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 adjust how clients draw down their assets within retirement. Many retirement plans run through complex investment analysis while looking at retirement spending as a singular input that does not account for the 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 provides an overview of our different Retirement Spending Strategies and background information about these different thought processes.
Retirement Spending Overview
When modeling a client's retirement monthly expenses, RightCapital gives you many options for how to spend down their assets. There are many factors and life events to plan for when modeling a client's 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 exclude any other expenses you have entered in the net worth, such as a mortgage, debt, insurance payments, or life events entered as 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.
This method involves inputting a client's monthly expenses in today's dollars and then inflating them at a pre-determined general inflation rate yearly. 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.
Retirement Spending Smile
This method is called "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 healthcare 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.
Retirement Spending Stages
The Guardrail method, also known as the Guyton/Klinger decision rules, consists of 3 different components. The first component is the Withdrawal Rule. When the portfolio return is negative, there is no inflation adjustment on retirement expenses. The second component is the Capital Preservation Rule. When the withdrawal rate exceeds the upper band, reduce retirement expenses by 10%. Finally, the Prosperity rule, when the withdrawal rate goes below the lower band, increases retirement expenses by 10%.
Within RightCapital, our default Guardrails model will be as follows. Our inflation adjustment is set to No inflation adjustment if the previous return is zero or negative. Our Capital Preservation Rule states that "Before age 80, if withdrawal rate is 20% greater than the 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 adjust these models based on your preferences.
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.
A client has 1M 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 will 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.