The journey to a successful retirement involves many years of disciplined saving and investing. As you stand on the threshold of a well-deserved indefinite vacation, one crucial challenge remains: How can you ensure that your savings will last your whole lifetime?
Navigating retirement distributions can feel like walking a tightrope. Withdraw too much, and you risk your nest egg running out. Withdraw too little, and you won’t be able to enjoy the quality of life you desire. Often, retirees end up adopting a static plan that is too conservative — or worse, too reckless.
The most common retirement distribution strategies involve consistently withdrawing some fixed percentage or dollar amount from your portfolio, similar to the hypothetical scenario below. While this approach is attractive for its simplicity, it’s not very flexible.
As you can see, this individual’s retirement income plan has an 85% “Probability of Success”. The projected end of plan median portfolio balance is $1,627,538. At age 86 years old the individual could potentially have $0 or over $4.6 mm. In our experience, having such a wide range of potential outcomes is not the most optimal way to plan for retirement income.
In this article, we will discuss the guardrail approach, a dynamic strategy for retirement distributions that pivots away from “success or failure” to a framework for making adaptive adjustments.
What Is the Guardrail Approach to Retirement Distributions?
The original guardrail framework was introduced to the financial planning industry after a research paper by Jonathan T. Guyton and William J. Klinger in the Journal of Financial Planning in March of 2006. It provided research on how calibrating your distributions based on how retirement unfolds could increase sustainable withdrawal rates.
The risk-based guardrail strategy we currently use begins by specifying an initial monthly withdrawal amount. From here, two “guardrails” are established — one above and one below your current portfolio balance. These guardrails are designed to provide a framework for when adjustments to your income would be advised. If your investment conditions are better than anticipated, then your ability to spend increases. However, if these conditions deteriorate to certain point, then you have a lever to reduce spending until things improve.
Source: Income Lab
In this hypothetical scenario below, we look at an income plan during a period that experienced a global financial crisis, pandemic, high inflation, and four S&P 500 Index bear markets. The green dotted line represents upward income adjustments, while the red dotted line represents downward. As you can see, in favorable markets, withdrawals were increased, causing the portfolio balance to decrease. But when the portfolio hit the lower guardrail, withdrawals were cut back. Through this adaptive process, both the income and portfolio were guided through this challenging period.
Source: Income Lab
Balance & Guardrails
Source: Income Lab
What Are the Pros and Cons of a Retirement Guardrail Distribution Strategy?
While a guardrails retirement income strategy can be an attractive way to systematically adjust your retirement plan over time, it is not without some drawbacks. Let’s briefly review the major pros and cons of this strategy.
1. Flexibility and responsiveness to life changes.
Standard retirement approaches, which assume a fixed withdrawal rate, can struggle to accommodate a change in personal, health, financial or economic conditions. No one has a crystal ball on what the future holds so it is important to have a plan that is flexible and adaptive. The guardrail approach is specifically designed to account for these types of changes.
2. Psychological comfort.
For some retirees, it may be comforting to know that a plan is in place that accounts for shifts in the market. There is typically a tightening of spending when there is negative economic or market news. This adaptive framework can help to have clearly defined points at which a lifestyle adjustment may be necessary.
3. Potentially higher spending.
The guardrail framework provides steps that can reduce the risk of underspending throughout retirement. The risk of underspending is the regret that individuals can have at the tail end of retirement, when they look back and wish they would of retired earlier or spent more during their healthier years.
The guardrail approach requires you to frequently monitor your portfolio and perform calculations. This concern can be alleviated by working with a flat fee financial advisor or financial planner on implementation and monitoring of the strategy.
2. May result in income reductions.
Income reduction is often seen as the biggest drawback of the guardrail strategy. This is why it is critical that the guardrail strategy is part of a broader comprehensive financial plan that accounts for income required to cover your essential non-discretionary expenses.
3. Could result in a low ending portfolio balance.
While this isn’t necessarily a bad thing, since it would mean you maximized your retirement savings, many people want to leave behind a legacy for the next generation. Exhausting your portfolio could inhibit achieving this goal if you don’t establish a legacy goal as part of the guardrail framework.
Who Is the Guardrail Approach Right For?
Given the pros and cons we discussed, the guardrail approach may not be right for everyone. Let’s walk through some of the characteristics that could make this strategy a good fit for a retiree.
- You are able to control expenses. If you can adapt your discretionary lifestyle expenses in the case of an income reduction, the guardrail approach might be right for you.
- You have other sources of income. If you have a pension or social security income that you can draw on while retired, this can help supplement any income reductions you have to bear as a result of crossing a lower guardrail threshold, making you a good candidate for the guardrail strategy.
- You are willing to work with a financial professional. As described, guardrails aren't simple to implement and monitor. That will likely mean working with a financial professional to handle the process with you.
- You have a long retirement horizon. If you’ve retired early, you may need your portfolio to span decades. Consequently, it’s imperative to have a plan that is flexible to adjust to personal, health, economic and financial conditions.
Using the Guardrail Approach With a Flat Fee Financial Advisor
The guardrail approach may be more complex than other retirement strategies, but its flexibility, adaptability, and sustainability make it a compelling choice when compared to simpler approaches. And while it’s not easy to see your income dip during retirement, there is a psychological benefit to knowing that you have a framework to use that minimizes the risk of overspending or underspending throughout retirement.
If you’d like to speak with a flat fee financial advisor in Tampa about whether the guardrail approach is right for you, our team at Southshore Financial Planning is here to serve you.