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Morningstar analysis suggests that retirees could start out with a 3.9% withdrawal rate.
You’ve done the work of saving for retirement, but now that you’ve reached your golden years, do you have a plan for how you’ll spend down your nest egg?
For future retirees, Morningstar suggests withdrawing 3.9% of your portfolio the first year and then adjusting for inflation every year after that, according to a new report.
The researchers found that a starting withdrawal rate of 3.9% had a 90% probability of success over a 30-year retirement horizon, assuming a portfolio composed of 30% to 50% stocks, with the remainder in bonds and cash.
So what would this practically look like for a retiree?
If someone had roughly $1 million saved, they would withdraw $39,000 the first year. The next year, they would withdraw $39,959, assuming a 2.46% inflation rate.
Your withdrawal strategy is just one decision you’ll make when retirement planning. Make sure to carefully weigh factors like taxes, investment fees, and Social Security timing, too.
The retiree would then continue to adjust their withdrawal amount based on the inflation rate every year. In nine out of 10 scenarios, they would end up with at least some money left over if their retirement lasted 30 years.
While this guideline can be helpful as a rule of thumb, it should be used as a starting point—factors like taxes and investment fees can further erode investment returns, the researchers point out.
For example, someone who has the bulk of their retirement savings housed in a Roth IRA and invested in low-cost index funds will part with less of their money when taking withdrawals compared to someone who’s tapping a traditional 401(k) that’s primarily invested in actively managed funds.
This is because withdrawals of investment earnings from Roth IRAs are tax-free. In contrast, you must pay ordinary income tax on both your investment earnings and any contributions you withdraw from a traditional 401(k).
You’ll want to consider your retirement strategy holistically, weighing the impact that Social Security will have on your retirement income, too.
Those who adhere to the 3.9% withdrawal rule and delay collecting Social Security until age 70 will end up with the total highest lifetime spending amount, according to the Morningstar report.