Should Retirees Adopt a Flexible Withdrawal Strategy?
Retirees should consider being flexible with their spending plan.
Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar.com. Amid stock market volatility and exceptionally low yields, some retirees maybe wondering if they should be reconsidering their withdrawal rates. Here with me today to discuss the topic is Christine Benz. Christine is Morningstar's director of personal finance. Christine, thanks for joining me today.
Christine Benz: Susan, it's great to be here.
Dziubinski: Let's step back and start talking a bit more broadly about what are some of the challenges or limitations of a fixed withdrawal rate strategy in retirement?
Benz: Right. Before we get into that, let's just do a little stage-setting about what we're talking about when we talk about a "fixed withdrawal rate strategy." That's basically the 4% type guideline that Bill Bengen developed. And the idea is that you take out 4%--or 3% or whatever that initial percentage is--of your balance at the beginning of retirement and then you just inflation-adjust that dollar amount as the years go by. That's attractive in that it will ensure that you have a somewhat stable standard of living in retirement. You wouldn't really get buffeted around a lot. On the downside, we've subsequently had a lot more research about withdrawal rates, and a lot of it points to the virtue of being somewhat flexible about withdrawals to the extent that you specifically can take less in down markets. That can be really impactful in terms of helping ensure that your portfolio lasts over what is increasingly a long time horizon for a lot of retirees, maybe 25 or 30 years or even longer.
Dziubinski: And doesn't the data also show that spending in retirement isn't necessarily flat? It changes over time.
Benz: It does. And that's a really good point, Susan. Our colleague David Blanchett has done some terrific research where he's actually looked at the trajectory of retiree spending. He calls it the "retirement spending smile." But the basic conclusion is that people tend to spend a lot early on in retirement. There's some pent-up demand to travel and take advantage of newfound leisure time. Then there's spending trails off in the middle years of retirement. And this is on average, certainly there are many retirees who do things differently, but the spending might tend to trail off in the mid-70s period. Health is still good, but maybe retirees just aren't doing as much travel and maybe not doing as much eating out and so forth. And then his research shows that spending tends to increase later in life, so the real-world pushback on a fixed withdrawal rate system is that when you look at the data retirees just don't spend that way.
Dziubinski: Given what's going on in the market and spending trends that we've seen, where should a retiree start if they want to start considering adopting a more flexible approach to their withdrawals?
Benz: There are a few different ways to look at it. You could use a very simple fixed rate withdrawal where you're just taking, say, 3% or 4% of your portfolio year in and year out. That might be the starting point for thinking about this. The downside with being really dogmatic and taking just a single fixed percentage year in and year out is that you get buffeted around by whatever your portfolio's value is. Let's assume that someone is using a 4% fixed percentage withdrawal from their portfolio and their portfolio is $1 million today, well, that's $40,000 in their first year. But if in next year their portfolio drops by 20% to $800,000, that's just a $32,000 withdrawal. That's a big change in standard of living. I think most retirement research, most planners that I speak with would suggest that doing a fixed percentage probably isn't going to work for many retirees. It just results in too many fluctuations in standard of living.
Dziubinski: Now, one somewhat simple way to tackle that, and you've talked about this before, is to adapt some flexibility when it comes to withdrawal by looking at what's going on in the market and specifically with what's going on in inflation. How would someone go about doing that?
Benz: This is some interesting research that T. Rowe Price advanced in the wake of the last financial crisis, where they were investigating sustainable withdrawal rates. And they came away with this idea of, if a retiree is using a fixed rate withdrawal system--like we talked about initially with the 4% initially but that dollar amount getting inflation-adjusted--if in those down years the retiree were willing to forgo that inflation adjustment, T. Rowe Price found that that really helped improve the portfolio's sustainability quite a bit. Retirement researchers have looked at that idea. I think it's a good starting point for retirees who might be inclined to use some sort of a flexible system. And the other good thing is that we know that oftentimes inflation is low in periods when the market is down, so that's another potential advantage in favor of this strategy.
Dziubinski: Another strategy that would add some flexibility involves required minimum distributions. Can you talk to that a little bit?
Benz: This is something that our colleague David Blanchett again has looked at. And the basic idea is the required minimum distribution system is attractive because it incorporates two key things. It takes into account your age, so all else being equal you're able to take more from your portfolio as you age, as your life expectancy declines, but it also takes into account your portfolio value. In that respect, it's really quite flexible and quite attractive because it incorporates those two key data points. David has said that he thinks that it's a really simple way for retirees to incorporate some of the flexibility that we've talked about being so beneficial.
Dziubinski: And finally, there are some strategies out there that attempt to blend this flexible approach with maintaining a somewhat stable standard of living. Can you tell us a little bit about those?
Benz: This is some research that was initially advanced by financial planner Jonathan Guyton, who we recently interviewed for our podcast, as well as William Klinger, who's a computer scientist. And basically the idea was they wanted to marry together a flexible withdrawal rate system, a fixed percentage withdrawal, but put some boundaries around it to ensure that a retiree wasn't disproportionately buffeted around by whatever his or her portfolio value was.
It gets a little bit complicated in terms of these specific guardrail strategies. For people who are interested, they can read the research paper. Vanguard also came up with some interesting research that attempted to walk investment advisors as well as investors through the logistics of incorporating such a flexible system. But I think that this in a lot of ways does bring together the best of both worlds. You are tethering your withdrawals to what's going on with your portfolio's value, but you're also ensuring that you're not having to spend way less than you would hope to simply because your portfolio is down a bit.
Dziubinski: Christine, thank you so much today for your time for helping us peel back the onion on how we might think a little bit more flexibly about our withdrawal strategies.
Benz: Thank you so much, Susan.
Dziubinski: I'm Susan Dziubinski with Morningstar. Thank you for tuning in.