The stock market is booming, outperforming your projections for the year, so go crazy and spend the extra returns in your retirement account, or ...
The markets are doing worse than you planned for this year. Whoa, rein in that spending.
So goes the idea behind the "guardrails rule" of retirement spending. Unlike the 4% rule, in which you spend a fixed amount each year, adjusted for inflation, this approach is more dynamic.
“The guardrails rule is best for retirees who want a flexible spending plan, not a rigid withdrawal rate like the 4% rule, and who are willing to make modest adjustments to preserve long-term confidence,” says Nancy Gates, lead educator and financial coach at Boldin.
The rule helps people to "go live their lives" a little more in retirement and slows them down when they're overdoing it.
You don’t want to run out of money during your golden years because you're having too much fun. You also don't want to outlive your money because you're being too frugal. This method can help prevent either scenario from happening.
Is the guardrails approach right for you?
Developed by financial planner Jonathan Guyton and computer expert William Klinger, the guardrails approach (PDF) to retirement spending is flexible and dynamic, tying your annual withdrawals to the performance of your investments. This means you must be willing to adjust your lifestyle, potentially every year, based on market results.
“It's good for people with a lot of discretionary spending, where they go maybe on a lot of trips,” said Eric Diton, president and managing director of The Wealth Alliance. “They can say, hey, it's a bear market, and I have to cut back. That’s easy, we won’t go on an extra trip.”
The guardrails approach to spending may be right for you if:
- Most of your retirement income comes from investments rather than pensions or guaranteed income.
- You have discretionary expenses that you can easily cut off or delay, such as travel, leisure activities, gifts, and/or luxury items.
- You're comfortable adjusting your lifestyle if the markets dip and won’t feel guilty spending if it rises.
- You want to track your plan regularly.
How the guardrails rule works
With this strategy, you set "guardrails" 20% above and below your intended withdrawal rate, adjusting your spending based on the performance of your investment account.
As an example, an intended withdrawal rate of 5% has an upper guardrail of 6% and a lower one of 4%. If a market downturn hits your savings, your withdrawal rate might exceed the planned 5% and hit the upper guardrail at 6%. At this point, you would decrease your spending.
On the flip side, a market rally could cause your rate to fall to the lower guardrail at 4%, allowing you to increase your annual spending.
Think of it like this: Cut spending if the withdrawal rate rises and hits 6%, or increase spending if the withdrawal rate falls and hits 4%.
In another variation, Gates said you can set guardrails based on the chance of success for your retirement portfolio. For example, adjust spending when your chance of success exceeds 90% or falls under 70%, she said.
This will require a financial adviser who will have to run complex Monte Carlo simulations to determine the spending rates.
When should you do it?
Whichever variation of the guardrails approach you choose, your spending level is typically set annually, taking into account market performance and comparing it with your spending target, said Gates.
A general rule when using this method: Refrain from trying to apply this process monthly or even bimonthly or more than annually.
“Reacting to month-to-month market swings can lead to overcorrections, so annual adjustments help keep spending aligned with long-term trends,” said Gates.
What could go wrong?
There’s a reason the guardrails method isn’t for everyone. It requires regular portfolio tracking, making spending adjustments and yes, following rules.
The latter can be a hard pill to swallow, even if you set out to do exactly that. Diton has learned that over his 40 years in the industry, people prefer stability. “It's great on paper, but … it's not real life for many people. They want to live life and spend a fairly constant amount,” he said.
The guardrails approach is effective when followed correctly, but even rule followers can sabotage the method.
If you manage your investments alone, key risks include making adjustments too quickly, ignoring alerts to cut spending or delaying cuts when the market drops — any of which could deplete your portfolio.
With this and any retirement withdrawal approach, it's best to seek the help of a trusted financial adviser.
A guide, not a guarantee
As with any drawdown strategy, the guardrails approach is purposely flexible. It should be used as a guide, not a hard and fast rule that can’t change based on circumstances.
You might not want to spend extra money in a year when the markets are booming, or you might have no choice but to spend more in a bear market, and that’s OK. For the long haul, the approach shouldn't have a significant impact on the longevity of your retirement nest egg.
“It's important to have guardrails,” said Derrick Longo, a wealth adviser at Exencial Wealth Advisors. “But when the rubber hits the road, you don’t want to not live your life because of a guardrail.”
