Why Retirement Decumulation Is the New Accumulation
By Andrew J. Tapparo, MSF, RICP®
Working toward a financially stable retirement is often viewed as a marathon, not a sprint. For decades, this journey has been painted primarily as an accumulation race—one where the focus is to save as much as possible while weathering the various market storms. While this period is critical to handle correctly, the overwhelming focus is on one simple task: save as much as you can into your investment accounts.
Yet things become more complex in the next financial stage of life, known as decumulation. The phase is when you strategically spend down your hard-earned savings to create an income stream during retirement. The goal, of course, is to retire comfortably without running out of money.
This stage of your financial life includes new tax rules, new financial decisions, and for some people an extra level of anxiety as they worry about making mistakes that will jeopardize their financial independence.
From my experience, many (if not most) people are capable of successfully navigating the accumulation phase on their own. It’s just not that difficult. However, the decumulation phase is a different type of race that most people aren’t prepared to handle completely on their own. In this article, I’ll cover 7 traps and pitfalls in the decumulation phase so you can have a comfortable, carefree retirement.
1. Navigating Taxes in Retirement
In the decades of working and accumulating assets, your taxes mainly revolved around how much you and your spouse made in your careers, and utilizing any credits and deductions to lower that amount. But there’s a lot more to consider in retirement, and each decision affects other decisions. For instance, are your investments diversified by account type?
In other words, do you have the right balance between tax-deferred accounts (like a 401(k) or IRA) and tax-free accounts (like a Roth IRA)? If not, maybe you’d want to consider a Roth conversion, where you convert a portion from a tax-deferred account into a Roth IRA. However, if you do that, it will not only impact your income taxes in the current year, it could also affect how much you pay in Medicare payments, as well as how much tax you pay on your Social Security benefit.
And that’s just one tax issue! Other issues that have tax implications include which account to distribute money from, when to claim Social Security, how to prepare for and handle required minimum distributions (RMDs), and more. There are a lot of moving parts for your tax situation in retirement and with one mistake or overlooked decision, you could get an unexpected tax bill that could also lessen your retirement income. On the other hand, if you properly prepare, it’s possible to lower or eliminate your taxes in retirement.
2. Portfolio Diversification
While a number of retirees want to flock to less volatile investments like bonds and CDs, I firmly believe you need to maintain a healthy allocation to stocks during retirement. Given the low historical returns of those two investments, plus rising inflation, as well as the planned distributions you take, you are in a potentially perilous situation.
Why? Because you are putting yourself at major risk of running out of money in the later years of retirement. As one of my favorite authors, Nick Murray, points out, “A fixed-income investment strategy in three decades of a rising-cost retirement is suicide. It may only be suicide on the installment plan, but it is nonetheless planned suicide.”
3. Withdrawal Order
There is both an art and a science in terms of where to generate your retirement income. If you have money in taxable, tax-deferred, and tax-free accounts, you’ll want to carefully consider your distribution strategy so you make tax-smart choices—not just in the current year, but over your lifetime. While it’s easy to understand how you might be taxed in the current year, you need to combine that knowledge with your future retirement goals, as well as what your income strategy will be 10 years from now. While taking money from one account may be advantageous right now, how will that decision affect your retirement and your tax situation 10 years from now? What you don’t want to do is decide the terms of your distributions today without regard for the consequences a decade from now.
4. Longevity Risk
Outliving your savings is a significant risk in retirement. Given the increasing life expectancy, making your savings stretch throughout your lifetime is crucial. A retirement planning expert can help you find a sustainable withdrawal rate, an appropriate investment strategy that is growth oriented, as well as guidance on when to take Social Security, all of which can increase your odds of having enough money to last your lifetime.
5. Social Security Decisions
One in three people take Social Security as early as they can, at age 62. Yet is that the right time to claim your benefit? As you may know, your Social Security benefit continues to grow up until age 70, and that benefit you receive has a cost-of-living adjustment. It is certainly tempting to take it as early as possible, but you also have to consider the long-term ramifications of that lower benefit amount and how it could impact your lifestyle in your late 70s, 80s, and 90s. Additionally, there are tax ramifications of receiving Social Security and still having an earned income, as well as the impact it makes on tax strategies like a Roth conversion.
6. Choosing the Right Medicare Plan
If you plan to retire before age 65, you need to carefully review your health insurance options until you reach 65 and are eligible for Medicare. While those plans are often costly, if you can make the numbers work, you shouldn’t let this stop you from retiring. And once you sign up for Medicare, you’ll have a new set of decisions to make, including whether to sign up for Original Medicare (Parts A and B) or a Medicare Advantage plan. If you choose Original Medicare, then which Medicare Supplement plan should you choose? There are a plethora of pros and cons to each option, including price, coverage areas, co-pays and deductibles, and even more. Also, if you do not sign up for Medicare at the proper time, it could cost you. Unlike Social Security, which rewards you for waiting to start your benefit, Medicare penalizes you with higher monthly premiums for the rest of your life if you do not enroll in a timely fashion. Things get even more tricky if you continue to work past the age of 65 and are covered by an employer-provided healthcare plan.
7. Changing Rules and Regulations
As if this isn’t enough, you also have to stay up-to-date on the changing laws that every new session of Congress may try to pass. Have ordinary income rates changed? Capital gains? Estate planning thresholds? Required minimum distributions? Social Security benefits or tax rules? That’s just the tip of the iceberg for you (or your advisor) to continually consider as you implement your retirement plan.
Do You Have a Comprehensive Retirement Plan in Place?
If you’ve spent decades accumulating for retirement, you owe it to yourself and your family to properly strategize on how you’ll spend those hard-earned savings. While the accumulation stage may have allowed you to do it all yourself, as you approach retirement, the financial landscape is more complex and the stakes are significantly higher.
Allow us at Tapparo Capital Management to deal with these complexities while you enjoy your retirement. We would love to see if we can help you make your retirement dreams a reality. To schedule a “Get Acquainted Call” to see if we are a good fit for each other, call 978-887-1121 or email andrew@tapparocapital.com.
About Andy
Andrew Tapparo is a fee-only financial advisor at Tapparo Capital Management, a financial planning firm in Topsfield, MA, helping clients turn their savings into a retirement income that lasts. Inspired by the quote “Choose a job you love, and you will never work a day in your life,” Andy founded Tapparo Capital Management in 1997 with a passion for helping clients enjoy a truly worry-free and fulfilling retirement and experience financial freedom. As a Retirement Income Certified Professional (RICP®), he designs retirement strategies along with sound money management to help clients retire with confidence.
Andy holds a Bachelor of Science in Industrial Engineering from Rochester Institute of Technology in Rochester, New York, and a Master of Science in Finance from Bentley University in Waltham, Massachusetts. Specializing in retirement income planning, Andy completed a comprehensive financial industry education program at The American College of Financial Services and was awarded the Retirement Income Certified Professional® designation. He is frequently quoted in the media as a financial expert.
Andy and his wife, Susan, live in Topsfield, Massachusetts, and have two beautiful daughters. Outside of work, he is an automobile enthusiast, enjoys taking road trips, and loves the Outer Banks of North Carolina. In his spare time, he volunteers with the local high school varsity girl’s basketball team as the team statistician and runs the team’s website. He is passionate about supporting charities that serve our veterans and their families. To learn more about Andy, connect with him on LinkedIn.