During the previous two editions of The State of Retirement Income, researchers at Morningstar recommended that the so-called 4% safe withdrawal rate for retirees should be lowered given current market conditions, but that has now changed.
Owing largely to higher fixed-income yields and a lower long-term inflation estimate, Morningstar’s modeling found that a starting withdrawal rate of 4% is safe for a balanced investment portfolio—the highest level in three years. This assumes a 90% probability of having funds remaining at the end of an assumed 30-year retirement period.
In contrast, Morningstar had previously suggested that the highest starting safe withdrawal rate for a 30-year horizon with a 90% probability of success was 3.3% in 2021 and 3.8% in 2022. 
According to the research, the highest starting safe withdrawal percentage comes from portfolios that hold between 20% and 40% in equities and the remainder in bonds and cash. Portfolios with different equity allocations than 20% to 40% have slightly lower starting safe withdrawal rates, write report coauthors Amy Arnott, Christine Benz and John Rekenthaler.
The reason for the higher rate? As yields on bonds and cash have increased, the forward-looking prospects for portfolio returns—and the amounts that new retirees can safely withdraw from those portfolios over a 30-year horizon—have continued to edge up since the Morningstar researchers covered the topic last year. The study also notes that a more moderate inflation outlook has helped, with a 2.42% long-term inflation forecast this year, versus 2.84% in 2022.
Portfolio Impacts
Meanwhile, investors might expect that safe withdrawal rates would increase with higher equity weightings, but that’s not necessarily the case, the study further observes. Arnott explains that their return assumptions still project that stocks will deliver better long-term returns than bonds and cash. Consequently, equity-heavy portfolios typically ended up with more money left at the end of the 30-year period, but stocks also court significantly higher levels of volatility, which makes the outcomes for all the withdrawal rates tested inherently less certain, the Morningstar researchers emphasize.
The trio goes on to note that the modest equity weightings of between 20% and 40% underscore the point that the model’s “base case” is conservatively generated. For one thing, they explain, its equity-return assumptions, especially for U.S. growth stocks, are below their historical averages (reflecting the fact that valuations are high by historical standards). For another, it targets a success rate of 90%, such that the steeper the success rate, the more that the recommendation will favor the less-volatile assets of bonds and cash.
Spending and Withdrawal Strategies
The study also includes detailed findings on the impact of more flexible spending and withdrawal strategies—an approach that involves changing withdrawal amounts from year to year, such as taking lower withdrawals in weak market environments and higher withdrawals in strong ones.
More specifically, the study tested four of the most widely used flexible strategies, benchmarking them against a system of fixed real withdrawals. The four methods include: (1) forgoing inflation adjustments following annual portfolio loss; (2) required minimum distributions; (3) guardrails; and (4) spending declines in line with historical data (new for 2023).
Overall, the study found that the guardrails system—flexible withdrawals with parameters, or guardrails, that prevent withdrawals from being either too high or too low—does the best job of enlarging payouts in a safe and livable way.
“For those seeking a simpler approach that provides more predictable withdrawal amounts, a fixed real withdrawal system that forgoes inflation adjustments after a losing year moderately increases lifetime withdrawals, without greatly increasing cash flow volatility,” the trio write. They add that this method is also straightforward to implement. Alternatively, retirees who believe that their spending needs will not keep up with inflation over their drawdown period might consider the simple system of making slight reductions to their annual spending over time.
“Retirees who are willing to employ more-flexible strategies or make other modifications to a basic approach of using 4% as a starting point for withdrawals and then adjusting that dollar amount each year for inflation can enjoy even higher starting withdrawals, assuming they’re willing to accept other trade-offs, such as fluctuating year-to-year real cash flows and the possibility of fewer leftover assets at the end of a 30-year period,” writes Arnott.
For retirees who require a fixed real withdrawal amount from year to year, they will need to keep their starting withdrawals at 4% or lower if they want to lock in a 90% probability of success over a 30-year time horizon. “Given that many portfolios may still be recovering from 2022’s bear market, that recommendation may be unwelcome,” the trio observe.
Another approach for achieving a higher withdrawal rate than the base case of 4% is to “build a ladder” of Treasury Inflation-Protected Securities (TIPS). At the time of the study’s publication, doing so provided a 4.6% withdrawal rate, with a 100% probability of success; using that strategy, however, also liquidates the portfolio by year 30 under all conditions, the researchers emphasize.
Still, while market conditions have improved, balanced portfolios have yet to win back all their 2022 losses as of Oct. 31, 2023. Making matters worse, the trio notes, is that higher inflation has forced many retirees to take bigger withdrawals as their portfolio values have shrunk.
Of course, the right level of flexibility in a retiree’s spending system will depend on an individual's situation, including the extent to which fixed expenses are covered by nonportfolio income sources.
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