that. But I would say that they need to err on the side of balance: The 100% equity portfolios, the 90% equity portfolios, across all of the simulations, did not deliver the highest safe withdrawal rate. The reason is that they’re subject to what we call sequence of return risk, which is basically that you encounter a really bad market environment early in retirement. If you’re stuck with that all-equity portfolio in that environment, you don’t have any recourse, you don’t have any safe assets to draw upon.
The Risk of a Stock Market Downturn
Smith: Sure. So, let’s talk about that then because we’ve had quite a few moments in the last five years where there have been significant stock market declines or bear markets. I mean, 2022 is an example, but more recently we’ve seen significant volatility because of the Middle East. So, what’s your message for retirees that encounter that? And how does it hit their withdrawal rates?
Benz: Right. You have two levers in that situation if you encounter a bad market environment early on in your retirement. If it happens when you’re 85, it matters a lot less if you have a downdraft in that period. But if you are, say, just retired and you have bad market losses, your two recourse actions would be to take that withdrawal rate down if you possibly can. So, spend less in order to preserve more of the portfolio that’s in place for when the market eventually recovers. And then you would also give yourself a bulwark of assets that you could draw upon in lieu of having to spend from depreciated equity assets. So that’s where bonds come into play. That’s where cash comes into play for a year like 2022, when we saw both stocks and bonds decline. So, the balanced portfolio and being able to reduce your withdrawal rate, those are the two levers you have in that scenario.
Smith: Christine, thanks so much for your time.
Benz: Thank you so much, Ollie.
Smith: For more on retirement planning and retirement investing, check out any of our international editorial websites, where you can sign up for any of our editorial newsletters, be it daily or weekly. We are unfortunately just about out of time. My thanks to Christine. I’ve been Ollie Smith for Morningstar.
This video is based on The State of Retirement Income UK 2026 report by Christine Benz, Amy Arnott, and Tao Guo.
