Morningstar Drops Recommended Safe Withdrawal Rate to 3.7%

According to analysts, higher equity valuations and lower fixed-income yields caused them to reduce their average safe withdrawal rate from 4.0% in 2023.

Morningstar Inc. has lowered what the investment research firm considers a safe retirement savings withdrawal rate for new retirees based on a 30-year outlook, according to the firm’s annual “State of Retirement Income” report released Wednesday.

To decide on the recommended withdrawal rate, Morningstar researchers considered forward-looking asset class returns and inflation assumptions for new retirees, excluding what they may be getting from Social Security or other nonportfolio income sources such as a company pension.

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In that forward-looking analysis, the authors concluded that higher equity valuations and lower fixed-income yields will likely lead to lower return assumptions for stocks, bonds and cash. That outlook led them to reduce their safe withdrawal rate for the average retiree to 3.7% in 2024, down from the 4.0% it recommended in 2023.

Based on conservative assumptions, the recommendation generalizes what will always be a very personal decision based on a person’s goals, asset mix and life expectancy, says Jason Kephart, director of multi-asset ratings for Morningstar and one of the authors of the report.

“Not everyone will have a full, traditional 30-year period for retirement,” Kephart says. “It really comes down to trade-offs—do you want more income in retirement or more money to leave to your heirs or charities? … There are different strategies, and we are using a more conservative baseline for income to last your lifetime.”

Kephart notes that this year’s report is aimed at retirees starting today; those who created a 4% strategy at the end of 2023 should keep that strategy the same.

The more conservative rate this year is partly based on the strong market run in 2024, Kephart says, and Morningstar expects that markets will be down a bit in 2025. The firm is also anticipating lower interest rates, including an expected rate cut by the Federal Reserve next week, in 2025.

Spending/Ending Ratio

Kephart and the team of analysts generally consider retirement spending strategies as balancing two priorities: maximizing a retiree’s spending, while also leaving inheritance for loved ones or charity. In this year’s report, they considered a new metric to balance those goals called a “spending/ending ratio” of lifetime spending relative to portfolio leftovers at year 30.

By considering that ratio, retirement planners can decide on what mix of strategies is best for them. These might include how to manage portfolio spending, delaying Social Security to increase its payout or investing in an annuity to lock in a guaranteed paycheck.

“We’re trying to look at the various things that people do use [when setting up for retirement],” Kephart says. “That could be an immediate annuity. It could be using a Social Security bridging strategy. … It comes down to how much you want to spend versus how much you want to leave behind and finding that sweet spot.”

First, taking flexible portfolio-spending: Retirees seeking a high level of lifetime income can institute a guardrails approach, combined with delayed Social Security. In the guardrails approach, retirees set a high and low guardrail for their withdrawal rate, adjusting it depending on how their investments are performing. While this approach can create income volatility, if a retiree has delayed Social Security, then that regular, known income stream will help offset the volatility, according to Morningstar.

Second, in terms of delaying Social Security to receive a higher monthly payout, the strategy is recommended for those who can, in the interim, draw nonportfolio income from sources such as a part-time job or rental income. However, if delaying means withdrawing higher amounts from savings, the researchers recommended potentially taking Social Security on time so the savings can benefit from compound interest over the 30-year retirement horizon.

Finally, Morningstar recommends considering adding a guaranteed income annuity to the savings mix. An allocation to a “simple immediate or deferred annuity” can help “enlarge in-retirement cash flows,” analysts wrote. Similar to trying to delay Social Security, retirees should consider how much money it would take to purchase an annuity, compared with keeping the money in an investment portfolio at a lower cost while potentially obtaining higher returns.

Building a Ladder

Morningstar also referred to a strategy of investing in Treasury inflation-protected securities with varying maturity dates and interest rates, known as a T-Bill ladder. With that strategy, a retiree could have 100% success with a 4.4% withdrawal rate, as of today, according to the researchers. However, that strategy would lead to full liquidation of the case scenario in 30 years.

Kephart says interest rates will be a key variable in 2025 and going forward. At the moment, further rate cuts may be possible next year. But new policies implemented by the administration of President-elect Donald Trump may shift that picture, with the potential for continued inflation. While inflation may create higher spending needs for retirees, the related higher interest rates may be a benefit for their portfolios, Kephart notes.

Despite the drop in a safe withdrawal rate, Morningstar noted a propensity for retirees to decrease their spending over time. If that is the case, analysts projected an actual spending pattern may allow for higher withdrawal rates of as much as 4.8% over 30 years with a 90% probability of success.

When it comes to financial advisers helping people come up with a retirement withdrawal plan, Kephart says the most important thing is having the conversation, no matter what number is used as the jumping-off point.

“The 4% [rule of thumb] conversation is a fine place to start,” he says. “But then you have to drill down and see how various factors might change that and how the money should be allocated.”

EBRI Panel: DC Plans, Social Security Can Create Strong Retirement Security Net

Panelists speaking at the institute’s winter policy forum made the case that a strengthened defined contribution system can partner well with Social Security for the majority of Americans.

Social Security and defined contribution plans can provide a solid retirement income picture for retirees, in part thanks to the evolution of the DC system, according to new research and a group of panelists who spoke at the Employee Benefit Research Institute’s Winter Policy Forum on Tuesday.

In recent years, various policy and research groups have questioned the viability of the DC system’s ability to provide Americans with enough income in retirement. But when used correctly, particularly for younger workers who started early in the DC system, Social Security and DC plans are complementary systems, said Craig Copeland, EBRI’s director of wealth benefits research, during a research presentation.

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During the panel discussion, Copeland reviewed the findings from the firm’s Retirement Security Projection Model on how the public and private systems work together to provide retirement income. The research introduced a metric called replacement rates. These rates, calculated by converting DC balances into annuities and combining them with Social Security benefits, offered a picture of retirees’ income relative to their lifetime average earnings.

“We are using metrics we haven’t traditionally relied on, so while these numbers are preliminary, the trends they reveal are significant,” Copeland said.

Age Groups and Income Replacement

EBRI’s research compared income replacement rates for workers aged 35 to 64, highlighting differences across income levels and age cohorts. For older workers (ages 60 to 64), DC plans play a smaller role in income replacement due to the limited contributions during their early careers and the prevalence of defined benefit plans during that time.

However, for younger workers (ages 35 to 39), the landscape shifts dramatically. With expanded coverage, automatic enrollment features and legislative improvements like the SECURE 2.0 Act of 2022, DC plans are poised to contribute significantly more to retirement income. Middle-income earners, in particular, benefit, with replacement rates increasing by nearly 25% compared with older cohorts.

“The DC system, when combined with Social Security, provides a robust level of retirement income,” Copeland noted. “For middle-income quartiles, this collaboration is especially critical.”

While Social Security serves as the foundation for retirement income—especially for lower-income workers—DC plans fill gaps for middle- and higher-income earners.

Impact of Social Security Cuts

The study also modelled potential Social Security benefit reductions. Copeland stated that a 25% cut to reflect the projected funding shortfall in the system could lower replacement rates to approximately 60% from the current range of 75% to 80%, disproportionately affecting middle- and lower-income retirees.

Social Security is a vital component of retirement income,” Copeland emphasized. “Any reduction has a profound impact, underscoring the need to preserve its solvency while enhancing private savings.”

Policy groups, including the National Association of Plan Advisors, have warned that some tax-advantaged savings programs, such as 401(k) accounts, may be at risk during federal legislative negotiations. No immediate plans are publicly on the table to change the DC tax system, though recent legislation has made post-tax Roth savings more prevalent in workplace retirement plans.

The Evolution of Retirement Planning

Peter Kapinos, head of workplace and investment marketing at Empower, stated that workplace retirement plans have evolved over the past 15 years. He noted the integration of Social Security benefit projections into retirement plan dashboards as a significant innovation.

“This provides participants with a clearer picture of their retirement readiness,” Kapinos said. However, he warned that Social Security decisions are not “set-it-and-forget-it” choices. With hundreds of claiming scenarios available, many workers struggle to optimize their benefits.

Kapinos said a recent study from Empower found that 88% of workers expect their workplace to provide financial planning support—signaling a shift in expectations from such services being seen as executive perks to becoming a near-universal demand.

Assessing Adequacy, Not Crisis

Michael Doshier, a senior retirement strategist at T. Rowe Price, called for a forward-looking approach to retirement adequacy, pushing back on claims of a broken system.

“Replacement ratios of income, while not perfect, are the best single indicator we have,” he said. Doshier highlighted the growth in workplace retirement plan coverage, especially in the private sector, which has reached 72%. Doshier also addressed small business participation, an area historically seen as underserved.

“By the end of 2022, over 13 million workers in small businesses were covered by defined contribution plans—an exponential increase compared to the defined benefit era,” he said.

Reinforcing the 3-Legged Stool

Will Hansen, chief government affairs officer at the American Retirement Association, reinforced the idea of Social Security and 401(k) plans functioning as two strong legs of a three-legged retirement stool.

“Social Security was always intended as a safety net for the most vulnerable, while the 401(k) was introduced to address gaps left by traditional pensions,” Hansen explained.

He dismissed claims of a retirement crisis as exaggerated, based on anecdotal and survey-driven data rather than empirical evidence. He also called on his peers to abandon crisis-laden language, stating, “the 401(k) system is resilient. We need to focus on how to improve it, not tear it down.”

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