How TIPS and Index Funds Beat the 4% Rule

The approach, he argues, empowers retirees to safely spend more of their wealth while avoiding both premature portfolio depletion and unnecessary underspending. This is possible because the TIPS ladder guarantees a pre-defined real dollar income stream, while supplemental withdrawals are made from the risky portion of the portfolio as if it is amortized like a fixed-term annuity.

“Unlike standard annuities, however, the time to maturity may be adjusted periodically and the periodic withdrawals vary with the market values of the risky assets,” Sharkansky explains. “[This approach] has distinct advantages over retirement income strategies commonly recommended by practitioners.”

Fixed-rate strategies, even with guardrails, can potentially deplete a portfolio, Sharkansky observes, with the retiree outliving their liquid assets and potentially living on Social Security payments alone.

“More likely, though, the [fixed or guardrails] strategy turns out to be overly conservative, leading the retiree to live below their means while accumulating a larger than intended legacy,” Sharkansky writes. “In contrast … an ARVA strategy essentially guarantees that the portfolio will not be depleted during the retiree’s lifetime. At the same time, ARVA positions the retiree to spend more of their available wealth with more control over their legacy.”

Ultimately, Sharkansky argues, an ARVA approach enables more total withdrawals than traditional methods that are typically described as “safe,” but that advantage comes with the trade-off that withdrawals vary from year to year with fluctuations in the risky asset values.

To support implementation of this retirement spending strategy, Sharkansky has also launched The Best Third, a website that allows both investors and financial advisors to explore and test the framework for free. Users can adjust inputs like retirement age, portfolio value, income needs, and confidence levels to generate customized, tax-aware income plans.

"The Best Third is an invaluable resource for investors and financial advisors alike, allowing them to explore what a new retirement paradigm looks like," Sharkansky added. "We often hear that our retirement years should be about enjoying the fruits of our labor. This new research can help retirees feel more confident with their retirement plans."

How It Works

To create their individualized spending plan, pre-retirees start by entering basic information for themselves and their spouse or partner. Next, users establish when they would like to retire and start drawing from retirement savings. They also input when to begin Social Security benefits and enter their estimated monthly amount.

One of the most important decisions in the process is determining the planning horizon — i.e., how long the money needs to last. The calculator uses actuarial data to help savers choose based on their preferred confidence level, whether they want a 90%, 95%, or 99% chance that they won't outlive your assets.

From there, the tool identifies specific TIPS to purchase, which accounts to buy them in, and how this strategy combines with Social Security and other income sources to meet the target spending goals.

For assets not needed for the secure spending base, the framework estimates the potential additional income from stock market investments and how much risk is acceptable to take according to the overall plan.

Finally, clients can test different "what-if" situations by creating multiple scenarios with varying retirement dates, Social Security timing or income targets. This flexibility allows clients to compare results and find their optimal strategy before committing to any particular approach, Sharkansky says.

High Marks From Practitioners

Among the experts who have reviewed the framework is Wade Pfau, the retirement researcher and founder of the Retirement Income Style Awareness platform. In a review of the work, Pfau said the findings present a valuable contribution to research on sustainable retirement spending.

“By combining a ladder of inflation-protected bonds like TIPS with a stock market index fund, it shows how retirees can manage longevity risk, adjust for changing spending needs, and draw variable income without running out of money," Pfau said.

The retirement researcher David Blanchett also had a chance to review the analysis prior to publication, given the significant amount of analysis he has done on this and related topics. He agreed that the work builds in a constructive way on a steadily growing stable of research into an important topic for current and future retirees.

“There’s probably at least two decades of research on dynamic withdrawal approaches at this point and how and why they are better than a static approach,” Blanchett told ThinkAdvisor. “What really surprises me, though, is the vast majority of financial planning tools still treat spending as static, where the amount spent each year in retirement evolves totally independent of what is reasonable given how the retiree’s situation has changed.”

It makes sense intuitively, Blanchett said, that spending can and should change through retirement. If the portfolio goes up, a retiree can safely spend more than expected. If the portfolio goes down, reducing spending on either a temporary or permanent basis may be called for.

“These types of on-going adjustments are what financial advisors should be doing with retiree clients during annual check-ups,” Blanchett said. “The fact they aren’t being incorporated into actual retirement planning tools can lead to some really suboptimal advice, especially around underspending.”

Advisors who are proponents of the 4% rule or its static corollaries might think that dynamic versus static doesn’t really matter, Blanchett added, but the research shows clearly that spending levels can increase significantly using dynamic models and better outcomes metrics.

“It really can make a difference,” he concluded. “It’s time for our tools to evolve.”

Pictured: John Manganaro