After a year of caution that first-year retirees should withdraw less than the standard 4% in 2022 to keep their retirement income plan on track, things may return closer to normal in 2023 according to the latest findings from Morningstar.
It was a challenging and painful year for retirement portfolios. Equities and bonds both sank, market volatility spiked for much of the year, and persistent, high inflation drove up the cost of living. The crunch on new retirees was especially strong as they were advised that retirement withdrawals should be limited to 3.3% for the first year. The authors of the report have since stated that they believe 3.3% might have been a high estimate for new retirees given the declines in bonds and stocks this year as well as high inflation.
The traditional 4% withdrawal rule has been long-established as a way to ensure that first-year retirees can maintain withdrawals from retirement portfolios at a steady pace over a 30-year time horizon while also rising over time to account for inflation. For 2023, Morningstar models calculated that a 3.8% withdrawal rate would be in line with maintaining the portfolio over the necessary time horizon.
“If you are thinking about retiring, you can use 3.8% as a test of the viability of the withdrawal you are considering,” Christine Benz, personal finance director at Morningstar and co-author of the research, told WSJ.
So, what changed? It turns out that when valuations are high, such as what has been the case leading up to this year, it’s one of the least ideal times to retire because of decreasing future investment returns. Now that those valuations have fallen, future returns are once again higher, allowing retirees to return to the more traditional withdrawal rate.
During periods of high inflation, withdrawals made according to the 4% rule jump because of adjustments to the high inflationary number. Coupled with the outsized effects that making withdrawals from a portfolio during a bear market can have by reducing holdings when a portfolio is already shrinking, it puts pressure on a portfolio to earn higher returns to compensate.
For first-time retirees or those early in retirement, it can be the set-up for significant challenges down the road and increases the risk of falling short of the retirement income time horizon.
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