Market Mini: How Much Clients Should Prepare to Spend in Retirement

Posted By on Mar 21, 2014|2 comments

Financial advisors have many ways to manage retirement income for their clients. The key to any income withdrawal strategy is to adjust withdrawals based on portfolio value and inflation.

The benefit of this strategy is that it enables clients to spend a larger amount of their portfolio and reduce their chances of running out of money.

Wade Pfau recently wrote a review of withdrawal-based strategies in his article, New Research on How Much Clients Can Spend in Retirement, published on November 19, 2013 on Advisors Perspectives.

In his review, Pfau cites authors from the Journal of Financial Planning, specifically Jonathan Guyton and William Klinger from issues in October 2004 and March 2006, and Larry Frank, John Mitchell and David Blanchett from issues in April 2009, June 2010, November 2011, March 2012 and December 2012.

Pfau’s work focuses on the probability of an individual running out of money. From this perspective, his analysis provides a starting point for financial advisors to initiate a conversation with their clients on potential shortfalls of income and how to build a strategy that may withstand unexpected inflation and stock market declines.

He also cites work by Blanchett, Kowara and Chen in using mortality updating constant probability of failure (MUCPoF) to help financial planners reduce or increase a client’s withdrawals based on a person’s likelihood of dying as well as their portfolio value. MUCPoF adjusts withdrawals each year based on the value of the portfolio and the life expectancy of an individual.

Applying the Three-Dimensional Rule to Financially Prepare for Retirement

Retirement is a time full of changes. As a result, Pfau recommends financial planners use a three-dimensional rule that updates the probability of death. Specifically, he recommends following Frank, Mitchell and Blanchett’s rule of using a dynamic measure of life expectancy. The three-dimensional view includes basing annual withdrawal decisions on age, market returns and asset allocation.

Authors Frank, Mitchell and Blanchett recommend that clients reduce withdrawals once the probability of running out of money is equivalent or greater than 30%. The alternative is that individuals will be FORCED to reduce their income in the future by much larger amounts.

Improving Withdrawal Strategies with Decision Rules

In his review of withdrawal-based strategies, Pfau also cites author Guyton’s four decision rules that include portfolio management, withdrawal rule, capital preservation and prosperity. By applying these rules, a financial advisor can increase the initial withdrawal amount and decrease the likelihood of a client running out of money throughout retirement.

The four decision rules are:

  • Portfolio Management – Take withdrawals from areas with the greatest growth from the year before, and move excess amounts into cash reserves.
  • Withdrawal Rule – Increase the withdrawal by the amount of inflation from the previous year unless the previous year’s portfolio return was negative.
  • Capital Preservation Rule- If an annual withdrawal is 20% above the initial withdrawal, spending should be reduced by 10%. This rule is skipped if a client is within 15 years of their maximum planning age.
  • Prosperity Rule – If the withdrawal rate has fallen by 20% or more; spending is increased by 10%.

Along with an annual dynamic approach to life expectancy, each of these rules can improve a client’s withdrawal strategy, although none of the rules account for higher or lower levels in the valuation of the stock market. Pfau notes that the rules can be difficult to implement and that such strategies may only be beneficial to those following strict budgeting techniques. For individuals unwilling to change spending habits, annuities and bond ladders may make more sense.

Additionally, one might see the probabilities of failure change not due to age but rather to stock valuations. Consequently, a direct rule based on stock valuations may be beneficial.

While the advancements in withdrawal strategies are beneficial, Pfau cites that the rules can be difficult to implement and that such strategies would only be beneficial to those following strict budgeting techniques. For individuals unwilling to change spending habits, annuities and bond ladders may make more sense.

Often times, financial advisors pursue a strategy of consistent withdrawals adjusted for increasing inflation. This happens until an individual can no longer sustain these withdrawals. To improve the possibility of not running out of money, financial advisors can make adjustments to withdrawal strategies that increase the amount left in their client’s retirement fund and reduce the chance that they will run out of money.


  1. Probability should not be in a retirement conversation unless it is tied to a guarantee. A client should be properly positioned to enjoy 100% of their wealth without the fear of running out. The fallacy of traditional financial planning is that portfolio management and rates-of-return are somehow predictable. To believe that an individual’s chance of success in retirement is tied to stock market returns or the necessity of reducing income levels is simply absurd.

    As an example, and pardoning the recent airline crisis, you have boarded an airplane. You found your seat and settled in. The door is closed and the plane is pushing back to begin taxying to position itself for takeoff. The pilot comes on the intercom and announces the current weather conditions, the flight time and altitude. He then says,”and, there is a 90% that we will land safely. Enjoy your flight!” Do you want to stay on that flight?

    Our job in this industry is to holistically prepare our clients such that we eliminate the uncertainties. When success in retirement is defined entirely by market returns we have failed our clients.

    Post a Reply
    • Keith,

      Good comments. Can you elaborate on what the alternative is to “Traditional planning” and how do you go about holistically preparing clients to eliminate uncertainties.

      Thanks for the post.

      Post a Reply

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