Key Takeaways:
- Many retirees struggle with the mental shift from saving for retirement to spending in retirement, also known as the decumulation phase, or when they start drawing from their retirement savings to produce income.
- Developing an efficient withdrawal strategy — whether the 4% rule, bucket strategy, or other method — that considers your needs and anticipates and adjusts to shifts can make the switch from saver to spender easier.
- Making the mental shift to spender may require reframing your mindset to view money as a resource and focus on value rather than cost, among other strategies.
As retirement planners in San Diego, we often observe how transitioning into retirement can be challenging for many retirees, especially as they begin tapping into their hard-earned savings — or decumulating their retirement funds. Making the switch from diligent saving to spending without the stability of a steady future paycheck can be daunting, prompting retirees to underspend. It may be surprising, but underspending can also come with consequences, including higher taxes, loss of joy, and regret. This contradiction of saving for this chapter while also avoiding or reducing spending once you’ve reached it is a challenge that can be overcome with proactive planning and a renewed mindset.
What is Decumulation?
Decumulation in retirement is the point at which a retiree begins drawing on their retirement savings to produce an income stream. In contrast, accumulation is the period through your career where you invest, save, and compound for your future retirement. Equally essential, your spending habits in retirement can significantly impact the longevity of your savings. Still, withdrawing from funds you’ve spent decades building can be uncomfortable for retirees. Blankinship & Foster Financial Advisor Jon Beyrer, a recent guest on the Boomers, Bucks, and Bling podcast, shared how many retirees, despite having sufficient savings, continue working because they fear financial insecurity in retirement. He also highlighted the growing strain many retirees face in juggling support for adult children and aging parents while trying to sustain their income in retirement. These fears underscore the importance of creating a strategic spending plan in retirement.
Why Strategic Spending is Important in Retirement
Many retirees share common concerns, such as fear of outliving their savings or market volatility, but a balanced strategy can make spending more manageable. Consider these common challenges retirees face:
- Longevity Risk (Outliving Your Savings): With retirees living longer, they must sustain their income for a 25- to 30-plus-year retirement. Thoughtful spending plays a vital role in ensuring you don’t outlive your savings.
- Market Volatility and Sequence of Returns Risk: It was easier to ride out market swings while you were still working, earning, and saving. However, in retirement, it can feel unsettling to withdraw funds during a down market. This is when a diversified approach to spending is beneficial in helping smooth out risks.
- Healthcare and Long-Term Care Costs: It’s important that retirees plan for rising costs and have reserves on hand for unplanned expenses in retirement, especially as health needs change.
- Inflation Eroding Purchasing Power: While your savings won’t be worth as much in 20 years as they are today, it’s crucial to strike a balance between sustainable withdrawals and safeguarding your savings with inflation-protected assets.
- Uncertainty About Spending Safely: This can be a major mental shift for savers in retirement, which may cause more conservative or under-spending. The key is to build a withdrawal plan that provides structure and allows you to enjoy your retirement while factoring in long-term growth and asset protection.
Common Decumulation or Retirement Income Withdrawal Strategies
Having a retirement income withdrawal strategy in place can help you transition from saver to spender more easily in retirement, knowing you have an efficient plan and the funds to execute it. Here are a few common decumulation methods:
- The 4% Rule: A common rule of thumb is to withdraw 4% of your savings annually, while making adjustments for inflation, rising costs, and changing circumstances. This is a good starting point for spending, but it can vary based on your lifestyle, needs, and expected lifespan to help ensure you don’t outlive your savings.
- Bucket Strategy: This is an effective method for categorizing your income by time horizon and risk into short-, mid-, and long-term buckets. The idea is that you can tailor your portfolio to your needs, allowing your other funds to grow and replenish throughout your retirement. Here’s what it generally looks like:
- Short-Term: Set aside the first few years of your retirement living expenses in a short-term bucket, drawing on things like a savings or money market account.
- Mid-Term: Allocate the next 10 years of living expenses to a lower-risk bucket, such as bonds.
- Long-Term: Put the remainder of your retirement living expenses in a higher-risk, growth-oriented bucket, such as stocks.
- Creating Guaranteed Income: Knowing you will have a set income for life can bring significant peace of mind when spending in retirement. A few ways you can do this are:
- Delay Social Security benefits: If eligible, monthly Social Security benefits are a guaranteed income source for life. Claiming at the earliest age of 62 may reduce your benefits, which is worth noting. However, if you can afford to, you can also increase your benefits every year you delay claiming your benefits until the age of 70, creating a steady inflation-protected income later.
- Buy an annuity: An annuity converts a portion of your retirement savings into an insurance policy that will issue guaranteed income immediately or at a future date for a term you choose. While fees are involved, the peace of mind that comes with a long-standing income stream in retirement may make an annuity a sensible choice for you.
- Tax-Efficient Withdrawal Sequencing: Taxes are also part of your retirement spending and should be planned for strategically. Creating a tax-efficient withdrawal plan, considering each savings vehicle’s tax treatment, can help you minimize your liability while allowing other savings to continue compounding. For example, you may consider a sequence, such as:
- Draw from taxable accounts first, such as investments. Ideally, this approach allows your other tax-advantaged accounts, such as a 401(k) or Roth IRA, to continue growing. Withdrawals on other accounts also add to your taxable income, whereas you’re only taxed on the gains of investment withdrawals, which may be lower, helping to manage your taxes and cash flow.
- Next, draw from tax-deferred accounts, such as a 401(k) or traditional IRA. While these withdrawals are taxed as ordinary income, you have more control over how much you withdraw to manage your tax bracket, which is essential in managing Medicare premiums and as you reach the required minimum distribution (RMD) age.
- Finally, draw from tax-free accounts, such as a Roth IRA. Ideally, you’ll allow tax-free accounts to continue compounding the longest, as withdrawals are tax-free and there are no RMDs, which are major long-term benefits.
How to Reframe Your Mindset from Saver to Spender in Retirement
In addition to a tax-efficient withdrawal strategy, the transition to spending in retirement can be a mental one. Here are a few shifts that can help reframe your mindset:
- Remember, This is What You Worked For: Enjoying your wealth is exactly what you spent decades working and saving for.
- Look at Your Money as a Means, Not an End: Rather than trying to maintain a certain number in your account, treat your money as the resource it’s meant to be. The wealth you’ve earned can help you create new experiences, make stronger connections, and live out the dreams you set aside while working.
- The Cost vs. Value: Similarly, enjoyable experiences may be worth more than the actual dollar amount. Consider the non-financial value, return on investment, and memories that spending can bring to your retirement.
- Accept the Natural Progress of Your Career: You’ve likely gone through various phases in your career, managing and making adjustments for raises, low-income years, supporting children, and more. The distribution phase of retirement is no different, and one you should view as a natural part of your career journey.
Take Control of Your Retirement Spending
Spending in retirement is more complicated than many retirees may initially think, comprising emotional and mental shifts. While everyone’s concerns and reasons are different, you may also struggle with the decumulation phase, as so many retirees do. In the face of uncertainty, having a plan can be a game-changer, helping you gain more clarity about your circumstances, structure, and peace of mind.
Begin assessing your current financial situation to determine a withdrawal and spending strategy that works for you — one that allows you to enjoy the fruits of your labor while considering your future security. On the podcast, Jon also recommended conducting a retirement “trial run” to experience your expected budget, everyday activity, and schedule.
At Blankinship & Foster, we love helping retirees prepare for every stage of retirement, from accumulation to decumulation, and the mental shifts that come with it. If you need help navigating the complexity and nuances of retirement, our team of fee-only financial planners will be happy to assist you, drawing on more than 50 years of combined experience. Contact us to learn more about us, our approach, and how we can help you achieve your ideal retirement.