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SAVERS NEARING retirement who expect their accumulated balance to afford a modest lifestyle may be kidding themselves. Based on the mandated withdrawal rates, retirees run the risk of running out of money just when they’ll need it most. Withdrawal rates should be much lower — more like 2.5% than 4% — if savers want to minimise the chance of running out of funds, according to a report by investment research firm Morningstar.
Instead of $1,250,000 being sufficient to fund $50,000 of living expenses, a retiree who wanted certainty of remaining solvent for life would need a balance of $2 million.
In its white paper Safe Withdrawal Rates for Australian Retirees, released in January, Morningstar tested safe withdrawal rates by running thousands of possible investment return scenarios for five hypothetical portfolios for periods between 20 and 40 years.
For each portfolio, optimal drawdown rates were calculated for five retirement periods and six probabilities of success.
The result is the table shown here, where lower expectations for future investment returns translate into leaner withdrawals if savers want to feel secure their money won’t run out. Here’s how the table works.
Find your portfolio
Find the table which roughly matches your portfolio’s mix of equities and bonds. If you hold cash instead of bonds as a defensive asset, as many self-managed super funds do, then substitute your cash allocation for a rough equivalent.
Find your retirement period
Next, look up the column for the years you want your funds to last. Remember, we are all living longer. It may be a good idea to also check the columns to the right of the one you’ve chosen.
Probability of success
Last, find the row which matches the chance of success you feel comfortable with. For example: if your portfolio is 50:50 equities and bonds, you’re planning for 30 years in retirement and you want a 99% chance of not running out of money (or a 1% chance of going broke), you’ll settle on a 2.8% withdrawal rate.
TABLE: WITHDRAWAL RATES BY PORTFOLIOS … TIME PERIOD TARGET SUCCESS RATE
| Portfolio % | Retirement Period (Years) | ||||
| Probability of Success % | 20 | 25 | 30 | 35 | 40 |
| 15% Shares / 85% Bond | |||||
| 99 | 4.5 | 3.6 | 3 | 2.6 | 2.3 |
| 95 | 4.8 | 3.9 | 3.3 | 2.8 | 2.5 |
| 90 | 4.9 | 4 | 3.4 | 2.9 | 2.6 |
| 80 | 5.1 | 4.2 | 3.5 | 3.1 | 2.8 |
| 70 | 5.3 | 4.3 | 3.7 | 3.2 | 2.9 |
| 50 | 5.5 | 4.5 | 3.9 | 3.4 | 3.1 |
| 30% Shares / 70% Bond | |||||
| 99 | 4.4 | 3.5 | 3 | 2.6 | 2.3 |
| 95 | 4.8 | 3.9 | 3.3 | 2.9 | 2.6 |
| 90 | 5 | 4.1 | 3.5 | 3.1 | 2.8 |
| 80 | 5.3 | 4.4 | 3.7 | 3.3 | 3 |
| 70 | 5.5 | 4.5 | 3.9 | 3.5 | 3.1 |
| 50 | 5.8 | 4.9 | 4.2 | 3.7 | 3.4 |
| 50% Shares / 50% Bond | |||||
| 99 | 4.1 | 3.3 | 2.8 | 2.4 | 2.2 |
| 95 | 4.7 | 3.8 | 3.3 | 2.9 | 2.6 |
| 90 | 5 | 4.1 | 3.5 | 3.1 | 2.8 |
| 80 | 5.4 | 4.5 | 3.9 | 3.5 | 3.2 |
| 70 | 5.7 | 4.8 | 4.2 | 3.7 | 3.4 |
| 50 | 5.9 | 5.3 | 4.6 | 4.2 | 3.9 |
| 70% Shares / 30% Bond | |||||
| 99 | 3.7 | 3 | 2.5 | 2.2 | 2 |
| 95 | 4.5 | 3.7 | 3.1 | 2.8 | 2.5 |
| 90 | 4.9 | 4 | 3.5 | 3.1 | 2.9 |
| 80 | 5.4 | 4.6 | 4 | 3.6 | 3.3 |
| 70 | 5.8 | 4.9 | 4.4 | 4 | 3.7 |
| 50 | 6 | 5.6 | 5 | 4.6 | 4.3 |
| 85% Shares / 15% Bond | |||||
| 99 | 3.4 | 2.7 | 2.3 | 2 | 1.8 |
| 95 | 4.3 | 3.5 | 3 | 2.7 | 2.4 |
| 90 | 4.8 | 4 | 3.4 | 3.1 | 2.8 |
| 80 | 5.4 | 4.6 | 4 | 3.6 | 3.4 |
| 70 | 5.9 | 5 | 4.5 | 4.1 | 3.8 |
| 50 | 6 | 5.9 | 5.3 | 4.9 | 4.6 |
BRIDGING THE GAP
There is a big difference between what the Australian government demands retirees withdraw from their tax-free savings and what Morningstar claims are sustainable amounts.
Minimum annual withdrawals are: 4% for under 65; 5% for age 65 to 74; 6% for age 75 to 79; 7% for age 80 to 84; 9% for age 85 to 89; 11% for age 90 to 94; 14% for 95-plus.
Going on Morningstar’s research, withdrawals of 2.5% are recommended for a 70:30 equities and bonds portfolio to last 30 years at 99% probability of success.
Retirees are free to reinvest any money they don’t end up spending, in which case it is possible to stick to the withdrawal rates suggested in Morningstar’s research and not break any rules.
Based on the researcher’s recommended withdrawal rates, however, many savers may find their balances are too low.
PLAN FOR TOMORROW TODAY
The 4% annual withdrawal became popular in the mid-1990s after a US-based financial adviser looked at 100 years of financial data and proposed it as adequate to minimise the chance of going broke. The “4% rule” soon became the norm.
That was more than 20 years ago, however, and Morningstar’s expectations for investment markets are below historical averages. The “4% rule” shouldn’t be anyone’s benchmark for a failsafe retirement spending strategy.
The risk of running out of funds in retirement should be taken seriously. When it happens, a government pension might not prove sufficient and family may not be able to help. There are two solutions: save more for retirement or spend less in retirement.
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