Motley Fool Money - Is the Retirement Safe Withdrawal Rate Below 4% or Almost 6%?

Starting point is 00:00:00 Is the retirement safe withdrawal rate below 4% and how not to overpay Uncle Sam? That and more on this Saturday personal finance edition of Motleyful Money. I'm Robert Brokamp, and this week I speak with Morning Stars Christine Benz, who, along with her colleagues, Amy Arnott, Jason Kephart, and Tao Guo, recently published an extensive report on the state of retirement income. But first, let's talk about a few highlights from last week's financial headlines. You know, here in the U.S., income taxes are a pay-as-you-go system. The certain amount must be withheld or paid throughout the year, otherwise you may owe penalties and interest.

Starting point is 00:00:41 To build it a buffer, most Americans have too much withheld. About two-thirds of tax filers get a refund with the average amount exceeding $3,000. And that figure will likely be even higher this year due to the passage of the one big beautiful bill last July, which will reduce the average households tax bill by $3,700, according to the tax foundation. Plus, according to our recent CNBC article, the amount it takes to move into a higher tax bracket for 2026 will be increasing 2.3% to 4%, depending on the bracket, so more of your income will be taxed at lower rates this year. Now, it makes some sense to play it safe with having more withheld from your paycheck, and I understand there's no feeling like completing your tax return and seeing that Uncle Sam owes

Starting point is 00:01:22 you money. But you missed out on the returns that overpayment could have earned if it was in your account and not the governments. So now is the time to reevaluate and perhaps change the amount you have withheld from your paycheck if you're working, or from your Social Security, pensions, and or retirement account distributions if you're retired. The IRS does offer a tax withholding estimator, but it's down for maintenance until January 17th. You can find other calculators online from payroll and tax prep software providers, and states also offer tools to calculate your state tax withholdings. In the end, your goal is to pay enough taxes to avoid penalties, but not much more. And if you determine that reducing your withholdings is

Starting point is 00:02:01 appropriate for you in 2026, make sure you then increase the amounts you contribute to retirement, college, brokerage, or high-yield savings accounts so that you're immediately putting those tax savings to work. For our next item, we turn to a Washington Post article by Michael Corrin with the headline, Why Smaller Houses Can Lead to Happier Lives. Corrin cites research, which shows that after an initial burst of satisfaction with new larger homes, people's life satisfaction typically returns to a baseline or even declines. The problem isn't that big houses make us unhappy, it's what we sacrifice to obtain them, including longer commutes, larger mortgages, and less time for socializing. Many people end up being house rich but relationship poor,

Starting point is 00:02:41 with expensive features like home theaters and formal dining rooms becoming unused dead zones. Studies consistently show that happiness peaks in households of four to six people, regardless of home size, and that neighborhood factors matter far more than square footage. Research from Vancouver found no significant well-being difference between people in various types of houses, you know, from single detached homes to townhouses or apartments, with residents prioritizing affordability, proximity of loved ones, and other factors like that. Europeans report higher well-being than Americans, despite smaller homes, because their walkable neighborhoods and public spaces reduce the pressure on the home as the primary living space.

Starting point is 00:03:16 The article suggests we should ask not how big a house can I afford, but rather what kind of home will sustain the kind of life I want. And now the number of the week, which is 5%. That's how much Japan makes up of the global stock market down from more than 40% in the late 1980s, according to the most recent edition of J.P. Morgan's Guide to the Markets. Meanwhile, the U.S. share has grown from 30% to 64%, which is near the peak reached in the 1960s, when U.S. stocks made up more than 70% of the planet's stock market. But last year, international stocks made up some lost ground. Japanese stocks returned 26% and non-U.S. stocks as a group returned 32%

Starting point is 00:03:56 and 2025. It was their best year since 2009, and the amount that international stocks outperformed the SEP 500 was the biggest margin since 1993. Up next, why a safe withdrawal rate in retirement might be less than 4% or almost 6% when Mali Full Money continues. The old adage goes, it isn't what you say, it's how you say it, because to truly make an impact, you need to set an example and take the lead. You have to adapt to whatever comes your way. When you're that driven, you drive an equally determined vehicle, the Range Rover Sport. The Range Rover Sport blends power, poise, and performance. Its design is distinctly British and free from unnecessary details,

Starting point is 00:04:37 allowing its raw agility to shine through. It combines a dynamic sporting personality with elegance to deliver a truly instinctive drive. Inside, you'll find true modern luxury with the latest innovations in comfort. Use the cabin air purification system alongside active noise cancellation for all new levels of quality and quiet. Whether you prefer a choice of powerful engines or the plug-in hybrid with an estimated range of 53 miles, there's an option for you. With seven terrain modes to choose from, terrain response to fine-tuned your vehicle for the roads ahead. The Range Rover event is on now. Explore enhance offers atrangerover.com.

Starting point is 00:05:13 The number one financial goal for most Americans is retirement. And once they retire, the primary goal becomes not running out of money. Here to discuss how much a retiree can safely spend is Christine Benz, the director of personal finance at Morningstar, and the co-author of a new report on retirement income. Christine, welcome back to Motley Full Money. Robert, it's so great to see you. Thank you for having me on. Essentially, this report has become an annual tradition

Starting point is 00:05:36 that began in 2021 with you and your colleagues at Morningstar. So let's start with you giving us the headline takeaway from the most recent edition and how much a new retiree could safely withdraw. Right. So we use what we call kind of a base case that we latch on to when we do this research. So we're assuming that someone wants kind of

Starting point is 00:05:56 paycheck equivalent in retirement. And the idea is to see if someone is starting out with a portfolio how much they could initially withdraw from that portfolio and then just inflation adjust that dollar amount thereafter. So we've been doing this research, as you said, Robert, since 2021. And in 2025, when we did the research, we're using our team's forward-looking estimates for stock and bond returns and inflation. And we came up with a three-point, 9% starting safe withdrawal rate for new retirees. So if someone has a million dollar portfolio, the sobering news from Matt is that they would want to take 39,000 initially

Starting point is 00:06:39 if they were using this very conservative spending strategy where they're just giving themselves a little nudge up or a little inflation raise for each year that passes. One of the pioneers of this type of research is William Bangan, who is considered the father of the so-called 4% rule. He came out with a new book last year and concluded that 4.7% is actually a good starting point with a well-diversified portfolio. One key difference between his research and what you all are doing at Morningstar is that he looks at historical market returns, whereas your research is based on projected returns. So does this indicate that Morning Star expects below average returns over the next 30 or so years? It does. Not necessarily over the next 30 years, but certainly over the next decade, given,

Starting point is 00:07:24 the strong run-up that we've had in U.S. equities, especially, our return assumptions are reduced over that whole 30-year time horizon because we think that the next 10 years probably won't be that great, largely because of high valuations. I would also point out that the overvaluation that we see isn't equally spread across the style box, that it's mainly in that large-cap growth component of the style box. But nonetheless, we think that the next 10 years, investors should be prepared for potentially some rough sled inequities. The 30-year period should be more or less normal in the assumptions that we use. Related to that, the research on safe withdrawal rates looks at how much someone can safely spend, but also what asset allocation supports that highest

Starting point is 00:08:13 withdrawal rate. So what does this year's report say about how much a retiree should have in the stock market? Well, it's interesting because it's quite low. I think the highest starting withdrawal rate that 3.9 percent corresponds with like a 20 to 50 percent equity allocation. Most of us, getting close to retirement or in retirement, probably have higher equity weightings. But the reason that our simulations home in on such a light equity waiting is because of this very conservative spending system that we employ as our base case. So the simulations are basically saying, okay, if what you want is kind of a paycheck equivalent over this 30-year period, you don't intend to waiver in terms of how much you'll take out, well, guess what? We can line that up today

Starting point is 00:09:04 in fixed income, or we can get most of that in fixed income because yields are a little better today. And of course, yields have come down a little bit over the past year. But nonetheless, they're higher than they were a decade ago. And so that's what our simulations arrive at is that fairly light equity weighting because fixed income returns and the stability of those returns are pretty attractive given today's yields. Your report also addressed a few of the key risks that people worry about in retirement, things like the impact of marketer spending shocks, series of bad returns, long-term care expenses. Is there an overall takeaway from your analyses of these risks? Yeah, I think the sequence of return risk is one that's top of mind for me

Starting point is 00:09:48 when I think about people just embarking on retirement. And the key point there is that it's helpful to have a couple of things in your toolkit to help address the risk of bad market returns showing up early in your retirement. So one is being able to rein in your spending if you possibly can. So if we have really calamitous market losses, your portfolio loses a lot of value. If you can spend less during those periods, that's certainly a best practice for retirement spending. And the other point I would make is build yourself a runway of safer assets that you could spend through if you needed to, so you wouldn't have to touch your depreciated equity assets. So those two strategies in combination should hold people in pretty good stead. if a bad sequence of return shows up within the next couple of years early in their retirement,

Starting point is 00:10:43 if people don't have safe assets to withdraw from, and if they don't rein in their spending, then that means that sequence risk really imperils their portfolio's ability to last over that whole 30-year time horizon. You mentioned early in retirement, and to dig a bit into how you did your analysis, you used Monte Carlo simulation to calculate a withdrawal rate that was successful 90% of the time. You also took a look at the 10% that failed. And what you found is that they tended to have bad returns or high inflation in that first five, maybe 10 years of retirement, which is consistent with William Beggen's research, which found that what happens in those first several years will have a disproportionate impact on how long your money will last.

Starting point is 00:11:27 Exactly. And so for people who are well into their retirement, for folks who are listening who have been retired for 20 years and maybe they're in their 80s at this point, Well, the good news is from a sequence of return risk standpoint, you've made it, that you've made it through the danger zone, that people who need to be really careful are the newly retired. And I think the high equity valuations they have today point to that as a real risk. What we've been discussing so far is the classic way to think about safe withdrawal rates, which you call the base case scenario. And that's taking out 3.9% in the first year and then adjusting that dollar amount for inflation for each subsequent year. But your report also looked at several dynamic withdrawal strategies, which generally speaking allow for a higher initial withdrawal rate, and maybe even more down the line if your portfolio

Starting point is 00:12:17 grows enough, but with the trade-off that you have to cut back whenever the portfolio loses value. Your report dug into the details of several of these methodologies and then get pretty complicated. But can you talk a bit about a couple that you think that demonstrate the pros and cons? Definitely. And one thing I would say, Robert, is when I think about this research, and the press it has garnered. I'm always sad when people home in on that 3.9% withdrawal rate.

Starting point is 00:12:44 Because for one thing, most people don't spend that way. Our expenses are a little bit lumpy in retirement. We're not just spending the same amount like robots year after year. But the other key point is that if someone uses that base case spending system, they will tend to leave big leftover balances at the end of a third. 30-year horizon. So they will have dramatically underspent during their retirements. And many people have quite tight plans where there are real quality of life tradeoffs if you underspend. And there are missed opportunities to do some lifetime giving versus leaving a big bequest after your

Starting point is 00:13:27 life is over. So my hope is that people do explore some of these flexible strategies because is they're the best way to lift your lifetime withdrawals from your portfolio? So a really simple one that we use in the paper is to look at people's actual spending patterns throughout their time horizon. So if you look at retirees in aggregate, what you see is a tendency to spend less as we age. And for many of us, this very much dovetails with the older adults in our lives, who maybe we have helped through their senior years. We know that as they move into their, say, mid-70s, early 80s, oftentimes their spending slows down a little bit and in general they're slowing down a little bit.

Starting point is 00:14:14 And of course, this isn't the case for everyone. I know plenty of us have plans to be very energetic and maybe traveling throughout our whole retirement. But if you are comfortable with this assumption that you'll be like most people and spend less during your, later years of retirement, it should give you permission to spend more in those early years of retirement. So the roughly 4% that we came out with in our base case, which assumes that someone's going to take that inflation adjustment thereafter, it's more like 5% initially if you're okay with that tradeoff of potentially spending less as you move into your, say, mid-70s and early 80s. So that's one strategy I would call out. Another one,

Starting point is 00:15:00 that our team really likes, but is complicated and probably too complicated to explain here, is called the Guard Rails Strategy. It was developed by Jonathan Geithen, who's a financial planner, as well as William Klinger, who's a computer scientist. And it calibrates changes and withdrawals a little bit more tightly based on how the portfolio has performed. But the Guard Rails aspect of it is that it doesn't jerk you around too much. So in a really bad market environment, It'll say, yes, you should take less, but you're not going to have to cut your spending to the bone. And that's where the guardrails kick in to kind of protect you from having to take too radical an adjustment in terms of your spending. So those are a couple I would call out.

Starting point is 00:15:46 But I would urge people to explore some of the tradeoffs that they're comfortable with in terms of their own spending plans. Yeah, your report does a great job of evaluating these various methodologies based on various criteria. one being the initial withdrawal rate, and for some of these it's as high as 5.7%. But also the spending volatility, because if you're following one of these dynamic strategies, you may have to cut back on your spending based on your portfolio's performance. You think of a time like the dot-com crash when the stock market was down three years in a row. That means your spending in retirement had to go down three years in a row. And another criteria was how much you had at the end of your life for maybe long-term care or to leave to your heirs.

Starting point is 00:16:25 So there are all these moving parts to think about as you change. choose the right withdrawal strategy for you. Yeah, thank you for mentioning the spending volatility, because when we initially did this research, I had begun talking to retirement planning experts and often heard, well, the RMD method, the required minimum distribution method, is a really elegant system in that it tathers your withdrawals to how your portfolio is behaved and that it also adjusts based on how old you are and what your longevity expectations are. And the RMD method is really efficient in that way.

Starting point is 00:17:00 It helps ensure that you spend your portfolio during your lifetime. The trade-off is that it jerks you around a lot in terms of your annual spending. So it's not for everyone. It's probably going to be most appropriate for people who have a lot of non-portfolio income coming in the door. So maybe you're someone with a pension, the dwindling share of our population with a pension. Maybe you've got a pension and you're just kind of using your portfolio spending to do fun stuff or to travel or whatever. Maybe that RMD type system is appropriate for you. But for a lot of people, I think it'll just be too volatile in terms of their paydays.

Starting point is 00:17:39 That's a good example to bring up in terms of how much you have at the end of life, right? So based on your report, the median amount someone would have after 30 years with the base case is 1.42 times what they started with. So they died with 42% more money than what they were tired with. Whereas with the RMD method, after 30 years, they only had 12% of what they started with. So they're kind of running out of money there at the end. And you have to ask, are you comfortable of that when you make these types of decisions? So those are just some of the trade-offs to consider when determining which strategy is read for you. Yeah, that was our goal with the paper.

Starting point is 00:18:14 And I would say, Robert, too, when people embark on this, really a key step is to take a look at your household budget. and see if you have fixed outlays, and we all do for our housing expenses, taxes, health care, et cetera, look at those fixed expenses. If you can figure out a way to have your fixed income align with those fixed outlays, that is a really great strategy. So if you can figure out a way to have Social Security maybe plus some other income, whether a working income or an annuity or something like that, If you can get those items to align, that makes the portfolio spending discussion a whole lot

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Starting point is 00:20:01 slash Motley for free shipping and 365-day returns. Quince.com slash Motley. It's time to get it done, fools. And last week we kicked off our year-long financial planning challenge, which we're calling a year well-planned and recommended that you calculate your net worth and track your spending. I also ask listeners to let us know how they stay on top of their finances, and I'd like to highlight three of the responses we received. First up from BG. Quote, I've used Quicken for decades, and they have a retirement planning section. It took me some time to work through, but also saved all of my work.

Starting point is 00:20:33 As I approached retirement from 15 years away, I noticed that was less anxious about saving for emergencies, vacations, kids' college, a wedding for our daughter, etc. Planning was highly useful, and we are doing very well in retirement. The time and effort was worth it. I encourage all fools to get started. end of quote. So thank you, BG, and I agree that not only will the work pay off in a more secure financial future, you may just feel better, thanks to being more on top of and in control of your finances. Quicken is definitely an excellent choice, and there are others to consider, including Empower, Monarch Money, Tiller, Wynab, and others. So see what's out there and choose a tool that you feel will work best for you. Next up we hear from Fred in Florida, who wrote, quote, 12 years ago, my wife and I went on a strict financial independence journey. We calculated our annual cost of living at retirement till age 95, all inflation adjusted. We came up with an amount that we should have by age 67, supplemented by 70% of Social Security,

Starting point is 00:21:30 just in case. What is unique with our plan is that we have an annual checkpoint that shows us if we are ahead or behind of our annual goal, and we can immediately make adjustments if needed. This helped us set an annual return of investment goal that guided us if we needed to be more aggressive or cautious the following year. it also helped us have an actual risk tolerance number, like if the S&P 500 drops 20%, is that a hit we can take and still be on track? Lastly, it helped us transition out of the strict saving mindset and enjoy our financial

Starting point is 00:22:01 freedom better, end of quote. Well, very impressive, Fred. I love that you broke up your retirement goal into annual benchmarks, and I particularly appreciate that you built in the possibility that you won't receive as much from Social Security is currently projected, which probably makes sense for those not close to retirement since the Social Security Trust Fund will be depleted by around 2032, which will lead to a 20% or so cut to benefits unless Congress does something about it. And finally, given how much we hear about AI these days,

Starting point is 00:22:29 let's hear from Greg in South Carolina, who wrote about the tools he uses to track his investments and expenses, which starts with, quote, an Excel spreadsheet that shows the balances of various accounts, has a pie chart that aggregates and classifies the amounts based on tax status, and then a rather complex projection table that estimates how the balances will grow based on a given rate of return, inflation rate, and withdrawal amount. As for expenses, I downloaded all of my 2025 checking history and used co-pilot Microsoft's AI tool to help categorize everything.

Starting point is 00:23:02 It worked pretty well except for a few errors that weren't the AI's fault. That helped me understand how much money my wife and I would need for our current baseline lifetime expenses. Based on that figure, it should be easy to estimate how much we'll need overall, taking into account taxes, healthcare, vacations, and other planned future shocks, such as a new roof, new car, etc. End of quote. Well, nice work and excellent idea, Greg. You know, one of the tedious parts of budgeting and tracking your spending is staying on top of every little expense and putting it in the right category, but it looks like Greg found an excellent solution. Plus, this type of information will be crucial for calculating how much someone needs for retirement.

Starting point is 00:23:40 A topic will cover in a future month during our year well planned. And that, my friends, is the show. Thanks for listening and thanks to Bart Shannon, the engineer for this episode. As always, people on the program may have interest in the stocks they talk about, and the Motley Fool may have formal recommendations for or against. So don't buy or sell stocks based sold down what you hear. All personal finance content follows Motleyful editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only.

Starting point is 00:24:10 See our full advertising disclosure. Please check out our show notes. I'm Robert Brokamp. Fool on everybody.

Motley Fool Money - Is the Retirement Safe Withdrawal Rate Below 4% or Almost 6%?

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