Should advisors adjust their clients' retirement withdrawals based on the ups and downs of the market?

The answer is a qualified but sometimes resounding yes, according to new research from Morningstar, which finds that building out a more a disciplined market-driven approach for clients’ retirement withdrawals can lift both starting and lifetime withdrawals.

There are, of course, trade-offs associated with flexible withdrawal systems versus those that deliver steady cash flows, Christine Benz, Morningstar's director of personal finance, said in a new blog.

Benz’s discussion comes on the heels of Morningstar’s release in mid-November of a study that came to the “uncomfortable conclusion” that retirees who want a predictable income with a high degree of certainty around not running out, should keep their spending down, she said.

Rather than the 4.0% withdrawal rate that is often cited as the safest, Morningstar found that a 3.3% starting withdrawal amount is likely to be sustainable for balanced portfolios over a 30-year time horizon.

That's sobering, but there’s more to the story, said Benz, who added that even modest tweaks to the withdrawal system can help elevate starting withdrawal amounts.

“For example, taking fixed real withdrawals but simply forgoing an inflation adjustment following a losing portfolio year resulted in a 3.76% starting withdrawal rate for a balanced portfolio,” she added.

At the same time, truly flexible withdrawal strategies such as the guardrails strategy, which was developed by financial planner Jonathan Guyton and computer scientist William Klinger, can increase starting and lifetime withdrawals even more, Benz said.

Here’s how it can work. “By cutting back on withdrawals in down markets but allowing retirees periodic raises in good ones, the guardrails method supported a starting safe withdrawal rate of 4.72%—above the 4% guideline,” Benz said.

Depending on the variable method an advisor chooses to use for client portfolio withdrawals, Morningstar found that they can provide a little or a lot of lift a client’s baseline withdrawals.

Flexible retirement withdrawal systems, however, do a have a downside that advisors need to consider, Benz said.

While they “may elevate withdrawals over a retiree's lifecycle, they can also lead to undesirable volatility in household cash flows. In short, they may not be very livable,” she added.

In fact, according to Morningstar, “the same withdrawal systems that delivered the highest starting safe withdrawal rates led to higher cash flow volatility on a year-to-year basis during the drawdown period,” Benz reported.

What could go wrong? “A fixed real-dollar method is not inherently problematic if a retiree embarks on retirement in a period of low bond yields and/or high equity valuations. But if these factors also lead to lower market returns, the starting withdrawal amount that is then inflation-adjusted throughout retirement might need to be uncomfortably low,” Benz warned.

“Employing a flexible withdrawal system helps address the above-mentioned sequence of return risk while also allowing for the possibility of higher withdrawals during times when the market environment is more rewarding,” she added.

The level of wealth a client has will also influence how flexible they may be willing to be with withdrawal levels, Benz said.

“A key factor in whether a given withdrawal system is ‘livable’ is a retiree's level of wealth and the extent to which changes in the withdrawal rate might be a small nuisance or begin to have a significant impact on the retiree's quality of life,” Benz said.

Put another way, “it is a good bet (though by no means a certainty) that a 25% reduction in spending would have a bigger negative impact on the quality of life for the retiree who goes to $45,000 from $60,000 than it would for the retiree who needs to drop to $150,000 from $200,000,” Benz warned.

Less income means there is less room to cut discretionary expenses, she added.

Clients who have greater non-portfolio income sources are also likely to be more comfortable with more-flexible withdrawals, Benz said.

The retiree “who covers most of their basic living expenses—housing, food, utilities, and healthcare, for example—from nonportfolio sources such as Social Security, a pension, rental income, or an annuity will be better situated to absorb variations in portfolio cash flows than would the one who is relying more heavily on the portfolio to cover basic needs,” Benz said.

What is important for advisors and clients to consider, she added, is that variable systems like the guardrails system “tend to be more efficient, increasing withdrawals in up markets and ensuring that the retiree consumes more of his or her portfolio along the way.”

At the end of the day, choosing the right withdrawal method “is highly dependent on the retiree's personal situation: level of wealth, stability of preretirement income, and desire for certainty about not running out of money, among other factors,” Benz concluded.