INTRODUCTION

Retirement can be an exciting time, but it can also bring about financial challenges. One of the biggest concerns for retirees is how to make their money last for the rest of their lives, while still being able to enjoy their retirement. According to the Office for National Statistics (ONS), the average life expectancy of a 60-year-old in the United Kingdom is around 84 years for men and 87 for women. The life expectancy calculator also suggest that a 60-year-old has 25% chance of reaching the age of 92 (male) and 94 (women). This means that retirees need to plan for a retirement that could last for several decades.

It’s clear that retirees need to manage their retirement income carefully to make their savings last as long as possible. This is where retirement income guardrails come in. In this article, we explore retirement income guardrails, and how they help you make the most of your retirement savings.

WHAT ARE RETIREMENT INCOME GUARDRAILS?

Retirement income guardrails are a set of rules that help you to manage your spending during retirement. The rules designed are to help retirees spend their money in a way that maximises their retirement income while minimising the risk of running out of money too soon. The purpose of these guardrails is to help you strike the right balance between enjoying your retirement and making your money last as long as possible.

Financial planner Jonathan Guyton created the original guardrail strategies, which he later improved upon in collaboration with co-author William Klinger. These rules enable retirees to have higher withdrawal rates, but they acknowledge that future expenses may not consistently increase with inflation, and retirees may have to reduce their spending in certain situations. The objective of this approach is to sustain withdrawals for up to 40 years.

The guardrail strategy has four basic rules:

• Portfolio Management Rule: Withdrawals are prioritised from assets that are overweighted, with equities being the first followed by fixed income. If the necessary amount is still not met, cash is used. If the need persists, withdrawals are then taken from underweighted assets, with fixed income being first followed by equities.

• Inflation adjusted Rule (Withdrawal rule): After experiencing consecutive years of favourable market returns, the withdrawal amount is raised to keep up with the inflation rate of the previous year, subject to a maximum cap of 6%.

• Capital Preservation Rule (Lower Guardrail): If the current withdrawal rate increases by more than 20% of the initial withdrawal rate due to a decline in the portfolio value (from either market returns or taking income withdrawals), the income withdrawal amount is decreased by 10% to ‘preserve’ the portfolio.

• Prosperity Rule (Upper Guardrail): This is the opposite of the Preservation Rule. If the income withdrawal rate has decreased by more than 20% of the initial rate due to portfolio value increases (market growth and or contributions), the withdrawal amount is increased by 10%.

In simple terms, the guardrail strategy ensures that withdrawal rates remain at a level that prevents excessive depletion of the retirement portfolio to a point where recovery becomes impossible.

Assuming all four decision rules are applied, Guyton and Klinger established that portfolios with at least 65% equities can safely start with initial withdrawal rates ranging from 5.2% to 5.6% with a 99% confidence level. This finding contradicts the commonly suggested lower initial withdrawal rates of around 4%. This 4% strategy was popularised by financial advisor Bill Bengen in the 1990s – also known as the ‘4% rule’.

BENEFITS OF RETIREMENT INCOME GUARDRAILS

To summarise, here are the advantages of the guardrail strategy:

• Provides a clear framework for retirement income management: The Gutyon-Klinger Retirement Income Guardrail strategy provides a clear and easy-to-understand framework for managing retirement income. This can be especially helpful for retirees who are new to retirement income management or who may feel overwhelmed by the complexity of retirement planning.

• Helps to manage risk: The strategy is designed to help retirees manage risk by ensuring that they have a steady stream of income throughout their retirement years. This helps to mitigate the risks associated with market volatility and unexpected expenses.

• Provides flexibility: The strategy is highly flexible and can be adapted to meet the unique needs of individual retirees. This can be helpful for retirees who may have complex financial situations or who may need to make adjustments to their income over time.

• Can help to reduce the risk of running out of money: The strategy is designed to ensure that retirees have enough income to maintain their desired lifestyle throughout their retirement years. This helps reduce risk of depeting their wealth and having to rely on government benefits or family for financial support.

DRAWBACKS OF RETIREMENT INCOME GUARDRAILS

To summarise, here are the disadvantages of the guardrail strategy:

• May not be suitable for all retirees: It may not be suitable for all retirees. Particularly those with limited retirement savings or who have a higher risk tolerance. This is because the strategy prioritises income stability over growth, which may not be suitable for all retirees.

• Requires ongoing management: The strategy requires ongoing management to ensure that retirees are on track with their retirement goals. This can be time-consuming and may require the assistance of a financial planner.

• Not guaranteed: The Income Guardrail strategy is not guaranteed. It is is subject to market volatility and other factors that may impact retirement income.

CASE STUDY: JOHN AND SUSAN’S RETIREMENT

John and Susan are a retired couple with a combined retirement savings of £500,000. They goal is to maintain their standard of living throughout retirement while ensuring their savings last as long as possible. To achieve this, they sought the help of a financial planner who specialises in retirement income planning. After analysing John and Susan’s current situation, goals & ambitions, financial situation and risk profile, the financial planner recommended a suitable asset allocation (equity vs fixed income) to allow them to start with a 5.4% income withdrawal rate, which would result in an annual income withdrawal of £27,000 or £2,250 per month.

To ensure that their retirement income lasts as long as possible, their financial planner recommended implementing the guardrail strategy. The prosperity rule and preservation rule are used to set guardrails at 20% of the original withdrawal rate of 5.4%. This approach involves adjusting retirement withdrawals based on the portfolio’s performance. If the portfolio value changes due to market movements or income withdrawals, and the original income withdrawal rate exceeds 6.5% of the new portfolio value (calculated as 5.4% + 20% of 5.4%), then a cut is needed. Conversely, if the income withdrawal rate falls below 4.3% (calculated as 5.4% – 20% of 5.4%), an increase is allowed. This helps to balance the risk of overspending or underspending during retirement.

During their retirement planning session, John and Susan were advised by their financial planner that to maintain their desired annual retirement income of £27,000, their portfolio value must remain between the range of £415,000 and £625,000. In case the portfolio value falls below the lower guardrail of £415,000, they may have to temporarily reduce their income by about £225 per month to ensure their retirement savings last as long as possible.

Over the course of their retirement, John and Susan enjoyed a comfortable lifestyle while still maintaining their retirement income guardrails. When their portfolio performed well, they took advantage of spending raises. When their portfolio performance was poor, they were prepared for spending cuts. As a result, they were able to enjoy a retirement without worrying about running out of money. They can focus on the things that mattered most to them, such as spending time with family and friends, pursuing their hobbies, and traveling.

Here is a diagram that illustrates the guard rail strategy for John and Susan:

CONCULSION

Retirement income guardrails can be a valuable tool for retirees who want to make the most of their retirement savings. Retirees can strike the right balance between enjoying their retirement and making their money last as long as possible by setting spending limits and preparing for unexpected changes in their financial situation.

It’s important to work with a financial planner who can help you to implement income guardrails tailored to your situation. By doing so, you can enjoy a comfortable retirement without worrying about running out of money.

Please note

Retirement planning is a complex area. It requires careful consideration of different factors, including your current situation, retirement goals and risk tolerance.

The income guardrail strategy, in particular, can be a complex and nuanced approach to retirement income planning. You set up income ‘guardrails’ to navigate the uncertainty of retirement income.

While this can be effective in providing a steady stream of income during retirement, it is not suitable for everyone. We recommend that you consult with a specialised financial planner before implementing the income guardrail strategy. This will ensure that it is the right approach for your unique needs and circumstances.

A professional financial planner will assess your individual situation, weigh the benefits and risks of different strategies. Based on the analysis, they will develop a personalised retirement income plan tailored to your specific needs and goals

Other points to take note of:

• This guide is for information purposes and does not constitute financial advice, which should be based on your individual circumstances.
• A pension is a long-term investment. The value of your investment and the income from it may go down as well as up. Your eventual income may depend upon the size of the fund at retirement, future interest rates and tax legislation.
• Past performance is not a reliable indicator of future performance.
• The interest rates at the time you take your benefits could affect your pension income. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation. These are subject to change in the future.