2018 The Income And Growth Challenge - September 2018
2018 SEPTEMBER: THE INCOME AND GROWTH CHALLENGE
Spending rules for capital preservation - September 2018
- Retirees want to grow income annually by inflation to maintain constant purchasing power (standard withdrawal rule).
- Each year, increases are granted regardless of the income return on the underlying portfolio. Capital could run out over a ±30-year period.
- Need to start with a low initial drawdown rate (4% or less).
- Formal spending rules can help to make higher initial drawdown rates (5%-6%) more sustainable.
- Moderate income requirements after tough return periods.
By applying a few spending rules, retirees can ensure capital preservation. The idea being that one dynamically adjusts your income drawdown in response to returns. In other words, first earn the returns before spending them.
The modified withdrawal rule. Withdrawals increase annually with inflation except when the retirement portfolio produced a negative return in the prior year, and when the current year’s increased rate is higher than the initial withdrawal rate. There is no catch-up for missed increases in later years.
The capital preservation rule. If the increased withdrawal rate in a given year exceeds the initial withdrawal rate by more than a certain percentage (e.g. 20%), the withdrawal rate is cut by a predefined percentage (e.g. 10%). This rule is only applied in the first half (10 to 15 years) of retirement. This spending rule could be further refined (at the expense of giving up some safety) by adding a prosperity rule. If the withdrawal rate falls by more than a pre-set percentage (e.g. 20%) below the initial withdrawal rate, the withdrawal is increased by a defined percentage (e.g. 10%).
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