Paper Poses New Withdrawal Rate Method

Today’s low interest rate environment can take a bite out of what would normally be a sustainable withdrawal rate in retirement, Morningstar said.

Most tools that calculate sustainable withdrawal rates in retirement use Monte Carlo simulations using long-term averages. This method is reasonable when markets are near those averages, but the current bond market presents a significant and sustained deviation, according to “Low Bond Yields and Safe Portfolio Withdrawal Rates,” a paper from Morningstar Investment Management.

Since retirees tend to invest heavily in bonds, these low yields will have a significant impact.

The probability of success for a 4% initial withdrawal rate over a 30-year period for a portfolio invested in equities at 40% would be about 48%, or slightly less than flipping a coin, said David Blanchett, head of retirement research at Morningstar Investment Management and one of the paper’s authors. Past research has tended toward estimations above 80%.

“The average person running these simulations is getting a falsely successful picture,” Blanchett told PLANADVISER.

“What you could have done in the year 2000 when bond yields were higher was say, based on this data, you could take out 9 % a year,” Blanchett said. “This model recognizes that things might change. I acknowledge that this might not be relevant in five years when bond yields are higher.”

 “One key problem with the analysis that people do with a safe withdrawal rate is assume the same return rate for every year,” Blanchett said.


Morningstar’s method factors in current bond yields and allows them to “drift” toward a higher value during retirement using a model primarily on historical relationships between asset classes. This can better replicate the actual bond returns that a current retiree or someone nearing retirement can expect during retirement.

A retiree who wants a 90% probability of achieving a retirement income goal with a 30-year time horizon and a 40% equity portfolio would only have an initial withdrawal rate of 2.8%. This low withdrawal rate would require 42.9% more savings if the retiree wanted to pull the same dollar value out of the portfolio annually as he or she would get with a 4% withdrawal rate from a smaller portfolio.

A purely historical model assumes bonds are going to return to long-term averages at the rate they have returned historically, Blanchett said. “In reality that’s good for investors. The long-term return will get back to 5-1/2%.” Blanchett expects yields to remain very low for approximately the next 10 years, which has significant implications not only for withdrawal rates but how much a person must save to achieve successful retirement income.


Morningstar’s model is predictive for withdrawal rates and the need for increased assets, and it is helpful for current retirees and those nearing retirement. “It is definitely relevant for someone currently retired or nearing retirement,” Blanchett said. People in their 20s or 30s have a much longer time frame—around 30 years. “But if you’re buying bonds over the next 10 years, this obviously looks at what is safe for a portfolio,” he said.

With very low yields on government bonds, Blanchett recommends that investors pay attention to diversification. Bonds are still an important part, but he suggests that real estate, higher-quality U.S. equities, emerging markets and other asset classes are also key in a diversified portfolio.

The paper also considers return sequence. In the earliest years of retirement, portfolios have a larger impact on the likelihood that a retirement income strategy will succeed than returns later in retirement, which is known as sequence risk. Sustainable withdrawal rates are analyzed at different success levels for different stock/bond splits over different horizons.

The paper was co-authored by Michael Finke, professor and Ph.D. coordinator at the department of personal financial planning at Texas Tech University, and Wade D. Pfau, professor of retirement income at the American College.

Morningstar intends to incorporate this forecasting technique into its 401(k) advice and managed account offering in the coming months.

The paper is available here.