Retirement Income Drawdown Part 4: Proportional Spending, Ratchets & Lockboxes

Proportional Spending

Part 4: Proportional Spending, Ratchets & Lockboxes

Hello everyone! Hope all is well. Today we have the fourth and final installment discussing Nobel Laureate William Sharpe’s book titled Retirement Income Scenario Matrices (RISMAT).

I’ve gone through all 729 pages which initially seemed very daunting. It was my Mt. Everest! But I knew when such a brilliant mind as Dr. Sharpe put pen to paper on the “nastiest, hardest problem in finance” that I had to give it a read and report back to my audience.

My thesis has come in four parts:

Part 1: Introduction & Longevity

Part 2: Inflation and Market Returns

Part 3: Social Security & Constant Spending

Part 4: Today’s post on Proportional Spending, Ratchets & Lockboxes

So let’s get it going and put a bow on this thing! Today we will be going over Dr. Sharpe’s last three retirement income strategies and my concluding thoughts.

Proportional Spending

The next logical step in analyzing income strategies after last week’s discussion on constant spending strategies (the 4% Rule) is a proportional spending strategy.

The way Dr. Sharpe sets this up is by basing the proportion of the portfolio value to be spent in each year with accommodation to life expectancy and the U.S. Internal Revenue Service (IRS) published tables for required minimum distributions (RMD) for each year (a method popular among some financial advisors).

I hadn’t realized the IRS puts such tables out, but not surprising since I’m aware certain tax-sheltered retirement accounts like Traditional IRAs are subject to RMDs beginning at age 70 ½.

For each age from 70 to 115, the tables provide a distribution period which can be used as a lens on life expectancy years. The table below shows the 2016 IRS Uniform Lifetime Table:

Proportional Spending

To determine the RMD for any given year, the IRS simply divides 1.0 by the life expectancy for that age, as shown below:

Proportional Spending

So how does proportional spending compare with the constant spending strategy? Well, as we found out last week, the 4% Rule resulted in nearly 17% of the portfolio value being left to Bob & Sue’s estate.

The Analysis

The first case Dr. Sharpe ran is again based on the “market portfolio”. The surprising result for the proportional spending strategy is that 19.5% of the portfolio value is left to the estate! That’s even more than the 4% Rule constant spending strategy! Dr. Sharpe’s conclusion:

“Even though they chose spending proportions that would provide relatively smaller incomes if they lived very long lives, there were many possible scenarios in which they would leave substantial estates.”

The Conclusion

Similar to the constant spending strategy, the results of the proportional spending simulations goes to show that without insured income such as annuities we have to accept the tradeoff of a smaller chance of running out of money with the greater the likelihood a significant sum is left to heirs. No surprise there, but always interesting to see some numbers put behind it.


The problem with proportional spending is that it may result in lower consumption (and happiness…) in years of recession when the market portfolio drops. However, this would obviously help with portfolio longevity.

Naturally we may cut back spending during rough times for our portfolio, however, Dr. Sharpe does point out various studies showing the rigidity of short-run consumption. While consumption levels may change during recessions, the studies have shown the change is little especially in reference to the magnitude of a recession. This makes sense to me…when I look back at the nearly 50% drop in the stock market during the 2008 Great Recession I probably wouldn’t have been willing (or able) to cut spending 50%.

A potential solution lies in the concept often utilized in many institutional funds and endowments. In such cases, spending levels are often based on a percentage of the average portfolio value over the prior 36 months, for example.

The extreme form of such spending policies is an approach where income/spending may never decline, but when conditions are favorable it may increase. This is known as ratchet policy.

The cases run by Dr. Sharpe are illustrative, but do provide insights into more stable income functions and guaranteed approaches.

That’s right…guaranteed approaches. You know what this means…paying an insurance company.

While such a strategy may sound appealing because it is playing toward your emotions and behavioral economics, the underlying reality is you’ll be buying an overly complicated insurance product, you’ll be paying a lot in fees, the insurance company is simply doing the investing for you behind the scenes, and in the scenario where you may pass early the insurance company keeps the money as profit instead of it going toward heirs.

However, if you are interested in hearing more, check out RISMAT Chapter 19. You may be happy to know Vanguard sells such a product known as Guaranteed Lifetime Withdrawal Benefit (GLWB) which has a Secure Income Rider through Transamerica Life Insurance.

That’s not for me though. Instead, I’d rather just work “one more year” (OMY) to provide a more “guaranteed” income stream for myself. Ahh the benefit and flexibility that early retirement offers. 🙂

Lockboxes & Lockbox Annuities

Generally speaking, “lockboxes” are used to put a certain amount of money in with designated use in a certain future year. A key point is that each lockbox has the same mix of assets as your entire investment portfolio. Lockboxes designated for use in the distant future will have a smaller initial allocation than lockboxes to be used sooner since they will have the most time to grow.

This concept might be something worth exploring more though as it did get me thinking. While setting up a lockbox for every specific year may be tough based on my intent to be solely invested in equities (via broadly diversified index funds) and their underlying volatility year-in and year-out. But given the natural ebbs and flows tend to smooth out over 5 year investment horizons, perhaps lockboxes could be set up with 5 year increments / buckets rather than one year.

This would then give me leeway throughout the 5 years to vary spending patterns, force the continued used of budgeting and planning, and help the preservation and longevity of investment accounts.

I haven’t given thought of how to set this up exactly, but it may be feasible and practical.

But I digress…

The Analysis

Dr. Sharpe sets up lockboxes under three scenarios.

  • First, a strategy where leaving an estate is just as desirable as an equal amount of spending at the time,
  • Secondly one where there is no intention of leaving an estate, and
  • Third being a 50 / 50 composite of the two prior strategies.

As I previously have mentioned, I’m not all that keen on leaving an estate so I’d likely fall into Dr. Sharpe’s second scenario as represented below:

Proportional Spending

The Conclusion

The end result in all three of Dr. Sharpe’s illustrative scenarios is a large portion left to the estate, ranging between 20% and 44%. Needless to say, Bob and Sue’s children / charities will be happy if they chose a lockbox strategy!

And yet again, this strategy goes to show that retirees like myself who don’t intend or target a certain degree of inheritance left to the estate face a dilemma. We either run the risk of living a long life with a resulting insufficient income stream or spend less than we could in our years alive and leave a large unintended inheritance.

The lockbox strategy which leaves 20% to the estate isn’t much different than the 4% Rule which left an estimated 17% to the estate or proportional spending which also left almost 20%.

Dr. Sharpe’s Solution

Dr. Sharpe’s ideal world would include a low-cost lockbox annuity which would solve this problem. But since no such product exists today, there are two other alternatives.

  • A combination of a lockbox strategy set to cover the years in which its beneficiaries are highly likely to be alive with the immediate purchase (at the time of retirement) of a deferred fixed income annuity that would cover the latter years of life.
  • Using the same lockbox strategy as alternative 1 above but with the addition of one more lockbox after covering the initial time period for the purpose of then buying a fixed annuity (or to pay the estate if beneficiaries were to die prior).

Of course nothing is for free. Insurance companies are for-profit after all. They wouldn’t sell such fixed annuity product if they weren’t making a profit in the aggregate. So at the risk of leaving an inheritance you are padding the pockets of insurance companies. Whatever helps you sleep at night, but I tend to revert back to choosing to work OMY…maybe that is because I’m an early retiree though and have that flexibility. After all, leaving an inheritance isn’t a bad deal necessarily.

But I don’t disagree with Dr. Sharpe. It would be somewhat foolish for me to do so given his brilliance in the realm of personal finance. And the conclusion proves that out. This solution of lockboxes for Bob & Sue’s initial 20 years in retirement combined with an immediate purchase of a fixed annuity to begin payout after year 20 does end up resulting in a lower combined portion of the portfolio going to either fees (to insurance companies or asset management) and the estate.

For Bob and Sue, who under each scenario have $1 million invested in the “market portfolio” at the time of retirement, report the following results in terms of where the money ends up:

Proportional Spending

Note that in the last two scenarios (Lockbox + Fixed Annuity / Lockbox + Fixed Annuity + Social Security) that the estate only receives income if both Bob and Sue die before the annuity takes effect. Plus, the deferred annuity is considerably less than half of their portfolio value so the resulting fees associated with it aren’t overly burdensome. If Bob and Sue die after the annuity takes effect then the excess value accrues to the insurance company as profit which isn’t necessarily so transparent in the chart above.

My Thoughts

The biggest flaw that Dr. Sharpe points out with the 4% Rule is that it calls for non-volatile spending plans using risky, volatile investment strategies which leads to sequence of return risk.

The potential (or logical) solution would be a proportional spending strategy. But then of course you run into the question of whether you can truly cut spending (happiness…) in conjunction and on par with market volatility?

Perhaps ratchets could solve this problem, but then again you are paying an arm and a leg in fees and are probably just better off risking it or working OMY.

Then what? Lockboxes, eh? There’s a solution. But spending year in and year out is subject to market conditions whereas the preference is constant and flexible spending as we please. Plus, you still risk leaving a substantial chunk to the estate.

Ok, so we go with lockboxes plus a fixed annuity. Well that’s an insurance product…are you willing to pay to offload some of this risk? Maybe…after all it does result in the objective of not leaving much left over to heirs (as if that’s a bad thing). But in reality that value left over in the annuity as a result of dying early is simply taken as profit by the insurer. Are Bob & Sue really getting the fully utility / happiness of their $1 million portfolio or are we just playing games here?

For me, I think I revert back to constant spending. It’s simple. It’s easy. You don’t have to fully spend at a constant level if you don’t want. And while leaving an inheritance isn’t a goal of mine, it isn’t the worst thing in the world and I see no other feasible alternative that suits me. And if I can get some comfort in Social Security being available for Lucy and I when we reach traditional retirement, then we can feel much more comfortable spending like there is no tomorrow (do you really see us doing that though…?) with that servicing as an added safety net.

We’ll see, we have time yet to weigh all options.

Do you agree / disagree?

Your Thoughts?

While these are my summary notes of Dr. Sharpe’s conclusions, there remains plenty to analyze and discuss in the future. Consider this an invitation for the rest of the personal finance / FIRE blogosphere to jump in.

For the folks currently in retirement or nearing their retirement date, have you given thought to the previously discussed strategies? I’d be most curious if you considered or ended up purchasing a deferred fixed annuity.

Thanks for taking a look!

The Green Swan





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  1. of interest was the IRS longevity equation. i ran the numbers and note that if age > 122 the longevity estimates begin increasing! If you can get past 122, you’ll live forever.

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