Finding Balance in Retirement

Finding Balance in Retirement: Improve Your Retirement Outcome with Guardrails

Retirement is the time of life to finally enjoy the fruits of your labour, but figuring out where to start can be daunting. Many retirees worry about running out of money, while others fear that they’ll end up as the "richest person in the graveyard," having spent too little. The good news? A dynamic spending strategy like the guardrails system can help you strike the perfect balance.

The Retirement Pay Cheque Puzzle

Let’s start with a common question: how do you turn your savings into a steady retirement income? For many, the idea of drawing down on investments is uncharted territory. Where do you start? How much can you safely withdraw each year? How do you keep taxes in check? These are just a few of the many questions pre-retirees face.

The key challenge is making sure that your savings last as long as you do. Too conservative, and you might miss out on enjoying your retirement years; too aggressive, and you could run out of money when you need it most. This undertaking is where a guardrails system can be your best friend.

What is the Guardrails System?

The guardrails system is a dynamic spending strategy designed to help you adjust your withdrawals based on the performance of your investments and changes in your financial situation. Imagine your retirement plan as a road, where the guardrails act as boundaries that keep you from veering too far off course, whether that’s overspending or underspending.

Here’s how it works:

1. Set a Baseline Withdrawal Rate: You begin by choosing an initial withdrawal rate, typically your average annual spending or around 4% of your retirement savings. This amount would give you a steady stream of income while preserving the bulk of your nest egg.
2. Establish Guardrails: Set upper and lower limits for your withdrawals. If your portfolio performs well, you might increase your withdrawals slightly (but not too much). If the markets take a downturn, you reduce your withdrawals to protect your savings.
3. Regular Check-Ins: Every year, you reassess your financial situation. Are your withdrawals still within the guardrails? If not, it’s time to adjust.

Let’s look at an example:

Meet Emily: A New Retiree

Emily has just retired at age 65 with $1 million in savings. If she chooses to use the guardrails system to manage her retirement spending, it would play out as follows:

Step 1: Setting a Baseline Withdrawal Rate

Emily starts by setting her initial withdrawal rate at 4% of her portfolio. Doing so means that in her first year of retirement, she will withdraw $40,000 ($1,000,000 * 4%) to cover her living expenses.

Step 2: Establishing Guardrails

Emily’s financial planner helps her set up “guardrails” around her spending. They decide on a 20% adjustment up or down based on her portfolio’s performance. The adjustment value is then multiplied by the withdrawal rate, giving us plus or minus 0.8% (20% x 4%).

• Upper Guardrail: If her portfolio grows significantly due to performance and her withdrawals fall below 3.2% of her new balance, she can increase her spending.
• Lower Guardrail: If her portfolio drops and her withdrawals rise above 4.8% of her new balance, she should reduce her spending.

Year 1: A Good Year

The first year of Emily’s retirement is a good one for the markets, and her portfolio grows to $1.1 million by the end of the year. Per the guardrails system:

• Her $40,000 withdrawal now represents only about 3.6% of her new balance ($40,000 / $1,100,000).
• Since this amount is still within the guardrails (above 3.2%), she continues withdrawing the same $40,000. Her advisor also suggests that she could increase the withdrawals slightly if she wants to enjoy a little extra.

Year 2: A Market Dip

In the second year, the markets take a hit and Emily’s portfolio drops to $900,000.

• Her $40,000 withdrawal is now 4.4% of her new balance ($40,000 / $900,000).
• This amount is still within the guardrails (below 4.8%), so she can continue withdrawing $40,000. Her advisor suggests caution in case the market doesn’t recover quickly.

Year 3: Time to Adjust

In the third year, the market dips again and Emily’s portfolio falls to $800,000. What happens next?

• Her $40,000 withdrawal now represents 5% of her new balance ($40,000 / $800,000).
• This amount exceeds the lower guardrail of 4.8%, so Emily and her advisor agree to reduce her withdrawal to $38,400 (4.8% of $800,000) to help preserve her savings.

Step 3: Regular Check-Ins

Every year, Emily and her advisor review her withdrawals and portfolio balance. If her portfolio recovers, she may be able to increase her spending again. If it declines, she’ll have to make further adjustments. The key is that Emily’s spending is flexible and responsive to her financial situation.

A visual representation of this concept can found below:

The Outcome

Thanks to the guardrails system, Emily can enjoy her retirement without the constant fear of running out of money. If her portfolio does well, she may even have room to splurge a bit. But if the markets are down, Emily knows how to adjust her spending to stay on track. This approach keeps her on the road to financial security without too many bumps along the way.

The flexibility of this approach allows you to adapt to changing circumstances while ensuring that you won’t outlive your savings.

Avoiding Common Pitfalls

One of the biggest mistakes retirees make is sticking to a rigid spending plan, regardless of market conditions or personal needs. The guardrails system helps avoid this trap by encouraging you to adjust your spending as needed, rather than blindly following a fixed rule.

Another pitfall is failing to account for taxes. Remember, not all your retirement income is tax-free. For example, withdrawals from traditional RRSPs/RRIFs are taxed as ordinary income. Being mindful of your tax situation optimizes your withdrawals to minimize your tax burden and maximize your net income.

Preparing for Retirement with Confidence

As you approach retirement, it’s important to start thinking about how you’ll manage your spending. This process isn’t just about setting a budget, it’s about creating a dynamic plan that adapts to your needs and circumstances. As our clients approach this new phase of their life, we assist via:

• Education: We take the time to explain the guardrails system and other dynamic spending strategies so you understand your options. For your perusing, you can find the academic whitepaper outlining the strategy by Vanguard here or the origin of the strategy here.
• Planning: We work with you to set realistic spending goals and establish guardrails that make sense for your specific circumstances.
• Monitoring: Once you’re in retirement, we don’t just set it and forget it. We regularly review your plan to make sure it’s still on track and make adjustments as needed.

The Bottom Line

Retirement should be a time to enjoy life, not stress about money. By using a guardrails system, you can have peace of mind knowing that your spending is under control and your savings are working for you. Whether you’re worried about overspending or dying with a fortune you never got to enjoy, this approach helps you strike the right balance. If you would like additional inspiration, check out the book Die with Zero.

We understand that market fluctuations are beyond our control. What we can control, however, are the decisions we make in response. The guardrails approach is an excellent way to start managing those controllable factors.

As you get closer to retirement, remember that preparation is key. By planning ahead and staying flexible, you can create a retirement plan that truly works for you, one that lets you enjoy your golden years without the fear of running out of money or missing out on life’s pleasures.