The Pros and Cons of 3 Retirement Spending Plans

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What You Need to Know

Retirement researchers say the time has come to move beyond the traditional 4% rule for retirement income planning.
In its place, retirees can lean on any number of dynamic spending strategies being identified by academics and industry practitioners.
Flexible spending strategies can result in better outcomes, but they also come with added practical complexity that cannot be ignored.

Research published late last year by Morningstar found that the current “safe” starting spending rate for a retiree wanting to use a fixed percentage withdrawal rule was 4% in 2023, but as explained in a recent webinar put on by the report’s three authors, the more important conclusions drawn in the paper pertain to its analysis of various flexible spending strategies.

As researcher and Morningstar vice president John Rekenthaler noted, the 4% figure identified in the paper is “more of a starting point for planning discussions,” rather than a strong recommendation for any actual retiree.

“That’s why our paper isn’t just one or two pages, but 30 or 40,” Rekenthaler said. “We aren’t just telling people to take 4% and adjust for inflation and that’s that. In the real world, flexibility is going to come into the picture.”

That sentiment was echoed by both Amy Arnott, a Morningstar portfolio strategist, and Christine Benz, Morningstar’s director of personal finance and retirement planning. According to the trio, the 4% starting withdrawal figure should allow a client and their advisor to do a quick assessment of whether one’s anticipated spending level is reasonable — but that’s where the planning discussion starts, not ends.

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During the presentation, the researchers highlighted a number of flexible spending strategies considered in their paper, discussing both the pros and cons of each method. They argued that flexible spending strategies can result in better outcomes, especially when an advisor and client work closely together over time and regularly revisit their assumptions, but these approaches also come with added practical complexity that cannot be ignored.

In the end, the authors concluded, advisors who can effectively communicate the importance of dynamic income planning will help their clients spend more confidently in retirement while also ensuring their long-term financial security.

Flexible Strategy No. 1: Skipping Inflation Adjustments in Down Years

Under the base-case 4% scenario, the analysis assumes that an individual will make annual adjustments to their withdrawals to account for the rate of annual inflation. Importantly, the strategy entails increasing the dollar-figure withdrawal amount itself by the rate of inflation and not simply adding the percentage rate of inflation to the 4% starting figure.

Rekenthaler said this is a fairly common misunderstanding, and one that could get a client in trouble rather quickly if they were to actually spend that aggressively.

One way to add flexibility to this approach, as Arnott explained, is skipping such an inflation adjustment in years when the portfolio experiences a market loss. For example, a person following this strategy wouldn’t increase portfolio withdrawals after the bear market of 2022, despite the large jump in inflation during the year.

The principal advantage of this approach is its relative simplicity, the authors suggested, but it is also potentially one of the more “painful” strategies.

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“This might seem like a modest step, but the cuts in real spending, while small, are cumulative,” Arnott explained. “That is, the effects of such cuts ripple into the future, as these changes permanently reduce the retiree’s spending pattern. This method is also inherently conservative because it doesn’t boost the real withdrawal amount even after a large increase in portfolio value.”

As such, clients using this method actually stand a higher chance of spending too little, resulting in excess wealth at the end of life that might not be desired. Their lifetime average withdrawal rate may also be unnecessarily low.

Flexible Strategy No. 2: Following the RMD Rule

As Arnott summarized it, the idea here is that a client can essentially mimic the framework that underpins the calculation of required minimum distributions from tax-deferred accounts such as 401(k) plans and individual retirement accounts. But, instead of waiting for RMDs to legally kick in at age 73, they can instead start “taking their RMDs” at the start of retirement.

“In its simplest form, the RMD method is to set withdrawals by taking the portfolio value divided by life expectancy,” Arnott explained. “During our tests, we used the IRS single life expectancy table and assumed a 30-year retirement time horizon, from ages 65 to 94.”

The advantage of this method is that it is “inherently safe,” as it is designed to ensure that a retiree will never deplete the portfolio, because the withdrawal amount is always a percentage of the remaining balance. In contrast to the other methods in the paper, the percentages withdrawn are based on the current portfolio value, not the original balance.

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