Knowledge Base: Retirement Spending Strategies

RightCapital understands not every client will draw on their assets in the same way. This is why we offer the ability to utilize dynamic spending strategies to make adjustments to how a client is drawing down their assets within retirement. Many retirement plans run through complex investment analysis while looking at the retirement spending as a singular input that does not account for behavioral impacts of aging or varying market conditions. When in reality retirement spending adapts in real time to market conditions and lifestyle changes as clients age.

This article is designed to provide an overview of our different Retirement Spending Strategies as well as background information about these different thought processes.

Retirement Spending Overview

When modeling a client's retirement monthly expenses RightCapital gives you many options of how to spend down their assets. There are many factors and life events to plan for when modeling a clients' retirement. Some are aligned with fixed expenses while others, like entertainment and travel will change over the course of retirement.

When entering the client's "Retirement Monthly Expenses" in RightCapital, it's important to remember what we are representing. Retirement expenses should reflect your average monthly expenses during retirement. These should be exclusive of any other expenses you have entered in the net worth, such as mortgage, debt, insurance payments, or life events entered as a separate goals, (as these will already be counted). We pre-load five customizable models for retirement spending which impact how the retirement expense goal is projected into the future.

Inflation Adjusted

This is by far the most popular method for clients to model out their expenses within retirement. This method would involve inputting a clients' monthly expenses in today's dollars and then inflating them at a pre-determined general inflation rate every year.

This is the default method for retirement expenses in RightCapital. The system would use the general inflation rate (default 2.5%) to inflate the monthly expenses each year. The biggest shortcoming to modeling retirement expenses in this way is they do not adapt to factors in the plan that would impact actual spending in retirement. The benefit to this model in many cases is that it will over estimate the expenses within retirement.

Retirement Spending Smile

This method is referred to as "Blanchett Spending Smile" and was created by David Blanchett. Research has shown that expenses within retirement decline slowly and steadily over time. The other consideration is Health Care costs, which typically increase over time. The idea is to create a spending smile where retirement expenses decrease over time but health care costs increase over time.

Within RightCapital, the pre-loaded Retirement Spending Smile will adjust the expenses by the normal inflation rate minus 1% each year. (For example: 2.5% inflation, 1% decrease would mean we are inflating the cost by 1.5% each year). The annual retirement health cost in RightCapital is a separate entry in the goals section that will follow the health inflation rate.

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Floor and Ceiling

The Floor and Ceiling strategy allows for retirement spending to fluctuate with market performance. Spending would be reduced in years of down markets, but will not be lower than the specified floor. While spending would be increased in years of strong markets, but no higher than the specified ceiling.

Example Scenario:

• Client has 1MM of invested assets and a retirement expense goal of $30,000/year. They also use a floor and ceiling spending strategy with a ceiling rate of 20% and a floor rate of 15%.
• Next year the invested assets grow by 7% (to $1,070,000), and the expenses are increased by the same amount until they are capped at the ceiling rate of 20% (expenses grow to $36,000).
• The following year, invested assets drop by 2% (to $1,0486,000), and the expenses are decreased by the same amount and are not capped since they do not drop below the spending floor of 15% (expenses drop to $30,600).

By default the Floor and Ceiling strategy in RightCapital will set the Floor to limit the spending reduction to 15% below the initial retirement expense amount (inflation adjusted). The Ceiling is set to 20% above the initial retirement expense amount (inflation adjusted). However the Floor and Ceiling can be adjusted depending on your preference.

Guardrails

The Guardrail method also know as the Guyton/Klinger decision rules consists of 3 different components. The first component is the Withdrawal Rule, when the portfolio return is negative, no inflation adjustment on retirement expense. The second component is the Capital Preservation Rule, when withdrawal rate exceeds the upper band, reduce retirement expense by 10%. Finally the Prosperity rule, when withdrawal rate goes below the lower band, increase retirement expense by 10%.

Within RightCapital our default Guardrails model will be as follows. Our inflation adjustment is set to No inflation adjustment if previous return is zero or negative. Our Capital Preservation Rule states that "Before age 80, if withdrawal rate is, 20% greater than initial rate, reduce spending by 10%." Our prosperity rule states, "Before age 80, if withdrawal rate is, 20% lower than initial withdrawal rate, increase spending by 10%". RightCapital will also elect to calculate the initial withdrawal rate based on the cash outflows in the first year of retirement unless you choose to override this with your own rate. As with any of the other pre-loaded models you can make adjustments to these models based on your preferences.