What 4% Rule? Morningstar Has a New Number

“If a retiree is willing to adjust their spending in line with portfolio performance, that allows for higher starting withdrawals and generally higher lifetime withdrawals,” Benz observes.

Ways to introduce such flexibility include forgoing inflation adjustments after the portfolio lost value in the preceding year to more complex systems such as the “guardrails” approach originally developed by financial planner Jonathan Guyton and computer scientist William Klinger.

“All of these systems allowed for higher starting safe withdrawal rates than the fixed real spending rate we used as our base case,” Benz observes.

The Nuts and Bolts of Alternative Methods

Among the alternative spending strategies considered in the report is forgoing inflation adjustments following annual portfolio loss.

The method begins with the base case of fixed real withdrawals throughout a 30-year time horizon. However, to preserve assets after down markets, the retiree skips the inflation adjustment for the year following a year in which the portfolio has declined in value.

This might seem like a modest step, according to the researchers, but the small cuts in real spending are cumulative. Their effects “ripple into the future,” permanently reducing the retiree’s spending pattern. As a result, the initial spending rate can range toward 4% or even 5%, depending on other assumptions.

Another method relies on required minimum distributions to set the withdrawal rate. In its simplest form, the report states, the RMD method is “portfolio value divided by life expectancy.” For life expectancy, the report used the IRS’ Single Life Expectancy Table and assumed a 30-year retirement time horizon, from ages 67 to 97.

This method is designed to ensure that a retiree will never deplete the portfolio — because the withdrawal amount is always a percentage of the remaining balance. The main downside, while changes in life expectancy are gradual, is that the remaining portfolio value can change significantly from year to year, adding volatility to cash flows.

The guardrails approach, meanwhile, attempts to deliver “sufficient but not overly high” raises in upward-trending markets while adjusting downward after market losses.

For example, when the portfolio performs well and the new withdrawal percentage (adjusted for inflation) falls below 20% of its initial level, the withdrawal increases by the inflation adjustment plus another 10%. The guardrails must apply during down markets, too. In this scenario, the retiree cuts spending by 10% if the new withdrawal rate (adjusted for inflation) is 20% above its initial level.

While this approach allows the initial starting withdrawal rate to climb, it requires diligence and discipline to be successful.

Credit: Adobe Stock