I am the first to admit that an analysis of retirement withdrawal rates is not the most exciting topic in the world. What is exciting is a retirement filled with spending on trips, meals and socialising with family and friends. And unfortunately, the amount of money that can be safely withdrawn from super each year will dictate if your retirement means sipping champagne in Paris or eating canned beans in your child’s spare bedroom.

The challenge with retirement is that we don’t know how long it will last. That is a nice way of saying we don’t know the date of our death. We also don’t know what market returns will be during our retirement. Too much spending, a long life and poor market returns and it might be time to start being nicer to your children and developing a taste for beans.

The good news is that Morningstar has dug through the minutia of retirement withdrawal rates in our annual State of Retirement Income Report. The report is a comprehensive review of withdrawal rates. We have written about the intricacies of withdrawal rates and estimating how much you need for retirement. This article is going to focus on something called flexible withdrawal strategies. Grab a cup of coffee and I will try to make this as interesting as possible.

What is the traditional withdrawal strategy?

Before defining flexible withdrawal rates it is important to understand the traditional way the financial planning industry has approached withdrawal strategies. A retire will select a percentage of a portfolio that will be withdrawn in the first year of retirement. A rate of 4% has traditionally been the figure used but there are lots of other considerations. You can learn more here.

That percentage withdrawal rate will dictate how much is taken out of a portfolio the first year of retirement. After that the dollar figure will increase by inflation. That is why it is called a fixed withdrawal rate. While the dollar figure may increase by inflation the standard of living of fixed.

I would be remiss if I didn’t mention that a safe withdrawal rate and the minimum required withdrawals by the ATO are two completely different things. The ATO is not concerned with your safe withdrawal rate. They are trying to get money out of the tax advantaged super account. Money withdrawn from super does not need to be spent and individual spending ecisions should be based on individual circumstances and not on ATO rules.

What is a flexible withdrawal strategy?

Now that we have covered fixed withdrawal strategies we can explore flexible withdrawal strategies. The purpose of a flexible withdrawal strategy is to make retirement savings last longer and increase the amount that can be withdrawn in decent market conditions. To understand we need to explore a concept known as sequencing risk.

As an investor starts to sell off assets in a retirement account the return that is received in the early years of retirement matter. They matter a lot. If a portfolio is falling significantly in value during the early years of retirement while a retiree is selling off assets, retirement savings will not last as long. Even if the market rebounds there will be lower account balances due to the withdrawals to take advantage of climbing markets.

An illustrative example brings this point home. In this example a retiree has a $500k portfolio that is entirely invested in the S&P 500 index and is taking $20k out each year. If we use the actual returns from the S&P 500 starting in the year 2000 over a 20-year period the retiree would have $165k left.

However, if we reverse the sequence of the returns the outcome is significantly different. In this scenario the average return is the same as the first scenario. Reversing the returns results in the retiree ending the 20-year period with a portfolio woth $782k.

The market dropped significantly in the early years of the first scenario due to the .com bust and the September 11th attacks. In the mid-2000s the GFC caused the market to plunge again. The returns after the GFC were extremely strong. In the second scenario with the reverse sequence of returns these strong returns occurred at the beginning of retirement.

A flexible withdrawal strategy can help retirees that have the misfortune of retiring into a bear market. The benefits are not simply downside protection. Flexible withdrawals also allow all retirees to support a higher withdrawal rate.

There are several different types of flexible withdrawal strategies but all of them involve adjustments to the amount of money withdrawn based on market conditions. Below are examples of flexible withdrawal strategies:

Method 1: Forgoing inflation adjustments following annual portfolio loss

This method, advocated by (among others) T. Rowe Price, begins with the base case of fixed real withdrawals throughout a 30-year time horizon. However, to preserve assets following down markets, the retiree skips the inflation adjustment for the year following a year in which the portfolio has declined in value. This might seem like a modest step, but the cuts in real spending, while small, are cumulative. That is, the effects of such cuts ripple into the future, as these changes permanently reduce the retiree’s spending pattern.

Method 2: Required minimum distributions (“RMD”)

This is the same framework that underpins required minimum distributions for super accounts as dictated by the ATO. In its simplest form, the RMD method is portfolio value divided by life expectancy. This method is inherently “safe” and designed to ensure that a retiree will never deplete the portfolio because the withdrawal amount is always a percentage of the remaining balance. However, an RMD system incorporates two key variables for retirement-spending plans: remaining life expectancy and remaining portfolio value. While changes in life expectancy are gradual, the fact that the remaining portfolio value can change significantly from year to year adds substantial volatility to cash flows.

Method 3: Guardrails

Originally developed by financial planner Jonathan Guyton and computer scientist William Klinger, the guardrails method sets an initial withdrawal percentage, then adjusts subsequent withdrawals annually based on portfolio performance and the previous withdrawal percentage. The guardrails attempt to deliver sufficient—but not overly high—raises in upward-trending markets while adjusting downward after market losses. In upward-trending markets, in which the portfolio performs well and the new withdrawal percentage (adjusted for inflation) falls below 20% of its initial level, the withdrawal increases by the inflation adjustment plus another 10%.

To use a simple example, let’s say the starting withdrawal percentage is 4% of a $1 million portfolio, or $40,000. If the portfolio increases to $1.4 million at the beginning of Year 2, the retiree could automatically take $40,000 plus an inflation adjustment—$40,968, based on a 2.42% inflation rate. Dividing that amount by the current balance—$1.4 million—tests for the percentage. The amount of $40,968 is just 2.9% of $1.4 million. As that 2.9% figure is 28% less than the starting percentage of 4%, the retiree qualifies for an upward adjustment of 10%. The new withdrawal amount becomes $45,065—the scheduled amount of $40,968 plus the additional 10% of $4,097.

The guardrails apply during down markets, too. Specifically, the retiree cuts spending by 10% if the new withdrawal rate (adjusted for inflation) is 20% above its initial level. For example, let’s say the retiree withdrawing 4% ($40,000) of the $1 million portfolio in Year 1 immediately strikes an investment iceberg, losing 30% of the portfolio value in Year 1. The portfolio drops to just $672,000 at the beginning of Year 2. The Year 2 withdrawal would be $40,968 on a pretest basis. But because $40,968 from $672,000 is a 6.1% withdrawal rate—far above the initial 4%—the retiree would need to reduce the scheduled $40,968 amount by 10%, to $36,871.

Method 4: Spending declines in line with historical data

We also tested a strategy that incorporates the average decline in spending that occurs over the retirement life cycle. In past studies, we incorporated this spending pattern by assuming that the hypothetical retirees did not adjust their annual withdrawals by the full amount of inflation but instead by 1 percentage point less than the annual inflation rate.

In this year’s study, we further refined this method by incorporating more specific patterns observable in retiree spending at various life stages. Research from the Employee Benefits Research Institute4 demonstrates that inflation-adjusted household spending has historically fallen by 19% from age 65 to 75, 34% from age 65 to 85, and 52% from age 65 to 95. We adjusted the annual spending numbers to match up with these longer-term declines. To reflect this, Method 4 assumes that real retirement spending declines by 1.9 percentage points per year between age 65 and 75; 1.5 percentage points per year between 75 and 85; and 1.8 percentage points per year between 85 and 95.

While protecting a retiree if market conditions are poor early in retirement a flexible wirthdrawal strategy allows higher spending early in retirement. The following chart indicates the initial withdrawal rate for each of the strategies mentioned above.

Withdrawal rate


Retirement spending is complex as there are a significant number of variables that influence how long a portfolio will last. All of these variables are based on an unknown future. The important consideration for a retiree who uses a flexible withdrawal strategy is that spending can shift year to year based on market conditions. This may be difficult in practice as retirees will need to constantly adjust their yearly spending.