Big upside from flexible spending in retirement

Back in 2010 I posted on an alternative retirement withdrawal approach that allows for higher safe withdrawal rates (SWR). Back then I didn’t have a detailed model of this approach to provide much more insight. Now I do. Its very worthwhile revisiting this strategy and discuss the great benefits it can have to retirement plans. This alternative approach relies on having some flexibility, on the downside, in retirement spending. Lets take a look in detail on how this works, its benefits, and how you can apply it to your retirement plans.

This alternative withdrawal method is called the floor-ceiling model (FCM) and it was pioneered by William Bengen, the man behind the concept of SWR in the first place. Basically, the method calls for spending a fixed percentage of your portfolio each year subject to certain limits. Applying a fixed percentage to each year’s portfolio value can and will cause dramatic fluctuations in spending. That’s where the limits come in. This is quite different from the traditional SWR strategy where your SWR percentage is applied once at the beginning of your retirement and all subsequent withdrawals are simply adjusted for inflation. The FCM method just applies a limit to how much of a decrease you are willing to endure to real spending in any given year. As it turns out there is no need for an upper limit. Having this flexibility to adjust spending during bad years increases the SWRs. The chart below is from my original post.

FCM SWRs Sept 2013

As you can see from the table, having downside flexibility in spending allows higher SWRs while also providing upside spending possibilities in years where the portfolio does well. In Bengen’s original model in addition to the FCM method he added alternative assets classes, e.g. small cap stocks, in calculating his SWRs. I wanted to recreate his approach but isolate the impact of purely applying the FCM method to the traditional portfolio allocations of the SP500 and 10yr government bonds for various allocations to stocks and bonds. The table below shows the SWRs for various asset allocations for the traditional SWR method.

SWRs for traditional SWR method sept 2013

And here are the SWRs for the various asset allocations for the FCM method with a -10% limit to inflation adjusted spending.

SWRs for FCM SWR method sept 2013

As the tables above show the FCM method allows approximately 10% higher SWRs in retirement. The downside being that on average you end up with less wealth after the 30 year retirement period. I think most retirees would trade a guaranteed 10% per year higher spending rate for the possibility of higher end wealth. I would. But that’s not all. To see the true impact of the FCM method vs the traditional SWR model lets look at the detailed spending by year for the worst case and the best case retiree in the historical record. The table below compares the tradition versus the FCM method for the 1966 retiree (the worst case) and the 1975 retiree (the best case) for a 70% stock, 30% bond allocation. For the FCM method I highlighted years in which spending decreased from the previous year.

SWR traditional vs FCM for 1966 and 1975 retirees sept 2013

For the worst case retiree, 1966, the higher FCM SWR of 4.84% came at a small cost. In two years spending would have gone down and overall total dollars withdrawn over the 30 years would have been slightly less. $3.37M vs $3.38M. For the best case retiree, the FCM not only had a higher SWR of 4.84% but provided huge upside in spending $422K of spending in year 30 vs $163K in spending for the traditional method. In addition total lifetime spending was 2.5 times higher with the FCM method. The downside was more volatility to that spending as you can see from the highlighted cells. A worthy trade off? I think so.

In short, allowing for some flexibility in spending into your retirement model can have some huge benefits with little downside.

Full Disclaimer - Nothing on this site should ever be considered advice, research or the invitation to buy or sell securities. These are my personal opinions only.

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9 Responses to Big upside from flexible spending in retirement

  1. Eric says:

    Paul, in thinking about the SWR approach in general, it seems that a 30yr profile is the standard. Have similar analyses been run for early retirees who have a significantly longer retirement profile like 50yrs? I’m wondering how much lower the SWR would be.

    • libertatemamo says:

      In general those longer scenarios are not looked at very often. I’ve run them out quite a long time because I’m living it. For a 40 year period it the SWR goes slightly below 4% but not by much. And with a flexible withdrawal strategy like the FCM method it stays above 4%. Have never run the 50 yr scenario.


  2. Randy says:

    All these models assume a starting portfolio value; with inflation adjusted withdrawals that will survive xx years. Are you aware of any models or approaches that allow one to calculate future withdrawals based on Current portfolio value on an annual basis?

    Example: If portfolio has grown say 25% due to serendipity and/or years of conservative spending; can a new 4% or 4.8% be applied? Alternately if value has dropped 25% due to bad luck and/or excessive spending, how is a new withdrawal rate calculated?

    It seems logical to apply the ~4% rate to the new annual portfolio value; but this does contradict some of the models underlying assumptions. Then again, a “new” retiree with $X portfolio value is instructed to apply the 4% “rule” to their starting value; so resetting the rate annually should work.

    • libertatemamo says:

      Randy, one advantage of the FCM method I describe in the post is that it the SWR percentage is applied to the current portfolio value in the given year, exactly what you are saying. It just doesn’t let the dollar amount go below some fixed percentage based on your inflation adjusted living expenses. This is why in the 1975 retirees case, a serendipitous case, the retiree was able to increase their spending significantly in retirement. The 1966 retiree didn’t have that luxury but the floor limit in the method kept their standard of living pretty much the same.

      If one is using the original SWR method, you can reset the SWR every X years based time left in retirement. For example, in a 30 year retirement, after 10 years, you can use the 20 yr period SWR which is 5.33% and re-calculate the dollar withdrawals based on that. This could lead to increased withdrawals in a serendipitous case or lower withdrawals in a bad luck case. An adjustment period of less than 10 years is not recommended. You can also use the concept of the current withdrawal rate (CWR) as an early warning indicator. Take a look at the CWR graph in this post.


      • Brad says:

        Thanks Paul good thought provoking post . The Bengen method appears to withdraw a fixed percentage from the remaining portfolio, while setting a floor based on the initial inflation adjusted withdrawal. Complicated to track and trust over 30 yrs; but highlights the significant advantages of how cutting back in hard times can increase future withdrawals.

        Bogleheads list some alternate flexible strategies:

        umfundi’s concerns and approach is similar to mine; withdrawals = 1/life expectancy; 5 yrs cash, 70% stocks. “Déjà Vu is not a prediction” Ain’t that the truth.

        • libertatemamo says:

          I don’t think its too complicated to track but definitely more complicated than simply adjusting withdrawals for inflation. Ans, yeah having flexibility to cut back in hard times is one of the keys to increasing retirement survivability. I also think using an early warning system, like the current withdrawal rate, is key.

          I’ll check out the bogleheads link, thanks.


  3. Brad says:

    Intrigued by your post, found this variable withdrawal method. It is re-calculated annually, based on current portfolio value; while accounting for age, longevity and expected real market returns.

    Need to delve deeper to understand the “smoothing” assumptions. Also based on 1972… data so doesn’t include 1966.

    • libertatemamo says:

      Any method has to look at the 1966 30 year period. If it doesn’t I would discount the withdrawal rates by at least 20%.


  4. Pingback: The impact of realistic spending on your retirement | Investing For A Living

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