Retiring Soon? You Need to See This New Report That Questions the 4% Withdrawal Rule

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?

When you retire, you should withdraw 3.9% of your portfolio the first year and then adjust for inflation every year after that, according to a new Morningstar report.

The Morningstar 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.

You would then continue to adjust how much you withdraw each year based on the inflation rate. If you did this, you would have a 90% chance of ending up with at least some money left over if your retirement lasted 30 years.

And as the researchers point out, it’s worth remembering that taxes and fees can erode your investment returns.

For example, if you had the bulk of your retirement savings housed in a Roth IRA and invested in low-cost index funds, you would part with less of your money when you withdraw your funds than if you tapped 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, as long as you’ve had the account for five years. 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.

If you use the 3.9% withdrawal rule and delay collecting Social Security until you turn 70, you’ll end up with the highest lifetime spending amount possible, according to the Morningstar report.

Ideally, you 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’ll withdraw three years’ worth of annual spending from your nest egg. You’ll then divvy that money among three separate TIPS, making sure that one bond matures for each year when you’re 68, 69, and 70.

Avoid the inflation adjustment for three years, as necessary. If your portfolio has a negative annual return for any year when you’re 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 turn 70, and you don’t take inflation adjustments after down markets. To do this, first calculate 3.9% of your portfolio plus the amount you project you’ll receive from Social Security annually. Then multiply that amount by 0.8 to yield your annual spending.