Throughout life, most of us spend the majority of our time concentrating on gathering money, possessions, and experiences. But as we age and move closer to retirement, it’s important to become aware of the transition called decumulation. Decumulation is the process of carefully spending your assets in order to maintain your lifestyle in retirement, and it’s a bit more complicated than the accumulation phase.
During accumulation, the goal is to save and invest wisely over time, which seems pretty straightforward. But decumulation adds complexity and involves carefully spending your saved money in a way without depleting your funds.
For many of our hardworking clients, the transition to the decumulation phase can be intimidating. Despite having a large savings fund, the idea of no longer receiving a regular paycheck can cause stress and anxiety. We often reassure them that with careful planning and spending at an acceptable level, they’ll be okay—and we’ll be guiding them every step of the way. In this article, I discuss 7 traps and pitfalls to avoid in the decumulation phase so you can experience 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 former financial advisor 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 financial advisor 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, carefully review your health insurance options until you reach 65 and are eligible for Medicare. 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 many pros and cons to each option, including price, coverage areas, co-pays and deductibles, and more. Also, if you don’t sign up for Medicare at the right 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 don’t 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.
Get a Plan in Place Today
If you’ve dedicated years to accumulating savings for retirement, it’s crucial to your financial well-being to shift gears and strategically plan how to spend those hard-earned funds. As retirement approaches, your financial picture becomes more intricate—making it that much more important to make wise, thoughtful decisions.
Let Infiniti Wealth Management manage these complexities while you enjoy the fruits of your labor. We’re here to explore how we can help turn your retirement dreams into reality. To schedule an appointment and determine if we’re the right fit for you, please call our office at 845-278-8638 or send us a message to set up a complimentary consultation.
Michael Durante is a founder, Certified Financial Planner™ (CFP®), and Certified Divorce Financial Analyst™ (CDFA®) at Infiniti Wealth Management, an independent, fee-only financial advisory firm. With over 25 years of experience, Mike specializes in serving women who are going through a life transition, whether that’s a divorce or the death of a spouse, as well as pre-retiree and retiree couples. He is passionate about helping his clients develop a personalized financial plan based on their values and goals so they enter retirement with confidence and peace of mind. Mike has both a bachelor’s degree in business administration and an MBA from Pace University. When he’s not working, Mike loves spending time outdoors hiking, biking, walking, golfing, campfires, the beach and doing yard work, as well as spending time with family and friends. Mike also enjoys to read, travel, and check out local restaurants and events. To learn more about Mike, connect with him on LinkedIn.
February 2, 2024 - Michael Durante, CFP®, CDFA®