There are all sorts of different advice on spending in retirement. The most commonly discussed advice is the 4% rule. This research suggests that one could spend 4% of their original retirement portfolio per year, and increase the spending amount by inflation each year.
On the one side of the spectrum, is the fixed dollar amount approach. This strategy starts with a dollar amount and then increases it over time usually by inflation. This creates stability in spending. The downside is it ignores both the dynamics of markets and the way most retirees spend–more in early retirement and less in later years when they’re at home more.
On the other side is the fixed percentage approach. This starts with a higher initial spending percentage. Spending amounts, however, have much more dramatic swings particularly during the midst of market downturns.
I am in favor of developing a Retirement Spending Policy that can help blend these two concepts. (Side note: planning for higher initial spending that steps down over time is often part of the plan too.) Having an established policy helps support higher spending where desired while protecting against potential risks that may manifest over a 30-40 year retirement.
Here are 3 areas that are typically included:
1 Inflation – An increase is made each year based on inflation except in years where the markets were down.
2 Capital Appreciation – If the markets have exceeded our expectations such that the spending amount has fallen to below a low threshold percentage, the spending target is increased, or more money is allocated towards gifting and inheritance accounts.
3 Capital Preservation – If the new withdrawal rate is above our expected long-term returns, it is capped out. Usually, this happens because market performance has been poor over the last few years. Capping spending during these periods helps the portfolio recover more before spending can be increased.
What rules do you use to guide your spending policy?
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