Flexible Spending in Retirement

Posted by on Nov 7, 2016 in Financial Focus, Retirement Planning

Many people cite the 4% rule for retirement spending as the best retirement spending guide.  This is based on William Bengen’s seminal article published in 1994.  His research concluded that 4% is the maximum sustainable withdrawal rate, even including the worst sequence of returns, given a rolling 30 years, and a portfolio with 50-75% in stocks.

However, as CNN Money’s Walter Updegrave points out, there is some flexibility that needs to be baked in. “It would be nice to be able to identify in advance a level of withdrawals that will meet your retirement income needs, assure that your money will last a lifetime and not leave you with a huge stash of assets in your dotage (along with regrets that you hadn’t spent more early in retirement).”

That’s the tricky part of retirement planning.  There are two very distinct, competing goals:

  1. Preserve the underlying value of the assets so they can support distributions for many years to come. (Think of elderly millionaires who refuse to spend their money because of depression era tendencies, culminating in a refusal to hire care around the house as they age even though they can fully afford to.)
  2. Spend as much as possible in the present as to not live a potentially unnecessary austere lifestyle.  (Think of anyone you know whose financial decisions seem to be a downward spiral of unnecessary unsustainable lifestyle choices, while they keep their heads in the sand because of their need to, “live like there’s no tomorrow.”)

Said another way, if you save every penny for tomorrow, then die, you were wrong.  If you spend every penny today, and then live, you were wrong.  Although both are wrong, it is apparent in the data that more retirees are afraid of over spending.  As one study shows, people are actually more afraid of outliving their money than death!

Flexibility is one way to address the fear of running out of money.  This approach requires you to make spending adjustments as needed over time.  Spend more when times are good, and delay withdrawals when markets are down.

This strategy requires a retiree to create three separate budgets:

  • A “frugality budget” of needed expenses (preferably without sacrificing basic living conditions: housing, medications, etc.)
  • A “normal budget” which is a combination of needed expenses and lifestyle expenses (vacations, gifts, etc.)
  • A “fortunate budget” with more vacations, potentially bigger gifts, etc.

By adjusting spending accordingly, you are not required to live an austere lifestyle early on, because you can adjust your spending to meet the needs of the portfolio as time goes on.  This flexibility can potentially increase the sustainable percentage distributed from a retiree’s portfolio.  We recommend you read the full article here.  Keep in mind there is no “one size fits all” approach to investing.  We recommend creating a living plan which addresses your specific goals and needs, tailored to your unique circumstances.

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