The 4% popular annual withdrawal rule was first formed during a period when interest rates felt relatively stable, and bonds were able to provide meaningful income without taking any kind of excessive risk. Unfortunately, this environment is no longer available, and after years of near-zero rates followed by the fastest rate hiking cycle in decades, so any assumptions that underpinned withdrawal rates are basically gone forever.
Rising interest rates will change the math for retirees in ways that aren’t always easy to follow, as higher rates mean better yields on bonds and cash alternatives, which sounds positive. However, it also means lower bond prices for existing holdings, compressed equity valuations, and increased volatility across asset classes. The net effect on safe withdrawal rates depends on when you are in the rate cycle and how a portfolio is structured.
For retirees who entered this period in life during zero-rate environments, like in 2020-2021, rising rates led to portfolio losses, which reduced the sustainability of withdrawal plans. If you’re looking to retire today, rates are higher than they were five years ago. The situation is actually improving, as higher starting yields on bonds and dividend stocks support higher sustainable withdrawal rates than were possible when 10-year treasuries were yielding 1.5%.
How Rising Rates Damage Bond-Heavy Portfolios
It’s important to start with the understanding that bond prices move inversely to interest rates, meaning rising rates cause existing bonds to lose value. A portfolio holding intermediate-term bonds has likely lost 10-15% in value in 2022 as the Fed started to hike rates very aggressively, and long-term bond funds fared even worse.
For retirees who are using systematic withdrawals from a balanced portfolio, these losses force them to sell more shares to generate the same income, which permanently reduces the portfolio’s ability to recover when rates stabilize. The traditional 60/40 portfolio, or 60% stocks and 40% bonds, got hit from both sides as rates rose. Stocks, in turn, declined as higher rates made future earnings less valuable and increased borrowing costs for companies.
In addition, bonds declined because rising yields made existing bonds worth less. The result of this scenario for retirees who were following a 4% withdrawal rule was that they suddenly found themselves withdrawing from portfolios that were down 15-20%, which is exactly the sequence of returns risk that can destroy even the best retirement plans. The safe withdrawal rate that worked when bonds provided stability and positive returns no longer works the same way when bonds are delivering negative returns alongside equities.
The Hidden Benefit: Higher Starting Yields Improve Sustainability
While rising rates damaged existing portfolios, they also improved the outlook for retirees who are looking to retire today or who can reposition their portfolios. When 10-year Treasury yields were below 2%, a conservative bond allocation wouldn’t generate much income. Now, with yields somewhere in the 3-4% range, the same allocation produces meaningful cash flow without reaching for high-yield corporate bonds or more risky alternatives.
Dividend stocks are also seeing the benefit from higher rate environments as bond yields rise, dividend-paying equities become more attractive relative to growth stocks that don’t pay income. Companies with strong balance sheets and sustainable dividends, names like Enterprise Product Partners (NYSE:EPD | EPD Price Prediction) at 6.88% and Realty Income (NYSE:O) at 5.65% provides yields well above Treasury rates while also offering the potential for growth.
A retiree building a portfolio today can construct a 60/40 portfolio that yields 4-5% or more, which is dramatically better than what was achievable just a few years ago. This higher starting yield also means withdrawal rates can be more conservative while still generating sufficient income, which improves the odds the portfolio lasts through a 30-year retirement.
When You Should Reduce Your Withdrawal Rate
If you retired in 2020 or 2021 with a portfolio optimized for a low-rate environment, heavy-allocations to long-duration bonds, growth stocks, or low-yielding stocks, the rise in rates that still exists today, even as they come down, has likely damaged your portfolio enough that maintaining your original withdrawal rate from just a few years ago.
A portfolio might have lost 20% in 2022 and is still recovering, and should probably shift from a 4% withdrawal rate to closer to 3% until portfolios can stabilize and rebuild value. The other scenario where reducing withdrawal rates makes sense is when retirees are holding significant bond positions that are underwater.
If your bond allocation is showing meaningful unrealized losses, selling these bonds to fund withdrawals locks in those losses permanently. In this situation, it’s advisable to temporarily reduce withdrawals and allow the bonds to mature at par, which preserves capital and avoids forced sales at depressed prices. This might mean cutting some discretionary spending, but it’s better than depleting a portion entirely.
When Higher Rates Actually Justify Higher Withdrawals
For retirees who are entering retirement today with fresh capital to deploy, higher interest rates actually support higher sustainable withdrawal rates than the traditional 4% rule. When you can build a portfolio yielding 5% from a mix of investment-grade bonds, dividend growth stocks, and income ETFs, a 4.5% withdrawal rate becomes more realistic because you’re not forced to sell as many shares to generate income, and much of your withdrawal is covered by the natural yield the portfolio is going to produce.
The key here is to properly distinguish between portfolios damaged by rising rates and those built in the current rate environment. If you’re 60 years old with $2 million and you’re constructing a portfolio today, you can allocate to bonds yielding 4-5%, dividend stocks like American Electric Power (NASDAQ:AEP) at 3.35% with growth potential, and covered call ETFs like JPMorgan Equity Premium Income ETF (NYSE:JEPI) at 8.19% for enhanced income.
This portfolio might sustainably support a 4.5% or even a 5% withdrawal rate because the underlying income generation is far higher than it was even five years ago. The improved yield environment we’re experiencing today more than offsets any volatility risk as long as you’re not chasing unsustainable yields from distressed companies or overleveraged REITs just to hit some arbitrary income target.
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