John Rekenthaler and Amy Arnott: What’s a Safe Retirement Spending Rate Today?

Episode Summary

Executive Summary: Morningstar researchers Amy Arnott and John Reckenthaler discuss their 2023 paper 'The State of Retirement Income,' which updates the safe withdrawal rate research. The baseline starting safe withdrawal rate for new retirees has risen to 4.0%, up from 3.8% in 2022 and 3.3% in 2021, primarily due to higher bond yields following market declines. They explore various flexible spending strategies, the role of TIPS ladders for guaranteed income, and the impact of recent inflation on retirement planning. The conversation emphasizes that the 4% figure is a starting point for discussion, not a universal recommendation, and highlights the trade-offs between different withdrawal approaches.

Main Topics: Safe Withdrawal Rate Update and Methodology (Priority: 5/5): Overview of the 2023 research showing a baseline 4.0% safe withdrawal rate for a 30-year retirement with a 90% success rate, using forward-looking capital market assumptions rather than historical data. Asset Allocation and Withdrawal Rates (Priority: 4/5): Discussion of how different stock-bond allocations affect withdrawal rates, with the optimal range being 20-40% equities for the baseline case, though 60-70% equity portfolios yield similar results. Dynamic Spending Strategies (Priority: 4/5): Four flexible withdrawal methods tested: skipping inflation adjustments after portfolio losses, RMD-based withdrawals, guardrails method by Guyton and Klinger, and spending patterns based on actual retiree data showing declining spending with age. TIPS Ladders as Guaranteed Income (Priority: 4/5): Analysis of Treasury Inflation-Protected Securities ladders offering a guaranteed 4.6% withdrawal rate, compared with the risk-based portfolio approach. Highlights trade-offs between security and flexibility. Inflation Impact on Retirees (Priority: 3/5): Examination of how cumulative 18% inflation since 2020 has increased the portfolio needed to support a given lifestyle, with particular danger for those experiencing inflation early in retirement. Sequence of Returns Risk (Priority: 3/5): Analysis of how poor market conditions early in retirement, like the 2022 decline, significantly increase the probability of portfolio failure, emphasizing the need for conservative adjustments.

Key Arguments: Forward-looking forecasts produce lower safe withdrawal rates than historical averages due to elevated asset prices, but 2023's rate returns to the classic 4% due to higher bond yields. While the optimal baseline portfolio is 20-40% equities for maximum safe withdrawal rate, 60-70% equity portfolios achieve nearly identical rates with higher ending balances. Dynamic spending strategies can significantly increase starting withdrawal rates but introduce year-to-year cash flow volatility that retirees must accept. TIPS ladders currently offer an attractive guaranteed 4.6% withdrawal rate but come with trade-offs: zero ending balance at year 30, loss of flexibility, and lock-in of that specific strategy. The guardrails method provides the highest starting safe withdrawal rate among flexible strategies while maintaining reasonable ending portfolio values. Recent inflation has been particularly damaging for new retirees because it raises baseline spending for the entire retirement period, while poor 2022 returns compound the problem. A blended approach combining guaranteed income for essential expenses with a growth-oriented portfolio for discretionary spending offers a practical compromise between security and flexibility.

Data Points: Baseline safe withdrawal rate: 4.0% - For a 30-year retirement with 90% success rate, up from 3.8% in 2022 and 3.3% in 2021 TIPS ladder withdrawal rate: 4.6% - Guaranteed inflation-adjusted withdrawal rate with no ending balance after 30 years Success rate trade-offs: 2.4% to 5.3% - 100% success rate yields 2.4% withdrawal; 50% success rate (median) yields 5.3% Cumulative inflation impact: 18% - Price increase from end of 2020 to 2023, requiring $1.2 million portfolio for lifestyle that cost $1 million previously Historical average withdrawal rate (40% equity): 4.5% - Based on 96 years of market history, compared to forward-looking forecast of 4.0% Historical average withdrawal rate (100% equity): 4.8% - Highest historical average but with extreme variability, ranging from 2% to 7% in different 30-year periods Retiree spending decline: 19% - Average decline in inflation-adjusted household spending from age 65 to 75, continuing through later decades

Pivotal Quotes: "These numbers of 3.3% rising to 3.8% to 4.0%, they're not conclusions. We're not saying we did all this work and we've got a 30-page paper, but you can boil down the answer to 4.0%." — John Reckenthaler: Emphasizing that the safe withdrawal rate should be a starting point for discussion, not a definitive answer for all retirees "The guardrails method... has the highest starting safe withdrawal rate of any of these methods, but also leaving a decent median value at the end of the 30-year period." — Amy Arnott: Identifying the guardrails method as a preferred dynamic spending strategy that balances higher initial withdrawals with meaningful remaining portfolio value "A tips ladder portfolio is self-liquidating, it goes to zero. At year 30, there's no more money left in it. And if you live to year 31, there's nothing left in your portfolio." — John Reckenthaler: Highlighting the critical trade-off of guaranteed TIPS income: the portfolio is fully consumed by the end of the planned retirement period

Implications: Retirees should view the 4% figure as a baseline, not a target. Combining guaranteed income (TIPS, Social Security) for essential expenses with flexible withdrawal strategies for discretionary spending offers the best balance. Recent high inflation and market volatility underscore the importance of conservative planning, especially early in retirement. Dynamic strategies can increase spending but require tolerance for cash flow variability.