The Transition from Retirement Saving to Retirement Spending

May 28, 2020

According to the magazine  Scientific American , more people die coming down Mt. Everest than going up. Apparently, this is true in climbing in general. On the way up, intent on reaching the goal, climbers are focused and energized. On the way down, physically spent and less motivated, they are more prone to mistakes and accidents. 

I see a direct parallel here with financial planning. The entire planning industry is based on saving and investing to build a nest egg for retirement – the climb up the mountain. There is very little focus on what happens once you reach that goal. How you adjust your investments and spend your money – the safe trip down the mountain – gets little attention. 

The transition from accumulating wealth to spending wealth can be a difficult one. It requires a different mindset and demands that investments play a new role. Because it is new and unfamiliar territory, I feel investors may need at least as much guidance from a wealth advisor in the spend-down phase as during the accumulation period. 

Part of the challenge is that once you reach retirement, it is generally not feasible to go back. If you find, for instance, that after 15 years of retirement you are depleting your assets too quickly, it is unlikely you can un-retire and replenish your nest egg. 

The spend-down phase would be much simpler if you had a foolproof crystal ball. 

For instance, if you knew you would live to exactly 85, your spouse would live to exactly 88, you would spend $100,000 a year, inflation would remain constant at 2 percent, your diversified portfolio would return 7 percent every year, you’d never need expensive 24/7 care, and so on, you could easily run the numbers and validate your spend-down plan. 

Of course, real life is nothing like that. Life is unpredictable, especially in one’s later years.  

Spend-down planning must recognize the uncertainties of retirement while using available tools and techniques to maximize your opportunity to live with dignity and independence and to leave the legacy you envision.  

Here are some topics to discuss with your wealth advisor as you prepare for and execute your spend-down plan: 

No matter how sophisticated medical science becomes, it is impossible to know whether a healthy person will remain healthy to age 95 or encounter life-threatening medical issues at 65. According to data from the Social Security Administration , a woman turning 65 today can expect to live to almost 87 (84 for men). An upper-middle-class couple age 65 today has a 43 percent chance that one or both will survive to at least age 95, according to the Society of Actuaries. It is best to plan for a long life, well longer than average. This, of course, means a longer spend-down period. 

After a lifetime of being thrifty and saving for retirement, many people find it difficult to start spending for retirement. Some investors want to spend investment income only, not principal, which can lead them to buy high-yield, potentially high-risk investments. A comprehensive long-term cash flow analysis can help you get your arms around what is an appropriate level of spending. 

Although inflation rates have been modest over the past decade, the drain of rising prices over long periods is very significant. Historically, the rise in the Consumer Price Index has averaged about 3 percent. That rate of increase would mean your spending would double in 24 years, the length of retirement for many people. All planning should reflect realistic inflation levels. 

You and your spouse have choices about when you begin taking your Social Security benefits. In general, the longer you wait, the greater your monthly benefit will be. The rules on spousal benefits are complicated; the timing you choose can have a big effect on your benefit amount. It is worth the time to research the topic or discuss it with your advisor.

If you want to learn more about Social Security planning, check out this blog post on Understanding Social Security Benefits.

Pay close attention to the fees mutual fund managers charge. The net expense ratio states the percentage of fund assets paid for operating expenses and management fees. Actively managed funds often charge fees of more than 1 percent. Passively managed funds usually charge much less. These small, consistent savings compound into a big difference over the remainder of your lifetime. 

The most important investment performance measure is your after-tax return – not what you earn but what you keep after taxes. That is what you can spend, save for the future, or give away. 

What many investors forget is, within some limits, you can control what you pay in taxes. Here are two examples of techniques any investor can use to reduce the bite of taxes.  

First is tax loss harvesting. This process does what it says: It harvests losses in securities that have declined in value to offset gains in other investments. So, if you sell some holdings at a profit, you could sell others at loss. The loss nets out some or all the gain, reducing the tax due. 

The second technique is asset location. This means putting the right kind of assets in the right kind of accounts. Because of the differing treatment of capital gains and interest income, you can reduce your taxes by holding stocks in ordinary investment accounts and bonds in tax-deferred accounts. 

Holding stocks in taxable accounts, not tax-deferred accounts, also helps position your family for a tax-free step-up in cost basis upon the death of the accountholder. 

There are many ways to transfer wealth to future generations and to philanthropic causes. Depending on your personal circumstances, it may be beneficial to begin that transfer well before you die. Doing so will mean the beneficiary has access to the funds sooner, and the bite of taxes may be reduced as well.   

In the end, your money can go only four places: your own spending, your heirs, charity, or the government. Smart planning can make sure more of it goes where you want. 

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