5 Ways to Boost Retirement Income

Say what—3.7%?

That was likely the response of many preretirees and retirees when we released our retirement spending research last December. For people seeking a high degree of certainty that they’d be able to receive an ultra-consistent stream of income from their portfolios over the next 30 years, my colleagues Amy Arnott, Tao Guo, Jason Kephart, and I concluded that 3.7% was a reasonable starting percentage. Retirees could then inflation-adjust that initial amount throughout their retirements. That light withdrawal rate is an outgrowth of both the ultraconservative spending system we use as our base case and our team’s muted return expectations for US equities for the next decade. In short, our methodology tilts toward caution because we assume that most people would rather play it safe than risk running out of money in retirement.

The good news is that retirees don’t have to settle for 3.7%, or $37,000 initially on a $1 million portfolio. In fact, a healthy share of the paper is dedicated to strategies that can elevate that starting withdrawal rate. These income-boosting strategies range from modest tweaks to more meaningful adjustments throughout retirement.

Below, I’ve outlined some of the strategies that help boost in-retirement portfolio cash flows, along with key caveats to bear in mind if you decide to pursue any of them.

Strategy 1: Settle for a Lower Success Rate

Starting safe withdrawal rate on a balanced portfolio: 4.2% (80% success rate rather than 90% in the base case)

One of the simplest ways to lift starting portfolio withdrawals is to adjust the desired success rate downward. We use a 90% success rate in the base case of our research. That means that we’re targeting the highest starting withdrawal rate that one could have taken so that the balance left over after 30 years was positive in 900 of 1,000 trials in our Monte Carlo simulations.

On the surface, a 90% success rate might sound dangerously low: Doesn’t everyone want a 100% assurance of not running out of money? But using a lower success rate results in meaningful increases in starting safe withdrawal percentages. Taking the success rate down to 85% boosts starting safe withdrawals to 4%; reducing it to 80% takes the starting safe withdrawal percentage to 4.2%.

Retirees who begin with a lower success rate and higher starting withdrawals will fare best if they’re also willing to revisit and potentially adjust their spending (beyond simple inflation adjustments) once retirement commences. That’s the general thesis in work from Derek Tharp, who concludes that retirees could reasonably start with a success rate as low as 50%—and a correspondingly higher starting withdrawal percentage—as long as they are prepared to make downward adjustments in weak market environments. As with all strategies that involve downward adjustments in spending, this approach will be most appropriate for retiree households with a high level of discretionary spending.

Strategy 2: Plan for Spending Decline Throughout the Life Cycle

Starting safe withdrawal rate on a balanced portfolio: 4.8%

Another strategy for boosting starting withdrawal rates is to assume that the retiree’s spending will trend down throughout the retirement years. Several studies have demonstrated that retirees tend to spend less as they age: David Blanchett’s research “Estimating the True Cost of Retirement” as well as research from the Employee Benefit Research Institute and T. Rowe Price. Retiree households of all net worth levels exhibit this pattern, indicating that retirees aren’t spending less because they’re worried about running out of money.

We’ve modeled that downward slope in spending into our research these past few years. In a variation on our base case, we assumed that retirees’ real spending declined by 2% per year throughout retirement. Not surprisingly, factoring in a downward slope in spending results in a higher allowable starting spending percentage of 4.8% on a balanced stock/bond portfolio.

Of course, the obvious trade-off with starting spending higher and assuming a decline is that retirees will have to engage in some belt-tightening as they age. Additionally, retirees employing this spending model will want to be sure to have a rock-solid long-term-care plan in place—either long-term-care insurance or a dedicated long-term-care bucket—to reduce the risk of high out-of-pocket long-term-care costs later in life. Finally, because it assumes a decline in real spending, this strategy delivered the lowest lifetime cash flows of any of the core strategies we tested. As such, it’s inappropriate for retirees who aim to maximize their own consumption during their lifetimes.

Strategy 3: Let History Lead the Way

Starting safe withdrawal rate on a balanced portfolio: 5.5%

In our withdrawal-rate research, we employ forward-looking return forecasts from our colleagues in Morningstar Investment Management; the goal is to factor in current market conditions, including equity valuations, bond yields, and inflation. Bond yields are indeed looking a bit better recently, but thanks to the long-running rally in US equities and correspondingly high valuations, the team’s return forecast for US stocks is pretty muted, especially for the next 10 years. For the 30-year drawdown period we employ as our base case, we use a 7.4% return assumption for US large-growth stocks and slightly higher return assumptions for the other equity asset classes.

That’s a key reason why our starting withdrawal percentage is lower than what would have been supported historically with a balanced portfolio. Employing return assumptions in line with historical norms, rather than assuming some reversion to the mean for US growth stocks over the next two decades as MIM’s return forecasts do, enlarges starting withdrawal percentages. Using the same type of Monte Carlo simulations based on long-term historical returns for each asset class, rather than MIM’s forward-looking projections, increases the starting safe withdrawal rate to 5.5% for a 50% stock/50% bond portfolio and 5.7% for a 60% stock/40% bond mix.

Of course, the risk of taking those higher withdrawals and running with them is that market conditions could be worse than they’ve been historically. Retirees who want to lean into historical returns would be wise to stay open to course corrections, ratcheting down spending if stocks experience a sharp downdraft early in their retirements.

Strategy 4: Employ a Flexible Approach

Starting safe withdrawal rate on a balanced portfolio: 4.2% (forgo inflation adjustment after a losing year) to 5.1% (Guardrails)

We devote a whole section of the research paper to strategies that tether withdrawals to the portfolio’s value with an eye toward enlarging starting and lifetime portfolio withdrawals. Taking a fixed percentage of a portfolio year in and year out is the most basic version of such a flexible approach, but we took it off the table because we assumed that cash flows would be uncomfortably volatile for most retirees.

Instead, we tested several other strategies that aim to adjust with portfolio fluctuations while also smoothing out cash flows for livability. The simplest of these was skipping the inflation adjustment in spending the year after a portfolio declined in value. That simple tweak lifted the starting safe withdrawal percentage on a balanced portfolio to 4.2% (versus 3.7% for our base case). Strategies that entail more frequent adjustments result in even higher starting withdrawal strategies. For example, the Guardrails strategy, which involves annually retesting the spending rate based on how the portfolio has performed, results in a starting safe withdrawal percentage of more than 5% on a balanced portfolio and even higher percentages for more equity-heavy mixes.

Obviously, retirees who employ one of these variable strategies need to have wiggle room in their budgets to make periodic course corrections. A strategy involving less-frequent spending adjustments, like forgoing an inflation adjustment following a losing year, will be most appropriate for retirees seeking something like a retirement paycheck. Meanwhile, a Guardrails-type strategy will suit retirees who can tolerate more course corrections because much of their household spending needs are coming from nonportfolio income sources like Social Security.

Strategy 5: Change the Duration

This is probably the least palatable of the income-enlarging options on offer, but it’s worth discussing all the same. We use a 30-year horizon in our research; for someone who’s 65, for example, we assume they’ll be spending until they die at age 95. But some retirees may have shorter spending horizons than that, either because they’re continuing to work and delaying portfolio withdrawals or because they expect to live fewer than 30 years in retirement. Indeed, the average life expectancy for a 65-year-old in the US is 17 years for men and 20 years for women. But income differences play a major role, with higher-income people enjoying substantially longer life expectancies than lower-income people.

Shortening the time horizon results in a higher safe withdrawal rate than our 30-year base case: The highest safe spending rate for a 25-year horizon is 4.3%, and for a 20-year horizon it’s 5.2%.

The major caveat with those planning to delay retirement or assuming a shorter-than-average life expectancy is simply that it’s difficult to predict the future. Preretirees tend to be poor judges of when they might actually retire, generally assuming they’ll continue to work longer than they actually do. And while an individual’s health and family history can help inform life-expectancy assumptions, life expectancy can be difficult to forecast, too.