Dynamic spending strategies involve making further adjustments to the withdrawal over and above inflation adjustments. These are rules-based increases or decreases to spending, depending on portfolio performance.
The guardrail strategies were originally designed by financial planner Jonathan Guyton and later refined with the help of William Klinger in their March 2006 article in the Journal of Financial Planning. The guardrails consist of the ‘capital preservation’ and ‘prosperity’ rules as follows:
- The capital preservation rule: if the current withdrawal rate rises above 20% of the initial rate,then current spending is reduced by 10%
- The prosperity rule: spending in the current year is raised by 10% if the current withdrawal ratehas fallen by more than 20% below the initial withdrawal rate
Timeline’s default setting uses the rule as prescribed above. However, planners can adjust the numbers to set their guardrail levels. The Timeline app enables users to model the guardrails in combination with Guyton’s inflation adjustment or any of the other three inflation adjustment rules.
Here's an example.
A retiree starts out by taking a £40,000 withdrawal from a £1,000,000 portfolio, resulting in an initial withdrawal rate (IWR) of 4%. Suppose by year four of their retirement, the portfolio has performed rather well and is now worth £1,400,000. However, due to annual inflation adjustment, the withdrawal that year is now £45,000. The current withdrawal rate (CWR) is now 3.2%. In this case, the CWR is now 20% lessthan the IWR. The prosperity rule is triggered, and the withdrawal is increased by 10% from £45,000 to£49,000. This increase is permanent and reviewed annually until either the prosperity rule or the capital presentation rule is triggered.
Suppose by year seven of the retirement, the portfolio is now worth £900,000, and the retiree is drawing £50,000 (due to cumulative inflation and previous increases). The CWR is now 5.5%. In this case, the CWR is now 38% more than the IWR (i.e., from 4% in year one to 5.5% in year seven). Accordingly, the capital preservation rule is triggered, and the withdrawal is reduced by 10% from £50,000 to £45,000 a year
Financial planner Michael Kitces first described this strategy in his June 2015 article, The Ratcheting Safe Withdrawal Rate – A More Dominant Version Of The 4% Rule?
The strategy works on the basis that a retiree starts out with a given withdrawal rate, but increases it by 10% (over and above the inflation adjustment) if the portfolio value exceeds 150% of the original value.The caveat is that such spending increases can only take place once every three years at most.
Timeline’s default setting is a more conservative increase of 5% (rather than the 10% proposed by Kitces) if the portfolio value excess 150% of the original value. However, a user can set their spending increase levels and the levels at which it’s triggered.
Here's an example.
A retiree starts out taking a £40,000 withdrawal from a £1,000,000 portfolio. Under Ratcheting Rule,their withdrawals are reviewed on an annual basis.Suppose by year four of the plan the portfolio balance is now £1.52m, and the annual withdrawal is now£44,000 (due to inflation adjustments). Since the portfolio is now over 150% of the initial balance, the withdrawal is ratcheted up 5% from £44,000 to £46,200.By year six, the client continues to enjoy the good sequence of return, and the portfolio balance is now £1.6m. However, on this occasion, the withdrawal is not increased because the second condition for ratcheting rule is not met, i.e. spending increases can only take place once every three years at most.Since the withdrawal last ratcheted up in year four, another increase is not due until at least three years later.