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June 29, 2020
If you’re reading this, you’re likely someone who: saves money, has built up some assets, and is starting to think about how to create a retirement drawdown strategy – a plan for how to turn your assets into income that will last for life.
Having a sound retirement drawdown strategy and keeping to it is crucial if you want to be able to live comfortably in retirement and not spend time worrying about outliving your savings. Most of the financial services industry has been focused on helping people accumulate or save and invest (and their business models are built on this).
How to decumulate, or drawdown, and generate retirement income in a tax efficient way is a complex topic that is starting to get more attention. Here are five steps to decumulation – a retirement drawdown strategy:
In order to set your withdrawal plan you first need to know how much you’ll need and want. From a risk management perspective – try to get the “need to live on” amount as low as possible.
Take a hard look at your expenses and find ways to get as efficient as possible – this is a huge driver of how much you need in retirement. Build a budget, go through all of your expenses – especially recurring expenses. Get rid of bad debt (credit card, car payments, student loans – ideally pay off your mortgage). Consider where you want to live, since that is a huge driver of taxes and expenses in retirement – here are some lower cost/higher quality of life places in the US, and here are some places to retire abroad.
Consider health care and insurance costs. Out of pocket healthcare costs for a 65 year old couple are more than double what the average household has saved. Read up on how Medicare and Medicare Supplemental Insurance work.
There is an interesting movement called Financial Independence Retirement Early (FIRE) – the FIRE Community has some great lessons for traditional retirement people around being frugal/efficient and mindful.
What you are spending today. Is not what you’ll be spending next year or in 10 years. The reality is that for most people their expenses drop by ~ 10% per decade in retirement.
Here are 9 tips for estimating future expenses.
The more income you have in retirement, the less you need to draw down from your assets, so think carefully about this one.
When many people think of retirement they think “no more work” – the reality is that part-time work is part of many people’s retirement – for income, for engagement, to give back, or for social reasons.
It can be a way of breaking down the problem of retirement income into smaller pieces – for example, if you were making $100K a year and think you only need $75K in retirement, then Social Security ($25K) + part-time work ($25K) + drawdown savings ($25K) sounds like a more achievable plan.
Working part time also gives you a hedge if there’s a big market correction – you’ll give yourself more time for your investments to rebound and you might be able to dollar cost average into the lower market prices. Here are some ideas to find a new chapter for yourself by working in retirement.
Recently more people have started getting smarter and are delaying the start of Social Security benefits.
However, about 33% claim Social Security at 62 – which is generally a bad idea. Basically – if you think you’ll have a long life – then you should delay as long as possible since you’re effectively “buying” an inflation adjusted lifetime annuity backed by the US government at a lower rate than you could buy it on the private market. You can explore your breakeven age Social Security here. If you’re married, have the highest earner delay until 70 – here’s why.
Originally, most equity investments were made with an eye towards how much income they would pay to the stock holder; today dividend paying stocks (or ETFs or mutual funds) play that role along with fixed income (bond/debt) investments, and increasingly more sophisticated investors are looking into alternative investments (“alts” include private equity, hedge funds, managed futures, real estate, commodities, and derivatives contracts). In an ideal world, your investments generate enough income to cover your expenses, but very few people achieve that.
Annuities are contracts with insurance companies that allow you to “buy” guaranteed income – they can be purchased with qualified or non-qualified money. Qualified Lifetime Annuity Contracts (QLACs) are growing in popularity. These allow you to use qualified savings to buy an annuity for guaranteed income, and as an added bonus, they allow you to delay RMDs until 85.
There are a lot of types of annuities and you need to be careful to make sure you buy one efficiently if you go down this path. See how much lifetime income you can buy with a lifetime annuity calculator.
Many people have some other big levers that they could potentially pull which could significantly impact their retirement drawdown strategy, so it’s worth considering them before they execute their drawdown plan.
The single biggest risk that everyone worries about is outliving their money, because no one knows how long they will live. There are a couple of ways to manage this risk:
For most homeowners, their home equity is about half of their net worth – it ranks within the top ten retirement income tips on NewRetirement for good reason. There are several ways you can access this asset:
The main part of enjoying and getting the most out of your retirement is being healthy. Eat right, exercise, get enough sleep, don’t stress out, be mindful, stay social with your friends, and get out for some nice long walks in the woods – preferably with your dog.
If your health is compromised, you’re much more likely to burn up your hard earned savings. Consider different ways to hedge the risk you’ll need Long Term Care – many people can self insure or buy an annuity or hybrid annuity/LTC product vs. pure long-term care insurance which is being offered by fewer insurers each year.
There are two key parts to a tax efficient retirement drawdown strategy.
Drawing assets from different kinds of accounts will impact the taxes you’ll need to pay when you draw down in retirement. There are essentially three places to hold your retirement savings, which are covered below. Ideally, prepare for your drawdown by positioning your savings and investments into the appropriate accounts so they can can be drawn down tax efficiently. The reality for most people is that most of their savings are in qualified accounts. How this money is held goes to the next item – tax efficient drawdowns of these assets.
Tax efficiently drawdown these assets by managing how you draw the assets from each one. The order in which you approach your retirement matters greatly and can have a huge impact on your retirement income. If you have enough assets, you’ll need to plan your drawdown in a way to try to avoid being pushed into higher tax brackets. The rule of thumb for tax efficient drawdown is the following:
Otherwise known as “don’t be forced to sell during a downturn.” A huge risk that anyone living off of their investments faces is being forced to sell assets during a downturn in order to create income to cover living expenses. There are a few big levers to manage this risk:
It is always interesting to see how other people are planning. Here is my retirement drawdown strategy: I’m still under 50 years old and more on the accumulation side of things and also facing more than 10 years of college tuition, but here’s how I look at our situation.
Retirement planning and decumulation is complex and involves big, sometimes long-term decisions. It can pay to have experts in your corner to review your plan or to help you take action to get it implemented. I have a CPA to help me with taxes and sometimes talk with expert legal or financial advisors who act as a fiduciary.
Today, you can find experts who you can pay for a specific service if you need or want help. The NewRetirement Planner is a comprehensive online tool that enables you to model and document most of the ideas and strategies outlined here. It’s a great way to build a free DIY retirement plan that is personalized for your situation.
Do it yourself retirement planning: easy, comprehensive, reliable
Take financial wellness into your own hands and do it yourself retirement planning: easy,
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