How to Plan for Retirement’s ‘Decumulation’ Dance

 Published: Thursday, 6 Jun 2013 | 10:25 AM ET

CNBC

 

By: Paul O'Donnell

RKO | Archive Photos | Getty Images

Fred Astaire and Ginger Rogers

 

As long as you've been saving for retirement, you've had your eye on "the number": the amount you need to save to get by. But once you decide to quit, there's another number you need to know—how much you plan on spending each month, and which retirement account it's going to come from.
Welcome to "decumulation," the process of unwinding the investments you've worked so hard to pile up over the course of your career.

How you spend your retirement accounts is as important as how you built them, and is subject to much the same forces that shaped your savings decisions: income, risk, and taxes. "You've got this dance between these three things," said Jennifer Landon, president of Journey Financial Services in Idaho Falls, Idaho.

But compared to the relatively straightforward process of saving, decumulating, to paraphrase the old saw about Ginger Rogers' dancing skills, can be like dancing backward, with higher stakes.
Traditionally, everyone's decumulation number was 4 percent — the percentage of your nest egg you could access each year and still stay flush. "With interest rates at an all-time low and volatility at an all-time high, the 4-percent rule no longer applies," said Landon.


In any environment, retirement can be disorienting. "People accumulate money in these different buckets—IRAs, 401(k)s, Social Security, securities—but they don't know how to transition from saving mode to 'Boom, we're retired,'" said Bill Smith, president of W.A. Smith Financial Group, near Cleveland.

Having a firm idea of how much you expect to spend will help determine how much money you will have to tap, which funds you'll tap, and in which order. (Not incidentally, it will also give you an idea if you really have enough money set aside.) "Knowing your number is critical," Smith said.
Your decumulation number is actually two numbers put together: your basic expenses for shelter, food, utilities and other routine bills, and what Smith calls "joy expenses": the money you need to travel, pursue your hobbies and generally find fulfillment. Financial advisors are often surprised at how few clients have even a ballpark idea of their number as they approach retirement.

Americans Aren't Saving Enough

 

CNBC's Mandy Drury Americans are saving too little for retirement. Debt levels are one of the reasons people have had such a hard time saving.

 

Once you have your expenses figured out, you match them against the income streams that come to you as fixed payments—a defined-benefit pension, your Social Security benefits (if you're taking them immediately), and other cash flow, like installments from the sale of a business. Any shortfall will need to be covered by withdrawals from retirement accounts. And that's where the dance begins.
Your primary consideration is taxation. Your retirement saving will be one of three types: tax-free, tax-deferred and taxable. The first of these types to take is taxable. "Our general philosophy is, if you're going to be taxed on it, you might as well take it," said Craig Brimhall, senior vice president at Ameriprise Financial. As a general proposition, too, financial experts agree the next stop should be a tax-free pool of funds—in most cases that means Roth IRAs, which contain after-tax money, municipal bonds.

That leaves the tax-deferred sources, chiefly traditional IRAs and 401(k)s, which, in many cases, have replaced retirees' homes as their greatest repository of wealth. They are also the most unwieldy. For one thing, as Landon pointed out, "Any time you put your hand in that big bowl of your IRA or other pretax assets, you're causing a tax effect." For a retiree in a 25 percent tax bracket, she adds, "$1 in an IRA is really worth just 75 cents." Put another way, you have to draw down 25 percent more of your savings each month to produce the same amount of revenue.
On the other hand, it's not advisable to save all of your tax-deferred money until you've drained most of your other resources. When you turn 70-and-a-half, and your IRAs or 401(k)s fall subject to "required minimum distributions"—IRS rules that mandate you withdraw a growing percentage each year—you not only lose control of your spend-down, you'll be exposing all of your income to higher taxes.

Most advisors recommend therefore that you deplete your tax-deferred funds each year, most wisely by converting them to a Roth IRA. Ameriprise's Brimhall suggests settling on a level of income tax that feels reasonable. "Let's say you don't want to go any higher than the 25 percent bracket," he said. "We'll take reportable income to that point, then shut that valve off and take tax-paid assets from there."