Are You Ready to Spend in Retirement? 5 Questions
Retirement often requires adopting a new mindset.
When you were saving for retirement, you were in the accumulation phase as you built wealth. Once you reach retirement, you move into the distribution phase where you begin spending those savings. This warrants a different approach to your financial decisions — and possibly a different adviser.
Just as doctors have specialties, so do many financial professionals. Those who concentrate on the accumulation phase are adept at helping you grow your money during your working years and finding ways to make the market work for you. Their view is long term — as it should be — because they are looking at your retirement from a distance.
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Other financial professionals specialize in the distribution phase of retirement. They understand the strategies that can help you maximize your retirement income, improve tax efficiency and make your savings last. Their primary objective is to help you avoid the costly mistakes that can derail an otherwise well-planned retirement.
1. How much income will you really need?
As someone who works in the distribution phase, one of the first things I discuss with clients is what type of lifestyle they want in retirement.
Do they expect to be on the go, traveling to bucket-list locales or buying that boat they fantasized about for years? Or do they envision being a homebody, reading books, chatting with friends and babysitting the grandchildren?
Their answer helps determine how much income they will need, and income is the heartbeat of retirement. Without a sustainable income strategy, retirement plans can go awry.
That’s why it’s important to make sure your income aligns with your spending goals. Your sources of income may include Social Security, a pension, IRA withdrawals, dividends and interest, cash and rental property.
For example, if someone expects to spend $10,000 monthly in retirement, their withdrawal strategy should be tailored to that need. I always plan for the worst-case scenario and recommend budgeting for more than you will actually spend.
2. When will you claim Social Security?
One significant decision that affects retirement income is when you claim Social Security benefits. The federal government offers plenty of options but not a lot of guidance on this, so Social Security is another area where a conversation with an adviser who specializes in the distribution phase is helpful.
You can begin drawing Social Security as early as age 62 but at a reduced amount that remains reduced for life. There are also income limits if you plan to keep working.
If you wait until your full retirement age (67 for most people these days), you receive more money and there are no income limits. Finally, you can postpone Social Security up until age 70 and receive a larger monthly benefit.
Each claiming strategy has its own advantages and trade-offs, which is why there is no one-size-fits-all answer. The right decision depends on factors such as your health, life expectancy, income needs, tax situation and whether maximizing survivor benefits for a spouse is an important consideration.
3. Can you lower your tax burden?
Taxes may not have been a concern during your accumulation phase, but they could become one during the distribution phase. There are ways to reduce your tax burden in retirement, but if you’re not careful, you could unintentionally increase it.
Roth conversions, for example, allow you to move money from taxable retirement accounts, such as traditional IRAs and 401(k)s, to a Roth account that isn’t taxed.
It’s better to start using them when you are still a few years away from your required minimum distribution age. You pay taxes when you make the conversion, but then your money grows tax-free and isn’t taxed when you withdraw it in retirement.
Be careful about transferring too much money into a Roth in the same year, though. You could bump yourself into a higher tax bracket or even cause an increase in your Medicare premiums if your taxable income grows too high.
With the right planning, you can reduce your taxes, keeping more of your money to pay for your retirement needs and wants.
4. Have you thought about sequence of returns risk?
Sequence of returns risk is a potential shadow looming over many retirements — and it may be one of the most significant differences between the accumulation and distribution phases.
It’s also another reason retirees need a financial professional who has distribution-phase experience.
Sequence of returns risk can be summed up this way: Before you enter retirement, the order in which your investment returns happen generally makes no difference.
For example, in a 20-year stretch, you can have weak years followed by strong years, or strong years followed by weak years, and at the end the total in your portfolio will be substantially the same.
This is not the case when you retire and are making withdrawals. If the market performs poorly in the first five to 10 years, that combination of market losses with withdrawals can severely drain your portfolio. By the time a recovery happens, you may not have enough in your accounts to capitalize on it.
On the other hand, if the market is strong in your first years of retirement and you are seeing growth even as you make withdrawals, you will be better poised to withstand a down market later on.
Sequence of returns risk is one reason people might want to revisit their investments as they approach retirement. One strategy is to reduce the level of volatility your portfolio faces.
5. And finally: Will you let yourself have some fun?
Many people are hesitant to spend money in retirement, watching pennies carefully and avoiding luxuries or anything even vaguely ostentatious. Remember what I said about retirement requiring a new mindset? That applies here as well.
People who lived frugally as they saved for retirement sometimes struggle to turn off that economical mental attitude when they reach the distribution phase.
They worry so much about running out of money that they risk missing out on the enjoyment these years they saved for can bring. I encourage them to spend that money, to reap the benefits of those years of frugality and to remember the adage they have heard their entire lives, “You can’t take it with you.”
Of course, they need clarity, structure and some level of comfort to make such a mindset adjustment. That’s where the right financial professional comes into play, helping them achieve that comfort by discussing income plans, expenses and any legacy they want to leave behind for children, grandchildren or favorite causes.
The distribution phase can and should be the fun phase — if you let it.
Ronnie Blair contributed to this article.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
