Your whole life, you’ve worked really hard. You climbed, and saved, and invested. And piece by piece, you built up your wealth. Now it’s time to use it! Maybe you’re retiring, or maybe another life event has recently affected your income.
As a financial advisor on Ellevest’s Private Wealth Management team, a big part of my job is helping people prepare for this. A lot of people don’t realize that planning how you’ll manage your wealth once your traditional income goes away can be even more complex than earning and saving it. But if you do it intentionally, it can make a big difference — for your lifestyle and your legacy.
Wealth accumulation is what you’ve already been doing — earning, saving, and investing your assets in a way that’s meant to help you hit your financial goals, like retirement.
Decumulation is the opposite — using up those assets in order to fund your best life later on. But if you want those assets to last until you no longer need them, you probably can’t just make withdrawals. You have to have a plan.
Types of decumulation strategies
There are a few different high-level approaches to decumulation, and the one you choose can help shape the more specific plan you make with your financial advisor. There’s no right or wrong way; the right choice for you will depend on how much you have invested, and what you want your life and legacy to look like.
The main approaches include:
Total drawdown: You plan to use up all your wealth in your lifetime, leaving $0 in the bank. This is a slightly risky approach (because it’s obviously hard to know exactly how long your lifespan will be), but it’s not unheard of.
Partial drawdown: You plan to use up most of your wealth during your lifetime, leaving a little left over for the next generation or donation.
Preserving principal: You plan to leave all the deposits you made over time untouched and fund your lifestyle using the investment returns and income (interest, dividends, etc) that you expect to earn.
Increasing wealth: You plan to spend less than the amount you expect your investments to earn over time — so in theory, your wealth would continue to grow, allowing you to leave a bigger legacy.
Planning your own decumulation
What would your ideal lifestyle look like?
This is where you get real with yourself about how you actually plan to spend your decumulation years, if you haven’t yet.
First: Will you keep working? Some people don’t plan to ever fully retire because their careers make them feel fulfilled. You might plan to drop down to part-time, or maybe you want to serve on some boards. Or maybe you want to try running a small business around your passions.
And second, how will you spend your time? Will you do a lot of traveling, or stay close to family? Do you want to volunteer somewhere? Where will you live?
All these things will help you decide how much money you’ll need to take from your investment accounts each year. That’s your annual withdrawal target, or your annual spending needs minus the income you expect to receive each year, whether it’s from continuing to work or what’s called “guaranteed income” (from pensions or Social Security).
Then you can take a look at your investments to see whether you’re in good shape to hit that annual withdrawal target and stay in line with the high-level decumulation approach you’ve chosen. If they don’t line up, your financial advisor can help you figure out where you’ll need to adjust.
How are your assets invested, and where will you draw from first?
Most people have multiple investment accounts. Some are taxable. Some, like Roths, are tax free. And some, like IRAs and 401(k)s, are tax deferred. To complicate things, some of those come with required minimum distributions (RMDs) that the IRS says you must withdraw each year (or else pay penalties).
As you accumulate your wealth, your financial advisor can help you make sure your assets are invested in a way that will help minimize your taxes once you need that money. For example, the interest payments that come from fixed-income investments (aka bonds) are usually taxed at your ordinary income tax rate. On the other hand, any money you make from selling corporate stocks that you’ve owned for a while is usually taxed at your (lower) long-term capital gains rate. So in that case, it might be helpful to put the fixed-income investments in a tax-deferred or tax-free account, leaving the stocks to go in a taxable account. But it will be a little different for each person.
Your financial advisor can also help you make a plan for when you’ll use the money that’s available to you during decumulation. Generally speaking, it’s usually good to take RMDs first (because you have to), then draw from your taxable accounts, then draw from tax-deferred accounts, and finally from tax-free accounts. “Guaranteed incomes” like pensions and Social Security are a whole different tax consideration — depending on your situation, it might make sense to avoid taking those payments for as long as you can. But again, the best timing will be different for everyone.
Then you can put those two plans together to make sure your investment portfolio will play nicely with your withdrawal plan.
Make it yours
Just like today, the way you spend money during decumulation is going to change month to month and year to year. You might move cities. You might remodel your home. You might take a big trip. You might find yourself with an addition to the family whom you desperately want to spoil. And so after your regular income goes away, you and your financial advisor should revisit and fine-tune your strategy once a year.
This is what you’ve been working toward your whole life. By building a decumulation plan around your wealth and your goals, you can spend your money — and your time — intentionally.
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