There’s encouraging news for those about to retire: The 4% rule “may finally hold true” as a safe starting withdrawal rate, according to a new report.
That figure, which comes from a new Morningstar analysis, marks a return to the 4% rate, often referred to as “the 4% rule” — a popular guideline that suggests retirees can spend 4% of their nest eggs in the first year of retirement before adjusting for inflation each year after that.
Amid high inflation and worsening market conditions, Morningstar determined the highest starting safe withdrawal rate was 3.3% in 2021 and 3.8% in 2022.
Now, due to higher interest rates and bond yields, retirees can feel comfortable drawing down more in their first year than at any point since 2021, the Chicago-based investment research firm found. An improved inflation outlook has also helped, according to the report.
“The 4% rule may finally hold true as a safe starting withdrawal rate when considering a 30-year time horizon,” Amy Arnott, a portfolio strategist at Morningstar, said in a statement.
Morningstar ran 1,000 simulations of future market conditions to determine the initial withdrawal rate that would allow retirees to maintain a steady annual income. In 90% of those trials, pulling 4% in the first year and adjusting for inflation thereafter left money in the account after 30 years.
The latest findings will be good news for soon-to-be retirees who can feel more comfortable pulling out additional savings initially than just two years ago.
In 2021, an investor with a $1 million portfolio following the 3.3% recommendation would have pulled out $33,000. Under the 4% rule, that same person can now withdraw $40,000 in the first year and feel reasonably comfortable they won’t run out of money.
The 4% recommendation comes from a portfolio that holds between 20% and 40% in stocks and the remainder in bonds and cash. With a lower stock allocation, the starting safe withdrawal rate is slightly less, Morningstar noted.
There are other caveats to the popular rule, which is meant as a general guideline. For one, it only takes into account investment portfolios, not other forms of guaranteed income like Social Security or pensions. Additionally, measuring the impact of inflation can be difficult because retirees’ major expenses vary from person to person.
For that reason, the 4% recommendation is meant to be a simplified way to think about drawing down your nest egg while academics and financial analysts continue to debate the best approach.
“The right level of flexibility in a retiree’s spending system ultimately depends on several different factors, including whether the individual wants to prioritize steady income over time, maximizing withdrawal rates, having money left over for bequest purposes, and the extent to which fixed expenses are covered by nonportfolio income sources,” Morningstar wrote in its report.
