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The good news about retirement income

When it comes to in-retirement income, and specifically the amount you can safely withdraw from your portfolio without running out, there is good news and bad news.

Chances are you’ve already heard the bad news, but I’ll repeat it just in case. Thanks largely to low bond yields, which in turn depress a portfolio’s return potential, new retirees should start with a lower withdrawal percentage than the standard guidance of 4%. Doing so will cut the odds that they’ll prematurely deplete their funds over a 25- to 30-year retirement time horizon and help blunt the impact of a bad equity market occurring early in retirement.

That’s sobering for people just embarking on retirement but there’s a good news story, too. A lower starting withdrawal percentage is advisable largely because core investment assets - stocks and bonds - have performed so well for so long. That means that at the same time that investors are being urged to lower their withdrawal rates, most investors’ portfolio balances are enlarged. Because the lower starting withdrawal rate is calculated on a larger amount, the net effect for most retirees’ actual spending is apt to be minimal.

The thinking behind a lower percentage

The drumbeat of bad news about withdrawal rates started in earnest in 2013, with a paper called 'Asset Valuations and Safe Portfolio Withdrawal Rates', co-authored by retirement researchers Wade Pfau, Michael Finke and David Blanchett. The paper noted that the combination of elevated equity valuations and low starting bond yields makes the standard 4% guideline dangerous, especially for people whose portfolios were overly reliant on bonds. They wrote:

“We find the probability of success for a 40% equity allocation with a 4% initial withdrawal rate over a 30-year period is approximately 48%.”

Most retirees, meanwhile, would prefer that the odds that they’ll run out of money during retirement be better than a coin flip.

Of course, equities have performed well since that time, and bond returns have been solid, too. Retirees who reined in spending eight years ago in anticipation of an unforgiving market environment would have done so prematurely. But in a conversation on The Long View podcast in April 2020, Pfau stood firm with the assertion that a 4% starting withdrawal was too rich, particularly given the Fed’s ultra low-interest rate policy. He said:

“Lower interest rates are going to push you toward something like 3% being a lot more realistic than 4% as a sustainable strategy in a low-interest-rate environment.” 

But that doesn’t mean a lower withdrawal amount

On the positive side, we’re talking about withdrawal rates, specifically, the percentage you can withdraw from your portfolio in year one of retirement. For many new retirees today, a smaller starting withdrawal percentage comes from a pie that’s larger overall.

To use a simple, admittedly arbitrary example, let’s say an investor retired in early 2011 with a $1 million 60% equity/40% bond portfolio. If she were using the 4% withdrawal guideline, or $40,000 initially with that amount inflation-adjusted by 3% annually, she would have pulled about $460,000 from her portfolio over the past decade.

Meanwhile, let’s say someone who was 55 and had a $500,000 60/40 portfolio back in 2011 is ready to retire today. Thanks to market appreciation and assuming that she hadn’t been engaging in regular rebalancing, her portfolio is now worth about $1.4 million.

Even if she takes a lower starting withdrawal of 3%, her larger balance means that her first-year withdrawal is about $41,722. Her first decade of withdrawals, assuming 3% initially with 3% annual inflation adjustments thereafter, would be about $478,000, roughly in line with the 2011 retiree’s numbers.

In terms of her take-home payout, her larger starting balance relative to the 2011 retiree helps make up for the fact that the advisable starting withdrawal percentage is lower.

New retirees in 2031 or some other point in the future may get a crack at a higher safe withdrawal percentage. But that would likely be because equity valuations had contracted and/or bond yields had gone up, which would probably have reduced their portfolio values somewhat.

In other words, higher starting sustainable withdrawal rates will tend to occur after poor market returns, when balances are lower. Meanwhile, lower sustainable withdrawal rates will be advisable after periods of good returns and enlarged balances.

Your mileage may vary

It’s also worth noting that criticisms that 4% is untenable in a low-yield world relate to starting withdrawal rates. The worry is that if a retiree takes out 4% of her balance in year one of retirement, then subsists on that same amount, with inflation adjustments, in subsequent years, she runs too high a risk of prematurely depleting her money over a 25- to 30-year period.

Such a system doesn’t factor in the portfolio’s value as the years go by. If she encounters big losses in her portfolio but blithely keeps taking out the same dollar amount, that will lead to too-high withdrawals at an inopportune time. That risk is particularly great in the early years of retirement.

For example, let’s say a retiree were taking fixed real dollar withdrawals from a $1 million portfolio, starting with 4% initially. Her year-one withdrawal would be $40,000 and her year-two withdrawal would be right in that same ballpark, perhaps a bit higher if she takes a raise for inflation. Behind the scenes, however, her portfolio could have dropped to $700,000 in year two of retirement, bringing her actual withdrawal percentage to 5.9% that year. She maintained her standard of living but did so at the expense of her portfolio’s sustainability.

Adjust withdrawals based on affordability

In practice, retirees may be more flexible in their withdrawals, taking more in strong market environments and less in weak ones. Such strategies, whether the RMD method or Jonathan Guyton’s 'guardrails' approach, add more variability to the retiree’s spending in exchange for improving the portfolio’s sustainability. Much of the latest research around sustainable withdrawal rates points to the benefits of flexibility for retirees who would like to ensure that they don’t run out of funds prematurely.

A key challenge for setting your withdrawal rate in retirement involves weighing how much variability in cash flows you’re willing to endure in exchange for improving your portfolio’s sustainability. Ultimately, it’s a highly personal decision and one that can get lost in the discussion of the right withdrawal rate.


Christine Benz is Morningstar’s Director of Personal Finance. This article does not consider the circumstances of any investor. Minor changes have been made to the original US version for an Australian audience.

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December 13, 2021

I'm not sure it's a particularly helpful scenario given the +$1M balance. If they're running out then I trust they've enjoyed themselves. I find the timing of such old topic interesting given it's contrary to the intent of the RIC (Retirement Income Covenant) now in front of parliament. The RIC is fundamentally about ensuring it's all drawn down rather than left is a tax free environment

Georgina Cane
June 25, 2022

I couldn’t agree more! The article also doesn’t acknowledge the Aged Pension as the ultimate safety net nor the fact that even if we wanted to mandatory withdrawals are set higher than 4%. And, before Graham Hand leaps in and says you don’t have to spend it I would ask the fundamental question: is the purpose of running your own SMSF so you can leave an inflated inheritance to your kids or the cats’ home or is it to enjoy? I really don’t think this US style opinion piece reflects well on Morningstar.

Ross Clare
December 13, 2021

The "'4% rule'' is a very US thing as the 4% relates to the initial account balance amount, with drawdowns increasing each year in nominal terms with inflation. After 20 years it is likely to lead to withdrawals much higher than 4% of the remaining balance as the drawdown amount increases in dollar terms with the account balance also going down in nominal terms. However, in the end the actual drawdown amounts might not be that different to what are required by the aged based factors applying in Australia.
The US also does not have a means tested Age Pension so while the rule might more or less work in the US it is less fit for purpose in Australia. Simple rules have a certain attraction, but there are plenty of online calculators available in Australia to run through different scenarios.

Jon Kalkman
December 11, 2021

Before the 2013 election, the Coalition, then in opposition, promised to review the mandatory pension withdrawals in recognition of our increased longevity. Once in government, they were captured by Treasury. As we have seen in the Retirement Income Review Report (which is essentially a Treasury document), Treasury is very keen to limit the amount held in super and passed on to beneficiaries. The reason for this concern is the generous tax concessions that super attracts, particularly in pension phase.

In fact, mandatory pensions are the trade-off for the zero-tax on earnings in a pension fund. The mandatory pension is set by the age of the member and is calculated as a percentage of the value of their fund balance at 30 June, and must be paid in cash, regardless of the actual income earned by the fund. Failure to meet this requirement means that fund will lose its tax-free status and will be taxed as an accumulation fund.

If the fund income is insufficient to pay this cash withdrawal, some assets must be sold because a pension fund cannot accept new contributions. Managing this cashflow and liquidity are just two more tasks the trustee of the fund needs to consider. Residential property can be a headache in a pension fund both because of its low yield and poor liquidity. But this is problem that eventually everyone will face as the minimum pension at age 80 is 7% and at age 90 is 11%. We will all become sellers of assets and need to transfer that cash out of super, just as Treasury intended.

You don’t have to spend it, but you do have to remove from super. Of course you could hold all the assets in an accumulation fund where there are no mandated pension rules, but then the fund income is taxed at 15%.

Not everyone will agree with me, but I like shares in my pension fund. They often produce higher income, are very liquid and can be sold in small parcels. Most of all, they take full advantage of the fund’s tax free status because they are entitled to the additional income provided by franking credits refunds, so that the total income from each share is more than 40% higher than the dividend alone. The more income produced, the longer I can delay the need to sell assets to satisfy the pension requirement. There are other issues with shares that are easily managed.

I explained the full impact of franking credits in a pension fund here. (Issue 422)

December 11, 2021

There are many “experts” who claim we can improve the equity of super tax concessions by taxing earnings in pension funds at 15%. Aside from the fact that the money in a pension fund has already been taxed, they should be careful what they wish for.

If pension funds were taxed at 15%, no one would use one. Why would anyone use a pension fund when an accumulation fund would face the same tax but without the mandatory pension requirements. That means you could withdraw as much or as little as you pleased from the fund and leave the remainder to continue growing until your death.

That is precisely what has happened to those people forced into an accumulation funds by the Transfer Balance Cap. By definition, this money in their accumulation fund is not needed for a comfortable retirement but it makes a wonderful estate planning tool for their beneficiaries.

It is the complete opposite of what super was intended for or what Treasury wants to see happen.

December 12, 2021

You make a good case Jon, especially when considering the franking credits.
The linked franking credits article is well worth a read, even for a second time!
I was also interested to note Treasury's very guarded view on this subject, and the recent history.

garry height
December 10, 2021

where did they get the figure start with 500000 thousand and in 10 years you end up with 1.4 million im not seeing anything like that

December 09, 2021

What average annual % return is being assumed here when they say drawing down 4% pa your super will be depleted in 25 years?

The average Balanced super return over the long run is in the order of 7-8% pa. So if you are drawing down 4%, your principal or capital base is still increasing, not depleting.

December 09, 2021

That baffles me also.I retired with around $360K in super, $36K has been withdrawn every year for 6 or 7 years ,now it is down to around $285K,at this rate it will never run out .

If I had been drawing down @$24 K per annum I would probably have more in that what I started with .As it isn't really needed most of it went back in to an accumulation account and claimed as a tax deduction,I retired early.Some went back into buying shares outside of super.
Now I can't contribute and I really need to stop being lazy and put everything into pension phase so it is tax free.This would take the retirement fund back to circa $380K.

December 10, 2021

"drawing down 4% pa your super will be depleted in 25 years": Implied is that, to have an acceptably small probability of not depleting funds within 25 years, the real return is 0% and nominal return is equal to inflation rate. Also implies is a higher probable that funds may not deplete and be a multiple several times the commencing value.

To 97 from 67, withdraw 4% / y, 3% / y inflation, commencing with $1, ending with $0; nominal rate of return: = (1 + RATE((92-67), 4%, -1, 0, 0)) * ( 1 + 3%) - 1 = 3.0% Real return rate of 0% results in no earnings and all capital being withdraw after 25 y. 

December 09, 2021

Why are you saving all you life if you never intend to draw down on the capital? The minimum draw down rates are in place for sustainability and fairness. If your return isn’t sufficient to meet the required draw down rate, then you draw down safely on your capital. Plan (prudently)for what you need assuming a draw down and invest accordingly. Anything extra is a bonus.

December 09, 2021

Clearly, it seems like most readers of Firstlinks - most likely not representative of "average Australian" - are too well off to need to rely on captial drawdown. Which is perfectly fine but the discussion on 'drawing down captial safely and efficiently" is largely irrelevant for them...

SMSF Trustee
December 09, 2021

Exactly right, Young.

Saving has always, for the average person, been something you do "for a rainy day". You put something away instead of spending it now so that the capital can be used when needed.
Retirement is the ultimate rainy day. Sure, the saving takes place over a long enough period that the capital grows from investment returns, but the draw down during retirement is supposed to include some or all of the capital at the time you retire. Maybe not on day 1, but eventually.
Anyone who complains about "the system" forcing you to draw down capital from your super, doesn't understand the point of it all.

Max Lewis
December 09, 2021

This is all news to me. I would have thought that an intelligently constructed portfolio, could provide sufficient certainty of income but at the same time the potential of the overall portfolio to produce an investment return, which gets close to, equals or exceeds the amount being withdrawn each year, expressed as a percentage of the capital base, would have done the trick .

December 10, 2021

The point I was making below is that not all investment asset classes held by a SMSF are the same.
A portfolio largely made up of shares, cash or bonds is obviously a lot more flexible when it comes to making a 4 - 6% drawdown from, than an investment portfolio that contains property.
A lot of SMSF investors purchase property because they like the security that the long term rental income can provide, however the relative net yield it generates is often lower than the mandated drawdown levels required from a pension phase asset (ie less than 4%).
The rental income may in fact be enough for a retiree to comfortably live off, but not high enough to meet the governments mandatory, age specific, drawdown requirements. Hence the problem arises with this asset class that an investment property must be sold off in its entirety if it is not capable of generating the minimum drawdown amounts. There is not a similar issue with the other above mentioned asset classes.
An SMSF investor does not need to sell off an entire share portfolio if it does not generate a 5% return for a year or two, but an investor who has a property in his SMSF may need to do just that. This is particularly the case over the past year where property values have risen but the rental incomes haven’t, making the rental yield even lower.
My case is that the investment universe for SMSFs is wider than just shares, bonds and cash. Property and the income it generates has its place in it. The minimum drawdown requirements, that are so much easier to execute with shares and bonds, do not easily dovetail with the kind of returns made from property rentals.
A lot of ‘Average Australians’ have invested in property through their super fund in the hope of generating an income in their retirement one day.
It would be good if the government's retirement income policy people had a more flexible way of dealing with it.

December 09, 2021

Hi Graham, I think Christine Benz's Morningstar research on retirement income is very worthy of further analysis by officials in the Australian Government's Retirement Income Policy Division.
I for one feel the mandatory 4% drawdown for those in Pension mode at 60 years of age (and rising to 5% at 65 yr, 6% at 75 yrs etc) is too restrictive, especially for trustees of SMSF's.
Without going too much into the history here, the mandated drawdown amounts of 4%, 5% and 6%, which covers the age range from 60 to 80 years of age, have been in place since the start of FY 2013/14. By comparison to today, a 2 year bank term deposit with NAB back in June 2013 earned you approx 4.2% interest, and rental yield for an Australian landlord was averaging just slightly under 4% according to Reserve Bank data. Even dividend yields were higher and more reliable from income producing stocks like banks, REITs and utilities. In other words, the yield that a retiree could depend upon was sustainable enough so that drawing down 4 - 6% would not adversely affect the capital base that the income was drawn from. The situation now is that yields are much lower. To draw down 4 to 6% can only be done by significantly eating into the capital base, which then further reduces future cash yields in the following years. This just makes the nest egg run out faster.
Of course, if the retiree is living off any form of rental income, then they are unlikely to be receiving a 4% return and unless they have additional cash in their fund, then they are forced to liquidate their asset to cash, as unlike a share portfolio, they cannot sell off the bathroom to have the extra cash they need to draw down. I believe that if a retiree in pension mode feels they can comfortably live on a 2% to 3% drawdown, so as to help make their nest egg last for the duration of their lifetime, then that should be their decision to make.

December 09, 2021

The Australian Government has set MINIMUM drawdown rates (other than covid years of 2019/20 and 2020/21) of 4% <65yrs, 5% 65-74yrs, 6% 75-79yrs, 7% 80-85yrs, 9% 85-89yrs, 11% 90-94yrs, 14% >95yrs.
To my limited knowledge you cannot down any less, unless the someone can enlighten me. The system appears to be designed to deplete your super if you live long enough.

Graham Hand
December 09, 2021

Hi David, that is true, but as I've said, it does not need to be spent. It just comes out of super, and as Dudley has calculated, it is probably still in a tax-free environment outside super so taking it from super is not a disadvantage.

December 09, 2021

and reduced minimum drawdown for Fin Yr 2021/22 just in case some missed that news which almost flew under the radar

December 09, 2021

"reinvest in a possibly less tax free environment and thereby get a lower real return":

Tax free threshold for senior couple: $63,314 / y.
Capital @ 5% nominal return: = $63,314 / 5% = $1,266,280.

Retiring with all financial assets in super, vast majority would never save so much of super withdrawals as to accumulate enough personal financial capital as to pay tax on the earnings. Those that do have recourse to investing in home improvement where capital gains are tax free and Age Pension Means Test free.
For those precluded from Age Pension by assessable assets > $891,500,

Young T
December 09, 2021

The 4% guideline and similar variants are, ultimately "guidelines" only. Whilst it's interesting - academically - to talk about their implications, in reality, retirees are unlikely to blindly insist on taking the same amount (plus inflation adjustments) year after year knowing what/how the market is doing and its impact on their account.

Which is why more flexible rules that link each year's withdrawal amount to the latest portfolio value/account balance such as the legislated minimum in Australia are always going to be much more sustainable - by design. The question is then whether or not the variability in income from year to year is acceptable to retirees. Again, in Australia, for those receiving either a part or a full Age Pension, the variability in the total income is somewhat "smoothed" due to the Age Pension (either as it being the majority of the total income or it being increased to a high amount as a result of means-testing). For those with a significant starting balance, the outcomes might be acceptable as income level - despite the variability - would remain above a certain "minimum living standard". However, the same can't be said for those with a modest balance and follow the legislated minimum rule.

Ignoring other insured/pooled longevity solutions , there are improvements to be made in guiding retirees to draw down more than the legislated minimum without sacrificing the sustainability of the portfolio. Both Advice and smarter drawdown designs can help with that.

December 08, 2021

It’s all a bit academic and ignores the government mandated age related withdrawal percentages! 4% is the minimum, stepping up to 5% after age 65! Furthermore, despite the unknowable longevity issue, Australia does have a reasonable fall back pension system to provide some support if the wheels come off prematurely.

Graham Hand
December 09, 2021

Yes, James, there is a mandated withdrawal from super but it does not need to be spent. All it causes is a transfer from the super system to another vehicle so there is still an effective ability to 'withdraw' a lower amount.

December 09, 2021

Yes Graham, however that is not what the article infers! It infers you can draw less than 4% and you can't, other than in a year like this, where lower drawdowns are permitted due to Covid/markets

Any retirement plan should start with the "mandated drawdown rates", personal cost of living and, if there is anything "left over" and there often isn't, how that should be invested and what the tax implications may be. For many retirees it will make no difference if funds accumulate outside Super, for others it will! Very personal!

December 09, 2021

Yes Graham, thanks I realised that. However, the system forces retirees to drawdown more than they should or would like and then reinvest in a possibly less tax free environment and thereby get a lower real return. I also acknowledge that during significant market ructions the government has given temporary drawdown relief by halving drawdown rates.

Perhaps significantly also, the rules make much older retirees then reinvest, possibly without advice (some won’t need it) when they may not be best equiped to do so!


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