I also pointed out that spending rules typically assume that spending will be flat throughout retirement, contrary to what Blanchett, Banerjee and several other researchers have found in studies of data for actual reported retirement spending.
The question most of these spending rules answer is, "how much can I safely spend from savings this year assuming I will spend that same amount every remaining year of retirement?", when the question retirees actually mean to ask is "how much can I safely spend from savings this year given what I assume I will need to spend in the future?"
The difference can be substantial. Quoting Blanchett from Estimating the True Cost of Retirement (PDF),
"When combined, these findings have important implications for retirees, especially when estimating the amount that must be saved to fund retirement. While many retirement income models use a fixed time period (e.g., 30 years) to estimate the duration of retirement, modeling the cost over the expected lifetime of the household, along with incorporating the actual spending curve, result in a required account balance at retirement that can be 20% less than the amount required using traditional models."Sustainable withdrawal rate models make this flat-spending assumption, though it isn't difficult to change the models to fit a different spending assumption. I ran my own Monte Carlo model assuming a 50% equity allocation with constant spending and estimated a 95th-percentile safe withdrawal rate of 4.1%. Then I modified the model to spend 1.5% less in real dollars for each year of ten thousand 30-year scenarios. The second model estimated a 95th-percentile safe withdrawal rate of 5%. That's 22% more annual spending, or $9,000 a year more "sustainable" spending than the SWR model suggests for a $1M initial portfolio balance.
Looked at from the wealth accumulation perspective, a retiree would need to save 18% less to generate the same annual spending if she expected expenditures to decrease 1.5% a year on average rather than assuming expenses would remain flat throughout retirement as most spending rules assume.
The ARVA (PDF) spending strategy model, or annually recalculated virtual annuity, is more problematic. ARVA assumes that the correct sustainable amount to spend in the current year is the amount that an inflation-protected life annuity purchased in the current year would pay out. The retiree doesn't actually need to buy the annuity, she can simply base spending on what would happen if she did. An inflation-protected annuity will pay out the same amount throughout retirement and it isn't clear to me how ARVA could be adapted to predicted declines in spending needs as we age.
This problem extends to life annuity strategies, in general. Inflation-protected life annuities will pay out a flat rate throughout your lifetime in real dollars that will not match declining expenditures. From that perspective, nominal life annuities may not be quite as bad as they seem, since inflation will eat away at the real annual payouts, but expenditures will probably decline, too. The problem is that even "normal" inflation of 2% to 3% is greater than the estimates of expenditure declines, so this is a poor way to match income and expenses. Runaway inflation could be devastating.
Moshe Milevsky's formula for calculating sustainable withdrawal rates without simulation also seems problematic, as it, too, assumes the sustainable spending that it calculates will continue to be spent throughout retirement. It isn't clear to me that regularly rising or declining spending could be incorporated into his probability models, let alone irregular net spending, but his math is well above my pay grade. Milevsky's formula doesn't accommodate the loss of a first spouse except under the assumption that spending doesn't decline. Based on his responses to similar questions in the past, I would guess he would tell us that these scenarios would have to be calculated individually with numerical analysis if we want to avoid simulation.
As I mentioned in Retirement Spending Assumptions and Net Worth, it is probably more common for a retiring household to experience irregular spending throughout retirement, and the SWR model can easily be modified to accommodate that expenditure, as well. I repeat that chart here for your convenience. The red columns show irregular spending. Your spending in retirement is much more likely to resemble this than a straight line.
Bond ladders work well with any spending pattern including irregular ones. It is simple enough to match bond purchases to different amounts of future spending.
If spending increases as we age in retirement, most spending rules will overestimate the safe amount to spend in the current year. It is more likely that your spending will decline over time, in which case these models will provide current-year safe spending amounts that are too conservative. With irregular spending, it's hard to know where to begin with most spending rules.
My last three posts have followed a theme. First, spending is more likely to decline as we age than to remain flat.
Second, by looking at our own non-discretionary spending and net worth, we may be able to determine a more accurate assumption for our own retirement expenditures.
And, third, most spending rules aren't based on a realistic financial model of actual retirement. They assume flat spending, fixed lifetimes (e.g., 30 years), constant risk aversion, and average market returns and they make other spherical cow assumptions that simplify the math but can lead to inefficient saving and spending.
I suggest modeling your expected expenses and income to consider expected market returns, life expectancy and expected expenditures. They are all "stochastic variables", which means they have a random probability distribution that can be analyzed statistically, but can't be predicted precisely.