Imagine that you save $2,000 for a four-day vacation. After covering the cost of a hotel, you have $1,500 left. On day one, you spend $800 visiting one of the world's most famous amusement parks. On day two, you pay $500 for two tickets to watch your favorite NFL team play.
By day three, you only have $200 remaining and aren't sure how you'll spend the final two days of your vacation. Now that you're in this position, you wish you'd saved more money or devised a better spending plan.
That's where decumulation comes into play. Defined as "disposal of something accumulated," it applies to all kinds of situations, including retirement. Just as your vacation would benefit from a carefully designed spending plan, a stress-free retirement requires a withdrawal and spending strategy that ensures your money will last throughout your golden years.
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Retiree survey
Late last year, a survey conducted by the fintech company IraLogix found that few American retirees have a plan for how they'll spend the money they get from Social Security and retirement accounts once they've received their final paycheck.
Specifically, the survey revealed some of the challenges retirees face as they manage withdrawals from their retirement accounts, like 401(k)s and IRAs -- an example of decumulation. While accumulation refers to gradually gathering resources over time, decumulation is that fun time in life when you figure out how to spend it.
However, for those who fail to create a spending plan, withdrawals can quickly deplete the assets they've worked so hard to build. While saving for retirement is vital, decumulation is equally important.
The findings
IraLogix discovered that a significant number of retirees navigate decumulation without a plan. Instead, they withdraw as needed, (perhaps) hoping the future will take care of itself. Only 22% of those surveyed report systematically drawing down retirement funds based on a fixed annual percentage.
In addition:
- 44% say inflation has minimal to no impact on their savings withdrawals, meaning the money they withdraw may not go as far.
- 24% stick to a fixed withdrawal rate, regardless of how the market is doing. Retirees without a plan B when the market is down must sell more of their portfolio assets to withdraw the money they require.
- 11% of respondents admit to withdraw 5% to 6% of their retirement accounts annually, a percentage that may not be sustainable over the long term.
Positive takeaways
The survey also revealed healthy habits, such as:
- 53% of survey respondents say they use the money they receive from Social Security benefits before tapping any other source. In theory, Social Security payments are a guaranteed source of income and one that can't be depleted by spending too much upfront or early in retirement.
- 31% of respondents keep a cash reserve cushion of 6-12 months to meet unexpected expenses, and 29% keep more than 12 months' worth of cash stashed away.
Devising a strategy that works for you
The ideal withdrawal strategy allows for leeway while also safeguarding your long-term financial security. It may also prevent you from paying more than necessary in taxes. Here are a few examples:
The 4.7% rule
The new 4.7% rule replaces the old 4% rule that's been a fan favorite since the 1990s. With the 4.7% rule, you take 4.7% from your retirement accounts in your first year of retirement, then adjust for inflation each of the following years.
Withdrawal sequencing
If you're concerned about the bite taxes will take out of your retirement income, this retirement income strategy may be for you. If you have multiple accounts, withdrawal sequencing focuses on the best order to draw from each. For example, you may want to draw from taxable accounts first, then tax-deferred, and finally tax-free.
Whether withdrawal sequencing works for you depends on factors like your tax bracket. You may want to discuss this strategy with a financial or retirement advisor.
Bucket method
The bucket method sets things up to allow your retirement assets to continue to grow long after you've retired. You begin by dividing retirement savings into imaginary "buckets" based on different time horizons and financial goals. Usually, there are three:
- Short-term bucket: Contains cash or cash equivalents that can be used to cover living expenses and get you through market volatility. Once that bucket is depleted, you'll tap into the medium-term bucket and finally, the long-term bucket.
- Medium-term bucket: This is where funds you may need over the next five or 10 years go. The money is invested in conservative investments, like bonds.
- Long-term bucket: This bucket is for needs 10 years or more away, and can be invested in more aggressive growth assets such as stocks to take advantage of potential appreciation.
After years of sweating and saving, decumulation represents the payoff. However, it's up to you to have a plan that allows your money to last you for the rest of your life.
