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New Research on How Much Clients can Spend in Retirement

November 19, 2013

by Wade Pfau

A major problem remains unsolved in the discipline of financial planning: How should clients adjust their spending patterns in response to changes in the value of their retirement portfolios? The original research on this topic was based on a fixed percentage of assets, adjusted for inflation. Numerous refinements to that model have been proposed, and I will look at how the updated models can help clients maintain their desired standard of living without depleting their assets.

A standard assumption in safe withdrawal rate studies for retirement is that a client spends constant inflation-adjusted withdrawal amounts until wealth is depleted. In this framework, the initial withdrawal rate is the only information needed to calibrate a strategy. This is a simplifying assumption for research purposes: It supports a smooth and predictable spending stream as long as financial assets are not depleted. But retirees will avoid playing this game of chicken, and they will usually choose to reduce their spending rather than see their financial assets plummet toward zero.

At the other extreme for systematic withdrawal strategies is the assumption that the client would spend a constant percentage of the remaining portfolio balance in each year of retirement. A variation of the constant percentage strategy is to base retirement spending on the required minimum distribution (RMD) percentage rules developed by the Internal Revenue Service.

Real spending can increase or decrease along with the fortunes of the market. This can ensure that wealth will not run out, though it provides no protection against low and painful levels of spending. Portfolio volatility can also wreak havoc on attempts to plan a stable budget.

Countless proposals have been made for dynamic withdrawal rates to provide a compromise between the desire to plan ahead and the need to make spending adjustments to reduce the odds of asset depletion. Such approaches seek balance between constant amounts and constant percentage extremes. I will focus on several research-based methods that I believe will best resonate with advisors. Each of these methods was introduced and developed in articles in the Journal of Financial Planning (JFP) and other practitioner-based research journals. The methods include the decision rules developed by Jonathan Guyton and William Klinger (JFP - October 2004 & March 2006), the joint work of Larry Frank, John Mitchell and David Blanchett (JFP - April 2009, June 2010, November 2011, March 2012, & December 2012) and subsequent modifications made by David Blanchett with co-authors from Morningstar ( Retirement Management Journal, Fall 2012, & JFP – September 2013). Links to each article are provided in the discussion below.