The years you spend saving and investing for retirement are called the "accumulation" years. Once you retire, you enter the "decumulation" years. While planning financially for retirement is critical, it's only half the battle. The other half involves ensuring you won't run out of money.
You've long heard that the earlier you begin to save for retirement, the better. The same is true of decumulation: The earlier you begin to plan for it, the easier it is to implement in retirement. Here are five solid reasons decumulation matters.
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1. It helps you to plan for sustainable income
John Hancock (a subsidiary of Manulife Financial) recently released a report on its first-of-its-kind Longevity Preparedness Index (LPI), in collaboration with the MIT AgeLab. Their research found that most adults are underprepared for longer lives, falling short in planning for housing, finances, and health.
Simply put, many retirees live longer than expected. Underestimating how long you'll live is a potential recipe for running out of money. It's OK that no one knows exactly how long they have here on Earth. But planning for decumulation takes that lack of certainty into account, designing a withdrawal strategy that allows your money to continue to work for you throughout your life.
Let's say you retire at age 67. Both of your parents died in their 70s, and you assume the same will be true for you. You may be right, but you may be very wrong. A strong decumulation plan includes a withdrawal strategy that ensures your money will last for decades. Even if you're surprised to still be alive in your 90s, your retirement plan will remain hard at work.
2. It's far more tax-efficient than winging it
Different retirement accounts have different tax implications. While taxes will be due on some retirement-account withdrawals, other withdrawals can be made tax-free. It all depends on the type of account you're drawing from.
For example, 401(k) contributions are normally made with pretax dollars, meaning you must pay taxes on withdrawals from the account when they're made. On the other hand, Roth IRA contributions are made using money you've already paid taxes on, so there's no need to pay more when you make a withdrawal in retirement.
A decumulation plan includes a strategy that allows you to minimize taxes over time, avoid unnecessary penalties, and maximize your retirement income.
3. It gives shape to your investment strategy
As you transition from accumulation to decumulation, you may want to rebalance your portfolio to reduce risks and protect the bank of assets you've already built. Throughout retirement, a decumulation plan gives you room to adjust your investments based on your financial needs and market performance.
In other words, it's not a "set it and forget it" plan. Decumulation should keep you engaged with how your portfolio is performing and your life in retirement is humming along.
4. It provides more time to plan for unforeseen expenses
You undoubtedly understand the importance of a hardy emergency fund. Planning for the decumulation phase includes preparing for all potential expenses (to the best of your ability). This includes setting aside emergency funds to cover broken water heaters and other home repairs. It includes putting enough money away to cover healthcare expenses in retirement, as well as long-term care.
5. It's customizable
Chances are, if you were to ask five friends, each would have a different mental picture of their ideal retirement. Just as you've chosen how you want to save for retirement, you're the one who gets to create a decumulation plan that matches your wish list.
For example, if your goal is to fish the 10 deepest lakes in North America during your first few years of retirement, you can plan your withdrawals accordingly. If you're planning a blowout party on your 75th birthday, you can plan for that. Knowing what you want provides your road map.
Decumulation planning is not just about how you'll manage your money in retirement. It's about ensuring your financial security, maintaining your lifestyle, and reaching your retirement goals.
