Understanding decumulation: Spending wisely in retirement

As you move into your retirement years, you’re likely thinking about the big shifts and changes of this new phase— from new day-to-day routines to extra time to spend pursuing hobbies or with loved ones. One major change you should also be considering is the shift from the years of saving and investing that got you to this point, to the new need to be strategic about spending. After spending your working years diligently planning, you’re now at the stage when you can begin to enjoy the result of those efforts. To make sure you can do that as long as needed, and to plan for your legacy as well, you’ll now want to spend time understanding and developing a comprehensive spending plan and strategies for decumulation—both of which we’ll detail in this article.

Concerns for retirees

Retirement is often envisioned as a period of relaxation and enjoyment, but it also comes with its own set of challenges: chiefly, ensuring that your savings and retirement income will last as long as you need it and understanding how tax liabilities may impact your portfolio. This involves transitioning from the accumulation phase, where the focus was on building wealth, to the decumulation phase, where the emphasis shifts to the strategic withdrawal of funds. Doing this effectively requires awareness of numerous factors, from the current market to the way your tax liabilities may be structured. Other concerns involve planning for and managing healthcare costs, adapting to potential changes in lifestyle, and being prepared for possible changes in  market conditions. The success of this phase largely depends on a well-thought-out spending plan and effective decumulation strategy.

Decumulation: From saving to spending and protecting retirement income 

Decumulation refers to the process of converting savings and investments into retirement income to support your expenses during retirement. Unlike accumulation, where the goal is to grow your wealth, decumulation focuses on strategically withdrawing from your savings to ensure a steady income stream without depleting your resources too quickly.

Your decumulation strategy should consider the following factors:

• Retirement lifestyle goals: Your desired lifestyle in retirement will significantly influence your decumulation strategy. Whether you plan to travel extensively, pursue hobbies, or simply maintain a comfortable standard of living, start with a detailed understanding of your needs, goals, and a realistic consideration of how they may change over time. 
• Life expectancy and healthcare needs: While it may be difficult to think about, estimating your life expectancy and accounting for potential healthcare needs can help you plan how much you may need to withdraw each year, and the extent of your tax liabilities. Longer life expectancies require more conservative withdrawal rates to ensure your funds last. Online calculators can help you with an individualized projection. 
• Tax liabilities: The taxes you owe in retirement will vary based on the composition of your portfolio, type of savings vehicles employed, and other factors. You may have already crafted your retirement plan with consideration for your tax liabilities, but consult with your financial professional regularly to ensure your strategies are up to date.
• Market volatility and economic factors: Economic conditions and market performance can impact your retirement savings. Your financial professional can help you develop a strategy that is structured according to your changing risk tolerance and accounts for market fluctuations.

Common challenges

There are a number of common challenges retirees may face. An experienced financial professional can help you consider and plan for each of these possibilities and how to protect yourself and your savings:

• Sequence of returns risk: Your investments are impacted by the performance of the market which means there’s always the possibility that when you retire you find yourself in a time of market downturn. While this may mean your nest egg appears reduced, your financial professional can help you make strategic withdrawal decisions that allow you to continue growing certain investments, while drawing income from other sources, and managing your tax liabilities.
• Inflation: Rising prices can erode your purchasing power over time. Regular check-ins with your financial professional can help you have a clear sense of your spending power over time. Working with your financial professional to make sure your plans will keep pace with inflation can help you maintain your standard of living.
• Longevity risk: For decades our life-spans have been increasing- a very good thing! However, this makes careful planning even more imperative to ensure you don’t outlive your savings. 
• Healthcare expenses: Medical costs tend to increase with age, as does the possibility of needing long-term care. You likely considered this in your retirement planning, but a financial professional can advise any needed modifications or enhancements based on your current needs and future projections.

Your comprehensive spending plan

Your spending plan is more than a budget— it’s a big picture plan that outlines your needs, expenses, and goals and incorporates your decumulation strategy to ensure everything is covered at the right time, including your tax liabilities. Follow these steps with your financial professional to create your comprehensive plan:

1. Assess your current financial situation
   • Start by estimating your annual expenses, including essential costs (housing, food, healthcare, tax liabilities) and discretionary spending (travel, hobbies).
   • Then, evaluate your income sources: Identify all potential income sources, such as pensions, Social Security, and investment accounts. Understanding the various types of income streams— and their requirements such as mandatory withdrawals— will help you determine how much you need to withdraw from your savings and when.
2. Choose withdrawal strategies- consult with your financial professional for the most strategic way to draw your retirement income from your savings, making sure to consider how different plans create different tax liabilities. Some options include:
   • Systematic withdrawal approach: This involves withdrawing a fixed percentage of your retirement savings each year. It provides a predictable income but requires careful planning to avoid depleting your funds.
   • Bucket strategy: Divide your savings into different “buckets” based on when you will need the funds. Short-term buckets hold conservative investments for immediate needs, while long-term buckets can be more aggressively invested.
   • Dynamic withdrawal strategies: Adjust your withdrawal amounts based on market performance and changes in your financial needs. This flexible approach helps manage risks associated with market volatility.
3. Mitigate tax liabilities
   • Understand Tax-Efficient withdrawal methods: A common strategy is to withdraw from taxable accounts first, then tax-deferred accounts, and finally tax-free accounts to minimize taxes and maximize after-tax income.
   • Use Tax-Advantaged accounts: Accounts like Roth IRAs and Health Savings Accounts (HSAs) offer benefits that can protect your retirement income while reducing tax liabilities.
   • Considerations for minimizing required minimum distributions (RMDs): Strategically managing RMDs from retirement accounts can help reduce taxable income and preserve your savings.
4. Incorporate estate planning into the spending plan
   • Ensure efficient wealth transfer to heirs: Plan for the smooth transfer of assets to your beneficiaries by designating beneficiaries and setting up trusts if necessary.
   • Minimizing estate taxes: Strategies like gifting and using tax exemptions can help reduce the estate tax liabilities on your heirs.
   • Utilizing trusts and other tools for legacy planning: Trusts can provide control over how your assets are distributed and offer tax benefits.
5. Strategize for sustainable retirement income
   • Combine Guaranteed and Variable Income streams: Balance guaranteed income (like pensions and annuities) with variable income (like investments) which can provide stability and growth potential.
   • Annuities and their role in retirement income: Annuities can provide a steady income stream for life, offering protection against longevity risk. Make sure you consult with your financial professional about possible tax liabilities. 
6. Adjust your spending plan over time
   • Regularly rebalance your portfolio with the guidance of your financial professional to help maintain your desired asset allocation and manage risk.
   • Be prepared to adjust your withdrawal rates based on changes in your financial situation or market conditions.
   • Stay flexible and ready to modify your spending plan in response to unexpected expenses or changes in income.
   • Always remember to include plans for your tax liabilities, which may change over time. 

With these steps and guidelines you should have a strong foundation of understanding to begin to develop your spending plan and decumulation strategy.