Here’s What Your Retirement Spending Rate Should Be in 2026

Key Concepts

• Safe Starting Withdrawal Rate: The percentage of a retirement portfolio that a retiree can withdraw annually with a high probability of not running out of money over a specified time horizon.
• Probability of Success: The likelihood that a retirement plan will last for the intended duration.
• Time Horizon: The expected length of retirement, typically 30 years.
• Inflation Adjustment: Increasing withdrawal amounts annually to keep pace with inflation.
• Fixed Real Withdrawal Percentage Method: A strategy where withdrawal amounts are increased by a fixed percentage each year to account for inflation, regardless of market performance.
• Flexible Withdrawal Strategies: Retirement income strategies that allow for adjustments in withdrawal amounts based on portfolio performance and other factors.
• Monte Carlo Simulations: A statistical method used to model the probability of different outcomes in a process that cannot be easily predicted due to the intervention of random variables.
• Asset Allocation: The distribution of investment assets among different asset categories, such as stocks and bonds.
• Non-Portfolio Income Sources: Income streams outside of a retirement portfolio, such as Social Security and pensions.
• Annuities: Financial products that provide a stream of income, typically for life, in exchange for a lump-sum payment or a series of payments.
• Guardrails Strategy: A dynamic withdrawal strategy that sets upper and lower limits (guardrails) for withdrawals, adjusting them based on portfolio performance.
• Bequest: An inheritance left to someone in a will.

Morningstar's State of Retirement Income Research: Safe Withdrawal Rates and Strategies

This summary details the findings of Morningstar's "State of Retirement Income" research, focusing on safe starting withdrawal rates for new retirees in 2026 and exploring various strategies to enhance retirement spending. The research was presented by Christine Benz, Director of Personal Finance and Retirement Planning at Morningstar.

1. Safe Starting Withdrawal Rate for 2026

• Definition: The research aims to identify the highest safe starting withdrawal rate for individuals embarking on retirement, assuming a 90% probability of success over a 30-year time horizon. This means a retiree retiring at 65 is expected to live until 95.
• 2026 Rate: For 2026, the calculated safe starting withdrawal rate is 3.9%.
• Methodology: This rate is derived from Morningstar's team's forward-looking outlook for asset class returns and inflation.
• Comparison to Previous Year: The 3.9% rate is comparable to the previous year's 3.7%, with a slight methodological adjustment in calculating forward-looking asset class return forecasts contributing to the similarity.
• Base Case Example: For a $1 million portfolio, a 3.9% starting withdrawal equates to $39,000 annually, which is then inflation-adjusted thereafter, aiming for a steady paycheck equivalent.

2. Misconceptions About Safe Withdrawal Rates

Christine Benz highlighted two significant misconceptions regarding the research:

• For Current Retirees: The research is primarily a guide for new retirees, taking into account current market conditions. It is not a year-by-year directive for those already in retirement, who are on their own established trajectories.
• Headline Number vs. Potential: Many individuals fixate on the headline withdrawal rate and may leave money on the table by not exploring alternative methods that can significantly lift their starting safe withdrawal percentage and lifetime withdrawals. The research paper dedicates substantial effort to helping individuals achieve higher withdrawal amounts.

3. Utilizing the Research: A Temperature Check and Trade-off Exploration

The research offers value to retirees in several ways:

• Temperature Check: It serves as a gauge of current market conditions. For instance, the 2021 research indicated a low 3.3% rate due to high equity valuations, low bond yields, and high inflation. This served as a cautionary signal for new retirees, emphasizing the risk of overspending in such an environment. Currently, market conditions are described as neither exceptionally great nor terrible, with improved bond yields.
• Exploring Trade-offs: Investors and advisors can use the research to understand the trade-offs associated with different strategies.
  • Flexible Strategies: Those willing to adopt more flexible withdrawal strategies can potentially extract more from their portfolios over their lifetimes, improving their quality of life.
  • Fixed Real Withdrawals: Individuals prioritizing predictability in cash flows and aiming for significant remaining balances at the end of their lives may find the fixed real withdrawal strategy more appropriate.

4. Flexible Withdrawal Strategies to Boost Spending

The research delves into dynamic strategies that can increase starting safe withdrawal percentages:

• Core Principle: Willingness to vary withdrawals based on portfolio performance leads to more efficient strategies.
• Downside: This flexibility comes with volatility in cash flows, meaning retirees may need to accept lower withdrawals in lean years and can take more in good years.
• Lifetime Consumption: Most flexible strategies encourage consuming more of the portfolio during one's lifetime, resulting in fewer leftovers.
• Potential Increase: More aggressive flexible strategies, which involve more significant adjustments, can lift starting safe withdrawal percentages as high as 6%. These are particularly beneficial for individuals with tight financial plans, but they must understand the associated trade-offs.
• Guardrails Strategy: Developed by Jonathan Gaitton and William Clinger, this strategy involves setting upper and lower limits for withdrawals. It tends to favor higher equity allocations to enable larger paydays and increased lifetime spending.

5. Suitability of Withdrawal Strategies

• Flexible Strategies: Best suited for retirees who aim to maximize their spending and are comfortable with income volatility.
• Rigid Strategies: More appropriate for individuals seeking high predictability in cash flows and for whom a bequest is a significant priority. These strategies generally involve less year-to-year variation in income.

6. Asset Allocation and Withdrawal Rates

• Historical Trend: Historically, stock-heavy portfolios have supported higher withdrawal rates.
• Current Base Case: For the base case (fixed real withdrawal system with a 90% success probability), Morningstar's Monte Carlo simulations gravitate towards conservatively positioned portfolios. This is due to the current attractiveness of fixed income yields, which provide predictability. The base case typically involves a light equity allocation (30-50%) with the remainder in fixed income.
• Flexible Strategies: Some dynamic strategies, like the guardrails strategy, favor higher equity allocations to facilitate increased spending.

7. Non-Portfolio Income Sources: Annuities and Social Security

The research also examines the interplay of portfolio withdrawals with non-portfolio income:

• Holistic Approach: It's crucial to consider retirement income holistically, not just portfolio withdrawals.
• Impact of Non-Portfolio Income: Enlarging non-portfolio income sources, such as delaying Social Security or purchasing an annuity, simplifies portfolio withdrawal management and increases comfort with portfolio variations.
• Social Security:
  • Delaying Strategy: Delaying Social Security is a beneficial strategy for many.
  • Bridging the Gap: A key consideration is how to fund income needs during the period between stopping work and starting Social Security. This can place a higher demand on the portfolio, especially if market downturns occur during these early years. Ideally, other income sources or a job would bridge this gap.
  • Annuity Comparison: Social Security is considered the "best annuity money can't buy" due to its lifelong income stream and cost-of-living adjustment (COLA) tied to CPI.
• Annuities:
  • Augmenting Social Security: Annuities can effectively supplement Social Security benefits.
  • Meeting Fixed Expenses: A modest purchase of a fixed, basic annuity can help meet essential living expenses, allowing for more flexible withdrawal systems with the portfolio.

8. Actual Retirement Spending Patterns

• Spending Tendency: Research from the Employee Benefits Research Institute (EBRI) indicates that retiree spending tends to not keep up with inflation as retirement progresses. People often spend less than the inflation rate, particularly as they move into their 70s and 80s.
• Implications for Planning:
  • Increased Early Spending: Factoring in this spending pattern allows retirees to spend more in their earlier years, provided they are comfortable with lower spending later in retirement.
  • Permission to Spend: This insight gives retirees "permission to live it up a little more" in their early retirement years when health is good and there's a desire for activities, with the understanding that spending may decrease later.

9. Scenarios That Can Derail Retirement Plans

• Early Market Downturns:
  • Impact: A significant market downturn early in retirement is a primary cause of plan failures.
  • Mitigation: The best practice is to reign in spending in the early years of retirement if a market shock occurs, rather than maintaining the same spending level regardless of portfolio performance.
• Early Retirement:
  • Longer Time Horizon: Retiring earlier (e.g., at 60 with a 35-year horizon) necessitates a lower starting withdrawal rate (around 3.3-3.4% in the base case).
  • Additional Costs: Early retirees often face higher expenses, such as self-funded healthcare.
  • Portfolio Dependence: If Social Security is delayed, there's increased reliance on the portfolio for income.
  • Conclusion: Early retirement is not a "free lunch" and requires more conservative spending and careful integration with Social Security and healthcare plans.

10. Final Takeaway

Christine Benz's concluding advice is: "Don't take that 3.9% and run with it. You probably can and should enlarge your spending if you are willing to be flexible." She urges retirees to closely examine their budgets, identify areas for potential spending reductions if needed, and then give themselves permission to spend more in favorable market and portfolio years.

This summary has been created in English, as per the provided transcript.