What was once considered a longstanding “rule” in terms of saving adequately for retirement is now seen as outdated, according to a new report from Morningstar cited by CNBC.
“Simply, the rule says retirees can withdraw 4% of the total value of their investment portfolio in the first year of retirement,” the article from the outlet reads. The dollar amount increases with inflation (the cost of living) the following year, as it would the year after, and so on. However, market conditions – namely, lower projected returns for stocks and bonds – don’t seem to be working in retirees’ favor.”
The basis for the assertion comes from a report recently published by Morningstar, titled “The State of Retirement Income: Safe Withdrawal Rates .” instead of 4%, the rule should now be closer to 3.3% according to the published report.
“Though the reduction may sound small, it can have a big impact on retirees’ standard of living,” the article reads. “For example, using the 4% rule, an investor would be able to withdraw $40,000 from a $1 million portfolio in the first year of retirement. However, using the 3% rule, that first-year withdrawal falls to $33,000. The difference would be more pronounced later in retirement, when accounting for inflation.”
It would come out to $75,399 versus $62,205, respectively, in the 30th year, based on analysis from CNBC itself.
For the past several decades, retirees have enjoyed favorable conditions regarding market developments including low inflation, low bond yields and high returns on their investments. This is according to Christine Benz, director of personal finance and retirement planning at Morningstar and co-author of the cited report.
“The dynamic has perhaps lulled near-retirees into a false sense of security,” the article says based on input from Benz. “Bonds are ‘highly unlikely to enjoy strong gains over the next 30 years,’ and high stock prices are likely to fall as they revert to the average, according to the report. The analysis concedes that this result is likely though not inevitable.”
One potential risk that faces any portfolio in the early years of retirement is sequence of returns risk, a phrase that has become increasingly familiar for reverse mortgage professionals since product advocates say that a reverse mortgage can help retirees avoid such risk.
“Taking too large a withdrawal from one’s nest egg in the first year or years – especially from a portfolio that’s declining in value at the same time – can greatly increase the risk of running out of money later,” the article says. “That’s because there’s less runway for the portfolio to grow once the investments rebound.”
There are caveats to such an analysis, however, including assumptions based only on a person’s investments as opposed to other sources of income like Social Security or pension plans, if applicable.
Read the article at CNBC.