Retirement Spending Policies
The Flexible Retirement Planner supports three retirement spending policies. These are Stable, Flexible, and Conservative. The selected spending policy determines how the simulation will handle the retiree’s requested spending each year as the plan unfolds.
A significant difference with this simulation tool is that it can adapt by adjusting withdrawals as your retirement plan unfolds (rather than waiting until the portfolio is almost gone).
The Stable spending policy causes the simulation to attempt to fund 100% of the requested annual retirement spending. This is done by withdrawing the full amount of expenses that are not covered by retirement income from the retiree’s portfolio. The annual spending amount is automatically increased each year by the inflation rate so that the retiree’s spending level keeps up with inflation. This spending policy most closely matches the spending policy that’s implicit in most other retirement planning tools. Note that even with the Stable spending policy, it is still possible for the percent of expenses funded to fall below 100% in a given year. This can occur as a result of the portfolio running out of money in some trials of the simulation, thus reducing the percent of expenses that are able to be funded. When the data for all runs is averaged together, these failed years cause the average spending to fall below 100%.
The Conservative spending policy attempts to model what a conservative or cautious retiree might do as their retirement unfolds. Basically, in any year where the portfolio shrinks and the portfolio balance is smaller than it was at the start of retirement, this policy withholds the cost of living increase (cola) for that year. This means that the retiree must cut back their spending. Otherwise, if the portfolio is bigger than it was at the start of retirement, some extra purchasing power that was lost in previous years is restored. However, the retiree never gets more than 100% of the expenses (adjusted for inflation) they requested, no matter how well the portfolio does. Finally, if the portfolio is growing, but has a smaller value than at the start of retirement, the percent of expenses funded is held steady (retiree gets a cola, but no extra increase).
Next, the Flexible spending policy extends the conservative policy by allowing the retiree to spend more than originally specified in the plan if their portfolio does well. In lean years, this policy mimics the conservative policy by withholding the COLA when the portfolio is shrinking and the balance is smaller than it was at the start of retirement. If the portfolio is growing, but is smaller than it was at the start of retirement, the percent of expenses funded remains constant (retiree gets a cola, but that’s it). However, following good years when the portfolio has a balance that’s greater than the starting balance, the flexible policy allows the percentage of expenses funded to grow well above 100%. The amount of spending growth depends on the relative size of the portfolio compared to the balance at the start of retirement. If the portfolio is at least two times the size it was when retirement started, spending percentage is increased by the inflation rate. If the portfolio is between one and two times the original size (at retirement start), an increase of 1/4 of the inflation rate is given. These thresholds were chosen somewhat arbitrarily and is still subject to further adjustment. However, simulation results aren’t hugely sensitive to small changes in these variables in otherwise successful plans.
The spending policy does not begin to affect the amount of spending that gets funding until the first year of retirement. Any spending that is specified prior to the first year of retirement will be subtracted from the portfolio without any spending policy adjustments.