You probably think a lot about how much you'll need to save for retirement. But how often do you think about just how you'll use that money when the time comes?
The accumulation phase of retirement planning is crucial, and because it can take decades, it's natural for that to be your focus. But having a distribution plan is a vitally important factor in making sure you don't run out of money. Here are three specific reasons not to overlook it.
1. It will help you plan how much you need to save
There's no one-size-fits-all answer to the question of how big a retirement nest egg you'll need. If you're going to receive a defined-benefit pension from an employer, for example, your target number will be different from someone who will have similar expenses but can only be sure about receiving Social Security. If you live in an expensive state like California or New York -- and plan to stay there -- you'll need more money than someone who retires in a state with a lower cost of living like Mississippi or Arkansas.
Your distribution strategy should take factors like this into consideration. Making sure to account for things like inflation, you can calculate an affordable spending budget for each year of your retirement. If you run the numbers and realize that based on your current saving and investing trajectory, you won't have enough to meet your needs, you can make adjustments like increasing your savings contributions while you're still working. That's a far better strategy than waiting until after you've retired to find out if you've come up short.
2. It'll help you control your expenses
Saving more will lower your chances of running out of money, but controlling your expenses is also vital. No matter how much you save, the lower your expenses are, the longer your assets will last. If you usually upgrade your lifestyle whenever you get a raise, the process of setting up a distribution strategy in advance may make you think twice. If you take on new expenses today, you might still have to pay them even when you're no longer earning income from your job.
If you won't be able to maintain your current lifestyle in retirement, discovering that ahead of time gives you the opportunity to work toward reducing your bills to more manageable levels. You can achieve this by taking actions like paying off a car note or downsizing your home before you retire.
3. It will guide your investment decisions
Bear markets happen from time to time. If one occurs when you are in your 30s, you can hold on to your stocks calmly, secure in the knowledge that you'll have decades during which your retirement accounts can recoup any losses that they suffered. If a downturn strikes when you're retired, though, the situation can be more acute. True, you likely won't have near-term needs for all of your money, so most of it can stay invested for growth. But if you are selling shares to cover your expenses, doing so when their values are lower means you'll need to take a larger slice of your assets, which leaves you with fewer shares in your portfolio to benefit when prices rebound.
Imagine you have $500,000 in retirement savings and plan on taking a $20,000 withdrawal at the end of each year. In a flat year, no-growth year for the stock market, your account would be reduced by your withdrawal to $480,000. In a year when your portfolio had a 10% return, they would increase to $550,000 and after your withdrawal, you'd have $530,000. In a year where you lost 10% of your account value, it would first go down to $450,000, and then your $20,000 withdrawal would leave you with $430,000 invested.
Bigger losses can make things even more uncomfortable, but creating a distribution strategy can help you plan better for these scenarios. Knowing how your account balances could be affected in years where your investments lose money, you can make your accounts more conservative or set aside a few years of distributions in cash so they won't be affected by market volatility.
One of your biggest fears about retirement may be running out of money. Saving more is an obvious way to try to prevent that, but it may not be enough of a strategy for you to avoid this stressful outcome. Having a plan that includes knowing how you will spend your money is essential if you want your nest egg to last throughout your entire retirement.