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.

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.

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

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.

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.