Every retirement strategy requires trade-offs. Dynamic withdrawal strategies grant some flexibility to retirees through market fluctuations.
Financial advisors can help investors weigh their options and customize a plan for their retirement goals. The State of Retirement Income report tested and compared dynamic withdrawal strategies (including one new method).
The Guardrails Method
The guardrails method, popularized by advisor Jonathan Guyton, sets maximums and minimums on spending at the outset of retirement.
In bull markets, investors can withdraw more from their portfolios—but not more than that predetermined guardrail. In poor market conditions, investors must withdraw less, but never below a supportable income threshold.
This withdrawal strategy works best for clients who are open to cash flow changes from year to year. Retirees will have less money at the end of their retirement, which might make it a poor fit for clients who want to make charitable bequests.
Retiree spending often follows a smile pattern. Retirees tend to spend more in the early years of retirement—often when their health is good, they’re active, and there's pent-up demand after a lifetime of work. Spending often dips in the mid to later years of retirement before rising again.
The haircut method responds to these lifestyle considerations. Under this approach, retirees increase their withdrawals each year for inflation—just one percent less than the actual inflation rate.
When Morningstar experts trimmed spending a percentage point lower than our baseline inflation assumption of 2.8%, it boosted starting and, in turn, lifetime withdrawals.
The haircut method gives early retirees permission to spend more. One trade-off: Spending early on in retirement has a ripple effect. Retirees would get more for their money by deferring spending.
The Required Minimum Distribution Method
Advisors can divide an investor’s portfolio balance by life expectancy, like the required minimum distribution tables that underpin IRAs.
One big trade-off is cash flow volatility. Investors will be buffeted by their portfolio value, which could be stressful for retirees with slimmer budgets. The RMD approach also consumes a portfolio over the retiree’s lifetime, which could conflict with a strong bequest motive.
The TIPS Ladder Method
For inflation-conscious clients, financial advisors can also explore treasury inflation-protected securities, or TIPS.
A TIPS ladder takes advantage of inflation-adjusted payouts to give investors a predictable source of retirement income. As one portion of an investment portfolio, TIPS ladders could help assuage inflation fears and cover necessities.
Let’s work backward. A TIPS ladder has one security that the investor can redeem each year. Picture an investor looking to cover $20,000 in annual fixed costs in retirement.
In their first year of retirement, they would buy a new 30-year TIPS worth $20,000. Thirty years later, the Treasury Department will redeem that for $20,000 in Year 30 dollars.
To receive $20,000 in Year 29, the investor would purchase TIPS that mature that year—but since they’ll earn interest payments on that first bond, the face value can be slightly less than $20,000. And so on.
A TIPS ladder will spend down the entire portfolio over the planned time horizon. In contrast, plans that are constructed to succeed at the 90% rate will likely still have money left in 30 years.