This week's Chart of the Week comes from the State of Retirement Income Report 2024. It looks at where asset allocation and retirement withdrawal rates meet. What's a safe amount to take out of your retirement pot each year to fund your life?

Many investors would have heard of the 4% rule, which was an attempt to solve this question. It is an attempt to find a safe withdrawal rate that will address sequencing risk and longevity risk while maintaining an inflation adjusted standard of living which increases the original withdrawal amount by inflation each year.

Put simply, it is supposed to protect you from the misfortune of retiring when markets are falling (sequencing risk) while making sure you don’t outlive your savings (longevity risk).

The 4% rule is not a substitute for minimum drawdowns from Super, which were never intended to represent a “safe” withdrawal rate and are not a mandate to spend the money you’ve taken out of a tax advantaged account.

Based on a study in the early 1990s by a US financial planner named Bill Bengen, the 4% rule is ultimately a rule of thumb using historical data to try and provide answers for a future that is unique to you.

Ironically, that ‘rule of thumb’ – crafted more than 30 years ago – directly contradicts the disclaimer that ASIC and every other regulator in the world requires to accompany all mentions of investment returns… past performance is not indicative of future performance.

Morningstar's State of Retirement Income report attempts to add more confidence and accuracy to the withdrawal rate that retirees use. They do this by looking at future projected returns for asset classes, instead of past returns that were used to formulate the 4% rule. 

The base case research is conservative in that it sets 90% as the target success rate. That means that for a given withdrawal percentage to be deemed a success, it must have funded each year’s scheduled withdrawal in 900 out of 1,000 trials. At first blush, retirees might be inclined to gravitate to a 100% success rate, but doing so reduces starting withdrawal percentages significantly. On the other side of this, reducing the target success rate by even 5 or 10 percentage points – to 85% or 80% - has meaningful implications for starting withdrawals. It’s all about balance. The chart depicts the starting safe withdrawal percentages for varying asset allocations, with success-rate targets from 50% to 100%.

For a more in-depth analysis of the findings, you can read Mark LaMonica's analysis of the report here.

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