Decumulation: Easing Clients' Fears with a Considered Approach to Retirement Spending

When developing a thoughtful decumulation strategy, it's important to first understand a client's financial picture, goals for their retirement years and the challenges they're likely to face. Spending priorities can play a significant role in the client's preferences when it comes to decumulation. Clients who wish to prioritize travel or other activities may be attracted to strategies that differ from clients who are focused on leaving an inheritance or simply maintaining their standard of living during retirement years.

It's also important to help the client evaluate their life expectancy and plan for future needs—including increasing healthcare expenses and long-term care needs. Anticipated tax liabilities and fixed living expenses are also critical pieces of the equation.

Clients should have an understanding of the of potential challenges they may face throughout their retirement years—including inflation and sequence of returns risk. Inflation can significantly impact a retiree's spending power. Clients should be prepared to revisit their decumulation strategies in the face of inflationary conditions.

Sequence of return risk is a market volatility issue surrounding the order in which returns on a client's investments occur. Essentially, if a greater proportion of low or negative returns occur during the early years of retirement, the client's overall returns are going to be lower than if those negative or low returns occurred at a later point in the client's (and the investment's) lifetime. In market downturns, it may be wise to draw upon alternative sources while allowing other investments to rebound and continue growing.

A Strategic Decumulation Approach

A client's goals, expenses and retirement income sources provide a starting point. Common sources of income might include taxable accounts, Social Security, tax-deferred retirement accounts, tax-free income sources (Roth accounts) and guaranteed income sources (pensions and annuities). Individual risk tolerance and outside market challenges must also be considered when developing a decumulation strategy. Various basic approaches exist.

Clients who prefer a formulaic approach to withdrawing from retirement accounts may begin by relying on the IRS' actual RMD tables. Even if the client has yet to reach RMD age, they can use the IRS' tables and base their annual withdrawals on their own account balance and life expectancy. The RMD approach is based directly on the client's actual account balance year-after-year.

Other clients may be more comfortable with a more dynamic approach—adjusting withdrawals based on market performance and changing needs over time. Many clients mistakenly believe that adopting a "safe" withdrawal rate is absolutely necessary to prevent them from running out of money during retirement. With quality financial guidance, clients who are comfortable with this approach can base their annual withdrawals on actual market returns and real-life inflation impacts.

Dividing retirement assets into buckets can also be useful. Buckets can be based on when the client anticipates needing the assets—with assets allocated to more immediate financial needs invested more conservatively than assets allocated for long-term use.

Tax-specific buckets can also be useful when it comes to minimizing tax liability. Clients can begin with their taxable and tax-deferred accounts and use nontaxable accounts (e.g., Roth accounts, HSAs) to minimize their overall tax exposure.

Conclusion

When it comes to retirement decumulation, flexibility can be the key to a successful approach. Conditions will change over time—and it's important to ensure that clients understand this fact. Once a basic strategic approach is in place, clients should be prepared with a plan to adjust that decumulation approach based on changing conditions—both within the market as a whole and the client's unique financial position.