Providing for retirement is the great unifier in the investing world. It is a challenge that all investors face.

While approaches will vary, at some point, each investor is faced with the need to convert a lump sum of money into an annual outlay to pay for day-to-day life.

Take too much out and you may run out of money before the unknowable date your retirement ends – otherwise known as death.

Take too little out and spending your golden years subsisting on white bread will lead to your kids eating caviar.

This quandary has led to countless products and employed an army of accountants and advisers ready to dissect each new set of government rules and regulations. And it has spawned one of the most famous and misunderstood axioms in personal finance – the 4% rule.

The reason the withdrawal rate matters is because it dictates the size of a portfolio needed to support certain spending levels. I covered this recently in an article on the 4 steps to calculate how much you need for retirement. 

While it can be considered a good starting point, the 4% rule shouldn’t be seen as a hard and fast rule, as revealed in a new retirement report by Morningstar.

What is the 4% rule

The 4% rule is an attempt to find a safe withdrawal rate that will address sequencing risk and longevity risk while maintaining an inflation adjusted standard of living which increases the original withdrawal amount by inflation each year.

Put simply, it is supposed to protect you from the misfortune of retiring when markets are falling (sequencing risk) while making sure you don’t outlive your savings (longevity risk).

The 4% rule is not a substitute for minimum drawdowns from Super, which were never intended to represent a “safe” withdrawal rate and are not a mandate to spend the money you’ve taken out of a tax advantaged account.

Based on a study in the early 1990s by a US financial planner named Bill Bengen, the 4% rule is ultimately a rule of thumb using historical data to try and provide answers for a future that is unique to you.

Ironically, that ‘rule of thumb’ – crafted more than 30 years ago – directly contradicts the disclaimer that ASIC and every other regulator in the world requires to accompany all mentions of investment returns… past performance is not indicative of future performance.

While the simplicity of the rule supports widespread adoption, the 4% rule is not based on the unique time you will retire, nor the unique retirement you will live. It is a jumping off point for further analysis.

A better way to view withdrawal rates

Our finances are deeply personal. The most important determinant of achieving your ideal retirement are inputs that only you can provide.

The 2023 Morningstar State of Retirement Income Report (“report”) is intended to represent a safe withdrawal rate for someone retiring today, while simultaneously allowing adjustments based on your personal circumstances.

The report incorporates long-term estimated returns that are based on the current environment.

Last year, the Morningstar analysis produced a 3.8% withdrawal rate, reflective of an environment that foreshadowed lower future returns as shares traded at historically high valuation levels and bond yields were historically low. This was an improvement over the 3.3% withdrawal rate in the 2021 report. 

After an unven year for both shares and bonds, the forward projected returns are more positive.

As a result, the withdrawal rate has lifted to 4%. While this improvement may be little solace for investors with lower portfolios it is indicative of some important truths about investing – valuation levels matter and dictate the level of expected future returns.

If you need $40,000 a year to support your lifestyle, that translates into a $1,000,000 portfolio at a 4% withdrawal rate. A 3.8% withdrawal rate and you need $1,052,000. At 3.3% you need $1,212,000.

The report also outlines how factors unique to you can influence the withdrawal rate.

Asset allocation between shares and bonds and the length of your expected retirement will lead to different withdrawal rates.

For example, for a 10-year retirement with 100% allocated to shares, the withdrawal rate rises to 8.3%. I've recently written about the considerations for a 100% allocation to shares in retirement. 

For a 40-year retirement with an all bond portfolio, the withdrawal rate drops to 2.9%. The following chart shows safe withdrawal rates by asset allocation and time frame.

Withdrawal rates by asset allocation

The approach you take to future withdrawals matters as well. Deviating from taking inflation adjustments to your withdrawal amount annually can lead to higher starting withdrawal rates and a lower amount required to retire. Forgo inflation and you can safely withdrawal 4.4% from your portfolio.

Success in investing often comes down to being thoughtful. Retirement planning is no difference. Can you put off retirement if it isn’t a good market environment? Can you set yourself up for success by adjusting your asset allocation and savings in the years proceeding retirement? What factors will influence the amount you need to spend in retirement? Most of us get one shot at getting this right. Time to do some homework.