Smart Retirement Planning Is About More Than Just Avoiding Failure


I’ve always been a big fan of road trips. Some of my fondest memories involve cruising through unknown roads soaking in beautiful scenes with the music turned up on the radio. Of course the best road adventures also involve a bit of concentration, as the most magnificent mountain vistas often come hand-in-hand with challenging hairpin turns. So even though road trips are a blast, you still have to be careful to avoid dangerous situations like taking a cliff-side turn with too much speed.

As a responsible driver acting in an abundance of caution, imagine for a moment planning your route ahead of time and deciding to set your cruise control for the entire trip to the minimum speed required to safely navigate the most dangerous turn. So even with miles of straight highways with no other cars in sight, you choose to never exceed 10mph. Sure, it will take you ages to get to your destination. And it might seem like not only an extremely inefficient way to travel but also a complete waste of the engine under the hood, but at least you won’t have to worry. Is it worth it?

I assume most people will find that idea completely silly and unrealistic, as dynamically adjusting your speed to the conditions of the road is a natural part of any intelligent driving experience. So why do so many people take this over-cautious approach with their retirement planning?

To explain, let’s take a quick step back and talk a little about safe withdrawal rates — the amount of money that one could have historically spent from a retirement account every year without prematurely depleting the portfolio over their lifetime. Tons of research has been done on this topic, and I’ve already covered many of the inherent assumptions that don’t really hold up in the real world. From the asset allocation studied to the country it applies to and even the definition of success, many of the most popular withdrawal rates studies contain a variety of assumptions that may not necessarily make sense in your personal situation.

Well, there’s one more that deserves attention — the default assumption that retirement spending is constant in inflation-adjusted terms and set sufficiently low to safely make every withdrawal even in the worst retirement timeframes. It’s the financial equivalent of never exceeding the slowest speed on your road trip, and for most people who stop to really think about the implications it intuitively makes zero sense. While I do appreciate the conservative mindset of protecting retirees in the worst case scenarios, I also can’t argue with the critique that it’s simply not a rational use of resources in all of the other scenarios.

Of course I’m not the first person to notice this limitation. William Bengen, the author of the original paper on safe withdrawal rates that established the famous “4% rule”, subsequently published ideas for how to make the fixed spending assumption more flexible. Smart financial minds like Bob Clyatt, Michael Kitces, and the team of Jonathan Guyton and William Klinger have similarly modeled a variety of different withdrawal strategies designed to maintain safety while maximizing the utility of the money you’ve been blessed to save. And brilliant researchers like Wade Pfau have done an impressive job of spreading the word about the options out there. So why does the simple constant dollar spending assumption persist as the most common choice for retirement research?

I assume it’s the same reason I struggled to create a tool to add to the site to study this topic. It’s complicated! And frankly the number of possible permutations are both a blessing and a curse.

Long-time readers of Portfolio Charts may remember that I used to have a tool designed for this very issue called the Retirement Spending calculator. I removed it from the site last year not because I doubted its usefulness but simply because it was extremely laborious to maintain. With so many different possible spending strategies, creating and updating unique sets of calculations for every method became a real pain and was a distraction from the many other things I wanted to work on. I’ve continued to offer the Withdrawal Rates calculator to study how asset allocation and retirement duration affects the numbers, but because it uses the same constant dollar spending assumption I fully admit there is a lot more room for exploration.

Well, sometimes the universe conspires in unison to send you a message. First, there were the many readers who took the time to write to express their interest in the tool (thank you!). Then I added the Sandwich Portfolio to the site, which reminded me of Clyatt’s 95% rule for retirement spending that I wasn’t properly accounting for. Michael Kitces really drove home the need recently with an excellent article on the topic containing his lament that “modern retirement planning software is very limited in its ability to model such dynamic spending strategies.” And Monevator just wrote a terrific summary on “why the 4% rule doesn’t work” based in no small part on the inflexibility of the constant spending assumption.

When the universe speaks, I listen. And as a natural-born problem solver, I recognize that there’s a critical need for more information on flexible retirement spending strategies and I want to do something to help. So rather than just throw up my hands at the complexity of the topic, I dug in and found a new approach.

Long story short, and after many long days and nights of research and tinkering, the Retirement Spending chart is back and better than ever.

At a high level, the Retirement Spending chart models every real-world retirement period we have data for* by tracking two different sets of data — the account values and the withdrawal amounts. While the charts may resemble a Monte Carlo simulation, every line tracks an actual historical retirement date and sequence of returns so it’s all about measurable real-world performance rather than theoretical models. You can sort of think of it like the venerable FIRECalc but with way more assets, more control over the spending method, and the ability to seamlessly model portfolios domiciled outside of the United States.

(*) In case you’re wondering, read this for more info on how the timeframe affects the numbers.

So where are the fancy-sounding spending options like Guyton-Klinger and the Clyatt 95% rule? That’s where the tool works smarter and not harder. Rather than make a list of every spending strategy and model them one at a time, I researched lots of options and compiled a list of the variables required to replicate any strategy you like. While there will always be a new idea or little detail not covered, believe it or not the vast majority of withdrawal strategies can be largely reduced to just four primary variables:

Withdrawal Rate : the percentage of the portfolio you withdraw every year to fund your retirement expenses

Change Limit : The maximum amount that a withdrawal can increase or decrease from year to year

Account Trigger : A simple rule for when you’re allowed to increase or decrease spending based on how the portfolio is doing relative to its original value

Withdrawal Limit : The minimum or maximum withdrawal you realistically need to pay the bills and live a happy life regardless of what a flexible spending strategy might recommend

Got it? That’s really about it!

For an example of how the chart works, let’s start with a few common assumptions in the retirement research community and model a US-based portfolio of 60% large cap blend and 40% intermediate term bonds, using a constant dollar spending assumption, and with the goal of lasting at least 30 years.

To model the idea of never changing the withdrawal beyond inflation, let’s enter 0% for both the increase and reduction change limits. In this situation the other options are grayed out because they don’t matter when there is zero change in spending. We can then tinker with the annual withdrawal until the first failure was at the end of 30 years. The chart rounds that number to one decimal, but for reference 4.17% seems to do the trick.

The first thing to notice is that the 4.17% matches the well-known 4% rule (independently calculated with the same assumptions) reasonably closely so we know we’re on the right track. It also matches the Withdrawal Rates calculation for the same timeframe, so we know the methodology is solid and repeatable. Next, look at the straight line Withdrawal Amounts of a constant $42k per year adjusted for inflation and keep that image in mind once we get to other possibilities.

And finally, with everything set up properly take a good long look at the Account Value chart. While the worst case scenario ran out of money in 30 years, the best case scenario soared to near $7 million! And that’s in inflation-adjusted dollars, so the practical purchasing power really is as big as it sounds. That’s what Kitces is referring to when he talks about the “extraordinary upside potential” in retirement.

So speaking of Kitces, let’s next see how his recommended ratcheting system* might affect the results. The basic idea is to allow a spending raise of 10% whenever the portfolio is at least 50% higher than its original value while never allowing a spending cut.

(*) Be sure to read the withdrawal methodology details in the calculator documentation for a few small caveats that shouldn’t make a big difference but are certainly worth noting in the spirit of transparency.

To do that, we keep the reduction at 0% but modify the potential increase to +10%. This opens up a few other options, and the one we need is the account trigger. Set that to +50%, and you’ll see the trigger line pop up on the Account Values chart at a level 50% over the original account value. With that activated, no spending increases will be allowed until the account reaches $1.5mm. And finally, you’ll notice the gray X in the withdrawal limit box. The Kitces Ratchet method does not utilize withdrawal limits, so the X disables that rule and allows any change regardless of the withdrawal amount.

See the difference? By preventing reductions in spending, the worst case Account Value scenario remained unchanged from the constant dollar method. But by allowing 10% increases when account values were high, the Kitces method safely spent more money in the good times and prevented the account values from unnecessarily running wild.

Also note that you can now see a few interesting tidbits in the Withdrawal Amounts chart. First, the ratcheting behavior is obvious with withdrawal levels only going up and never down. Second, do you see how the withdrawals didn’t change at all for the first three years? Look up and note when the account values first crossed the increase trigger. That’s how the trigger works. And finally, note how the spending increases have a relatively gentle ramp without rapid spikes. That’s the change limit in action limiting any single increase to no more than 10%.

For a more advanced example, what range of withdrawals might a UK Permanent Portfolio investor be able to support using a modified Guyton-Klinger strategy with a hard spending floor and a desire to maintain the initial portfolio value over time? I’ll leave the withdrawal rules explanation as an exercise for you to try for yourself, but let’s take a look at the results.

Not bad! The account values are a tight band tracking endowment perpetuity rather than retirement failure, and the withdrawal amounts are quite consistent. Also notice how the floor works, ensuring that spending will always be at least an inflation-adjusted $38k no matter what. I imagine an early retiree could work with this performance quite well with the confidence that plenty of money will remain for their families long after they’re gone. And at the very least, it clearly illustrates that the old over-simplified 4% rule of thumb drastically limits our thinking for how a smart retirement strategy might be structured for our own personal situations.

I could go on for days about all the different possible combinations that the Retirement Spending calculator can handle, but the best way to learn is to try it for yourself. I’ve gone to a lot of effort to provide instant visual feedback for each input, so play around and you’ll get the hang of it. And be sure to take the time to read the full write-up below the calculator, as I’ve included a bunch of detail on how everything works including recommended settings to model a variety of well-known spending methods. In fact I highly recommend walking though each method and entering the values for yourself to get up to speed and help connect the inputs with the ideas.

By the way, while you’re browsing the various portfolios that all include the new Retirement Spending calculations as well, you may notice that the Portfolio Growth calculator has also received a face lift. With the fancy new tool to model withdrawal scenarios, it seemed appropriate to refocus the Portfolio Growth chart on the accumulation side of the equation. You can still model growth paths including regular contributions, and based on user feedback I’ve also taken the opportunity to add a sampling feature that measures the full range of years it historically took to reach a certain financial goal. So no matter whether you’re interested in accumulation or retirement, I’ve got you covered.

Just like how driving at the same slow school zone speed on the straight line Autobahn makes no sense, I believe planning your retirement spending only for the worst case with no regard for potential prosperity is a shortsighted way to approach your financial strategy. I have a deep respect for conservative planning and I’m certainly not recommending reckless spending with no rules and reasoning to back it up, but computing technology has come a long way over the years and you definitely don’t have to use the same old assumptions from a study written decades ago to guide your choices today.

So branch out a little. The modern retirement research community is a relatively tight-knit group, and guys like Kitces and Pfau speak prolifically and eloquently on retirement planning. Be sure to read their work and check back here to test their ideas on your own portfolio. By making it easier than ever to replicate their charts for yourself using any asset allocation, home country, and spending strategy you can think of, my goal is to add one more voice to the chorus and spread the song far and wide.

Retirement is within your reach! Stop going along for the ride and take the wheel.

Try the Retirement Spending tool and start planning today.