Key Takeaways

  • The 4% guideline is a good quick and dirty way to assess whether your retirement portfolio is on track, but it has a couple of drawbacks.
  • The young retiree would want to be a little bit more conservative in their starting withdrawal rate.
  • If someone is willing to be flexible in terms of their lifetime spending, they can set their starting withdrawal higher.
  • Lifestyle changes, like housing, transit, and travel, will need to be factored into the calculus of early retirement.
  • For people who are willing to do some type of work in their retirement, that can make a big difference in terms of the financial viability of the portfolio.
  • Whether you want to leave a bequest or “die with zero,” that should inform how you go about spending during retirement.
  • When planning for the softer aspects of retirement, you should be thinking about the positive, nonfinancial things offered by employment that you want to retain.

Margaret Giles: Hi, I’m Margaret Giles from Morningstar. Many people think about their portfolio value or their number as the sole determinant of whether they can retire early. But Morningstar’s Christine Benz believes that would-be early retirees should factor in other considerations, too. She’s here today to discuss some of the key ones. Christine, thanks for being here.

Christine Benz: Margaret, great to see you.

Drawbacks of the 4% Guideline When Planning Early Retirement

Giles: Some early retirees use the 4% guideline to decide if they have enough to retire. Is that a good starting point?

Benz: It’s definitely better than nothing. It’s a good quick and dirty way to assess whether your retirement portfolio is on track, but it has a couple of drawbacks that I would point out. One is that the 4% guideline—kind of the classical 4% guideline based on William Bengen’s original research—it does look back over market history, sort of asking the basic question, “If you happen to retire into the worst possible environment, what was the most that you could have taken out over a 30-year horizon?” So that’s why in our research that we revisit annually, we plug in some forward-looking return forecasts for the market in an effort to incorporate what equity valuations look like today, what bond yields look like, and inflation and so forth. So that’s one reason why you would want to build on the 4% guideline. And then the other big one for young retirees is just that a lot of the research that our team has done and other entities have done on safe withdrawal rates has mainly been on a 25- or 30-year time horizon, kind of a normal in-retirement time horizon.

The young retiree would want to be a little bit more conservative. If, say, someone’s 55 and planning to be retired for 40 years, that would necessitate a smaller starting withdrawal, all else equal. So when I look upon our 2025 retirement spending research, for example, over a 40-year time horizon, our starting safe withdrawal percentage was 3.3%. It was 3.5% over a 35-year time horizon. In our base case, which assumes a 30-year time horizon, it was 3.9%. So that’s a meaningful difference and suggests that if you’re coming into retirement, have that long time horizon, you’d probably want to be a little bit more conservative with your starting spend.

How flexible spending strategies can maximise safe withdrawal rates

Giles: Right. So you think a related consideration ought to be how flexible someone is willing to be when it comes to their spending. Why is that so important?

Benz: Yeah, this is a massive lever. And we see this in our research on retirement spending where if someone is willing to be flexible in terms of their lifetime spending and, specifically, if they’re willing to take less if the market’s down and they may be able to take more when the market’s up, they can set their starting withdrawal higher in acknowledgment of the fact that they’ll make these course corrections as the retirement unfolds. Amy Arnott works on this portion of our research paper. I think the highest starting safe withdrawal with one of these flexible strategies was closer to 6%. If you are that retiree who can make those adjustments, you should be able to start higher, but you do want to take a look at your budget and just make sure that you actually have the leeway to make those adjustments as needed.

Lifestyle changes for early retirement

Giles: Right. Lifestyle changes also factor into that calculus of early retirement. What kinds of changes should would-be retirees be thinking about?

Benz: Yeah, you can contemplate changes, small and large. The classic one is, oh, if you’re not commuting or driving your car anymore or driving as much that you may be able to spend less on transit costs. But there’s some big-ticket ones that can come into play. I was recently talking to a young retiree who had moved from a high-cost urban area in the Northeast to a lower-cost place, kind of a rural setting in the South, and had found the ability to realize significant savings in terms of housing costs, in terms of property tax costs. But of course, there are immense trade-offs involved in uprooting yourself and moving to a new location. But I think it’s great for people who are in that preretirement zone to assess what sort of lifestyle changes that they might be willing to make in an effort to bring their costs down.

For some new retirees, they might be contemplating lifestyle changes like heavy travel, things that actually may increase their spending. So I wouldn’t rule out that possibility in some retiree households.

Giles: Right. So there could be changes in both directions.

Benz: Exactly.

Role of work in early retirement

Giles: You think that preretirees should really be thinking about the role of work in retirement, which may sound counterintuitive, but what kinds of things should they be thinking through?

Benz: Yeah. That flexibility in terms of retirement spending is really a superpower for retirees, but so is the ability to earn at least some income. And some people may want to make an absolutely clean break. They might say, “I’m 100% done with this,” and I get it, but for people who are willing to do some type of work, whether it’s contract work or part-time work at a job that just doesn’t feel very onerous, that can make a big difference in terms of the financial viability of the portfolio, that if you are coming into retirement with reduced spending from the portfolio, everything gets easier. Even if you’re not making additional contributions to your retirement plan, if you’re just spending less, that can be a game changer. But you also want to be careful. I sometimes talk to retirees who are working, and I think the assumption is that they’ll be able to continue to do that work in perpetuity. You may not feel like it, you may not be able to, so that can’t be your total plan. You need to have a backup plan in case working longer doesn’t pan out for you.

Leaving a bequest vs. ‘Die With Zero’

Giles: Right. That’s helpful to think about. You also think that a person’s attitude toward lifetime spending and bequests should really come into play here. How so?

Benz: Yeah, this is a dimension of our retirement spending research that comes through loud and clear—that people who do not have a strong bequest motive should favor one of those dynamic portfolio spending systems because it’s going to encourage you to spend more of that portfolio during your lifetime. So take a step back, think about what you’re trying to accomplish during your retirement years. If you’re a retiree who’s in that sometimes called “last breath/last dollar” camp or the “die with zero” mindset, then by all means you should explore one of those flexible spending systems that will get you spending more throughout your retirement. And that might also mean giving some more away during your own retirement to see some of your money working for your loved ones during your lifetime. It’s a little bit of a Rubik’s Cube, but certainly the end goal for your money, whether to end up with a lot or end up with nothing, that should inform how you go about spending during retirement, should be a component of the discussion.

Nonfinancial planning for retirement

Giles: Absolutely. Finally, you’d urge people to think about the softer aspects of retirement. What should they be thinking about?

Benz: Yeah, they should be thinking about all of the things that they get from work. They should be thinking about the positive things that they get that are nonfinancial. So the social engagements, the maybe little bit of physical activity, the intellectual stimulation, the purpose, which is not to say you need to keep doing that job forever, but it is to say that you need to be thoughtful about replacing those good things as you contemplate your retirement. What is going to give you those things that you’re no longer getting from work? I often hear from retirees who have pent-up demand for leisure activities, and this is absolutely a time to pursue them, but as Michael Finke said in my book, you need something to relax from, and the best days are the balanced days where you get something done and you just enjoy your relaxation that much more.

Giles: I love finishing on that note. Christine, thanks for being here.

Benz: Thanks so much, Margaret.

Giles: I’m Margaret Giles, Morningstar. Thanks for watching.

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