Summary
This strategy places an upper (cap) and lower (collar) limit on withdrawal adjustments.
Controls the pace of income increases.
Default cap and collar are 5% and 0% in Timeline Planning, but these can be changed.
Description
The cap and collar inflation adjustment approach is a rule that places limits on how withdrawals are adjusted for inflation annually during the plan. This strategy sets a cap (upper limit) and collar (lower limit) on the inflation adjustment. The result is that income increases over time but at a potentially slower pace than inflation. In Timeline Planning, the default cap is 5%, and the collar is 0%, but they can be modify according to the clients' needs.
Example
Imagine you begin your retirement with a withdrawal of £50,000. The following year, the economy sees an inflation rate of 7%.
Without any cap and collar adjustment strategy in place, you would adjust your withdrawal to match this 7% inflation rate. This would increase your next year's withdrawal to £53,500 (£50,000 * 1.07).
However, under the cap and collar inflation adjustment strategy, your withdrawal increase is confined to a cap of 5%. This means, even though the inflation rate was 7%, you would increase your next year's withdrawal by only 5%, which equates to £52,500 (£50,000 * 1.05).
In a subsequent year, let's consider that the economy experiences deflation, i.e., a negative inflation. Normally, this could lead to a decrease in the withdrawal amount. However, with a collar in place (set at 0% in this example), your withdrawal amount won't decrease. Therefore, even during a deflationary period, your withdrawal would remain steady at the most recent figure, which in this case would be £52,500.