After looking at Bengen’s 4% Withdrawal Rule last week, today we turn to the Guardrails Withdrawal Strategy created by Guyton and Klinger in 2006. Bengen’s 4% Rule is a static withdrawal strategy – he tested various fixed withdrawal rates over 30-year periods to calculate a safe withdrawal rate for retirement income. This is a static approach because he did not attempt to adjust withdrawals based on market performance.
As a result, one criticism of the 4% Rule is that it is too conservative and is based on the historical worst case scenario. In many scenarios, retirees could have taken much more income than 4%. Or they could have retired years earlier! In bad market scenarios, it also seems unlikely that a retiree would continue to increase their withdrawals every year for inflation if it risked depleting their assets.
A Dynamic Withdrawal Strategy is one which adjusts retirement income up or down based on market performance. Guyton’s Guardrail approach establishes a framework for retirees to adjust their income if necessary. The benefit is that you could increase your withdrawals if performance is above average. It also means you may need to reduce withdrawals during a bad stretch. A dynamic approach means you could start with a much higher withdrawal than just 4%. The guardrails creates an ongoing process to know if your withdrawal rate is in the safe zone or needs to change.
Guyton’s Guardrail Rules
Like Bengen’s framwork, Guyton looked at historical market performance over a 30-year retirement. Here are the main points of his Guardrails Withdrawal Strategy:
- Your initial withdrawal rate could be 5.4%.
- You increase withdrawals for inflation annually, EXCEPT in years when the portfolio has fallen in value, OR if your withdrawal percentage exceeds the original rate of 5.4%. In those years, you keep the same withdrawal amount as the previous year.
- If a market drop causes your current withdrawal rate to exceed 6.48%, then you need to cut your withdrawal dollars by 10%.
- If market gains cause your withdrawal rate to fall below 4.32%, then you can increase your withdrawal dollars by 10%.
- This strategy worked with allocations of 65/35 and 80/20. With a 50/50 portfolio, the safe withdrawal rate drops from 5.4% to 4.6%.
- After a year when stocks were down, withdrawals should only come from cash or bonds. On years when the market is up, he would trim stocks and add to cash to meet future withdrawals.
On a $1 million portfolio, the Guardrails approach suggests you could safely withdraw $54,000 in year 1. That’s significantly higher than the $40,000 under Bengen’s static 4% rule. And while you might forgo annual inflation increases if the market does poorly, you were already starting at a much higher income level. Even if you had a 10% cut in income, from $54,000 to $48,600, you are still getting more income than if you were using the 4% Rule.
Dynamic Withdrawal Range
The Guardrails approach establishes an ongoing withdrawal range of 4.32% to 6.48%. That is a 20% buffer from your original 5.4%. If your withdrawal rate goes outside of this range, you should decrease (or can increase) your withdrawals. The static 4% rule only focused on your initial withdrawal rate and then just assumes you make no changes regardless of whether your future withdrawals are high or low. The 4% rule is an interesting study of market history, but I think retirees want to have a more strategic approach to managing market risk.
The benefit to a retiree for implementing a Guardrails approach is significant. If you need $40,000 a year, you would only need an initial nest egg of $740,740 with the guardrails, versus $1 million under the 4% rule. And you now have a clear process each year to evaluate the sustainability of your current withdrawals. You are responding to markets to aim for an effective retirement strategy.
Calculating a sustainable withdrawal rate for retirement income will always be an unknown. We’ve talked about the challenges of sequence of returns risk, inflation, and longevity. While we can’t predict the future, having a dynamic approach to retirement withdrawals is appealing and intuitive. Is a Guardrails Withdrawal Strategy right for you? Along with portfolio management, our retirement planning process can offer great peace of mind that you are taking a prudent, well-thought approach to managing your wealth.