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Specialists say the four% rule, a preferred retirement revenue technique, is outdated

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Market conditions are putting pressure on the 4% rule, a popular rule of thumb for retirees to determine how much money they can live on each year without worrying about running out of it later.

Withdrawing money from the nest egg is one of the most complex financial exercises for households. There are many unknowns – length of retirement, spending needs (such as healthcare costs), and return on investment, to name a few.

The 4% rule is intended to achieve a constant annual income and give seniors a high level of security that their funds will last over a 30-year retirement.

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The rule simply says that retirees can withdraw 4% of the total value of their investment portfolio in the first year of retirement. The dollar amount increases with inflation (the cost of living) the following year, as it does the following year, and so on.

However, market conditions – namely, lower projected returns on stocks and bonds – do not appear to be working in favor of retirees.

Given market expectations, the 4% rule for seniors "may no longer be practical," according to a paper released Thursday by Morningstar researchers. Nowadays, the 4% rule should actually be the 3.3% rule, they said.

While the cut may sound small, it can have a major impact on retirees' living standards.

For example, applying the 4% rule, an investor could withdraw $ 40,000 from a portfolio of $ 1 million in their first year of retirement. However, under the 3% rule, this payout drops to $ 33,000 in the first year.

The difference would be more pronounced later in retirement when you factor in inflation: $ 75,399 versus $ 62,205 in the 30th year, according to a CNBC analysis. (The analysis assumes an annual inflation rate of 2.21%, Morningstar's forecast average for the next three decades.)

Why 3.3%?

According to Christine Benz, director of personal finance and retirement planning at Morningstar and co-author of the new report, retirees have seen "triple" positive market developments over the past few decades.

Low inflation, low bond yields (which drove bond prices higher), and strong stock returns have helped revitalize investment portfolios and secure payout rates, she said.

Benz said that the dynamic almost lulled pensioners into a false sense of security.

Bonds become "very unlikely to make strong profits over the next 30 years," according to the report, and high stock prices are likely to fall when they return to average. Analysis acknowledges that this outcome is likely, but not inevitable.

(While inflation has been historically high in the past few months, Morningstar expects a slowdown over the long term.)

In the first few years of retirement, investment returns are particularly important due to the so-called subsequent return risk. If you take too large an amount out of the nest egg in the first year or in the first few years – especially from a portfolio that is depreciating at the same time – the risk of running out of money later can increase significantly.

That's because the portfolio has fewer opportunities to grow once investments rebound.

Reservations

Of course, there are numerous caveats to this analysis of the 4% rule.

On the one hand, the 4% rule (and the updated 3.3% rule) only takes into account your own portfolio investments. It does not take into account non-portfolio sources of income such as social security or pensions.

For example, retirees who delay social security entitlement until the age of 70 receive a higher guaranteed monthly income stream and may not have to rely as heavily on their investments.

In addition, the rule of thumb uses conservative assumptions. For example, it uses a 90 percent chance that seniors will not run out of money during a 30 year retirement.

Retirees who are at more risk (i.e., a 65-year-old turns 20 on average today.)

Perhaps most importantly, the rule assumes that spending does not adjust to market conditions. However, this may not be a fair assumption – research shows that seniors generally fluctuate their spending as they retire.

In this regard, according to Morningstar, retirees have some options to ensure the longevity of their investments. In general, these will require lower withdrawals after years of negative portfolio returns.

For example, retirees can forego inflation adjustments during these years; You can also choose to reduce your typical payout by 10% and go back to normal once investment returns are positive again.

"There are some simple tweaks you can make," Benz said. "It doesn't have to be a huge strategy; it can be a series of these incremental optimizations that can make a difference."

However, there are tradeoffs to be able to be flexible. Most importantly, these annual adjustments in spending can mean large fluctuations in the standard of living from year to year.

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