Retiring Soon? How This New Withdrawal Rate Challenges the 4% Rule, Report Reveals

You’ve done the work of saving for retirement, but now that you’ve reached your golden years, do you have a plan for how you’ll spend down your nest egg?

For future retirees, Morningstar suggests withdrawing 3.9% of your portfolio the first year and then adjusting for inflation every year after that, according to a new report.

The researchers found that a starting withdrawal rate of 3.9% had a 90% probability of success over a 30-year retirement horizon, assuming a portfolio composed of 30% to 50% stocks, with the remainder in bonds and cash.

So what would this practically look like for a retiree?

If someone had about $1 million saved, they would withdraw $39,000 the first year. The next year, they would withdraw $39,959, assuming a 2.46% inflation rate.

The retiree would then continue to adjust their withdrawal amount each year based on the inflation rate. In nine out of 10 scenarios, they would end up with at least some money left over if their retirement lasted 30 years.

While this guideline can be helpful as a rule of thumb, it should be used as a starting point—factors like taxes and fees can further erode investment returns, the researchers point out.

For example, someone who has the bulk of their retirement savings housed in a Roth IRA and invested in low-cost index funds will part with less of their money when taking withdrawals compared to someone who’s tapping a traditional 401(k) that’s primarily invested in actively managed funds.

This is because withdrawals of investment earnings from Roth IRAs are tax-free. In contrast, you must pay ordinary income tax on both your investment earnings and any contributions you withdraw from a traditional 401(k).

Don’t Forget Social Security

You’ll want to consider your retirement strategy holistically, weighing the impact that Social Security will have on your retirement income, too.

Those who use the 3.9% withdrawal rule and delay collecting Social Security until age 70 will end up with the highest total lifetime spending amount, according to the Morningstar report.

Ideally, people would collect Social Security at age 70 and continue working until then, but if that’s not an option for you, the researchers have a few suggestions for building a financial ‘bridge’ between ages 67, the full retirement age for those born in 1960 or later, and 70:

• Create a three-year Treasury Inflation-Protected Securities (TIPS) ladder: With this strategy, you withdraw three years’ worth of annual spending from your nest egg. You then divvy that money among three separate TIPS, making sure that one bond matures each at ages 68, 69, and 70.
• Avoid the inflation-adjustment for three years, as necessary: Withdraw 3.9% of your portfolio plus the amount you project you would receive from Social Security annually. However, if your portfolio has a negative annual return for any year between the ages of 67 and 70, forgo the inflation adjustment the following year.
• Reduce your retirement spending temporarily: With this method, you’re limited to spending only a portion (80%) of your expected retirement spending until you reach 70, and you don’t take inflation-adjustments after down markets. First, calculate 3.9% of your portfolio plus the amount you project you’ll receive from Social Security annually. You’ll then multiply that amount by 0.8 to yield your annual spending under this method.