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Savings to Spending: Taking on the Retirement Decumulation Challenge

Cash flow. It’s what retirement is made of. And it turns out that securing cash flow from a portfolio is a bigger challenge than many retirees expect.

After decades of scrimping and saving, investing and growing, ‘flipping the switch’ and turning savings into an income plan can be very difficult. Both physically and emotionally, there are plenty of challenges facing some people heading into their golden years.

And the recent market environment hasn’t helped.

For financial advisors and investors, the problem is a tough nut to crack. But there are some ways to take on the decumulation challenge and turn a portfolio of savings into cash flows.

To learn more about retirement topics, visit our Retirement Channel.

The Retirement Income Challenge

Arguably, retirement is the single largest expense that people will save for over their lives. And it takes decades of steady and constant savings to be ready for retirement. That aspect is relatively easy. For the most part, many investors understand the accumulation part of savings: put money steadily into a portfolio of diverse assets and let compound interest do its job. The next part is the most difficult.

That involves turning savings into spending. Once your paycheck stops, it’s up to your portfolio to do the heavy lifting. And it turns out this aspect of retirement comes with another set of challenges, issues, and potential problems.

For one thing, on average, we do not have enough savings overall. The latest data from the Federal Reserve shows a grim picture for retirees. The Fed estimates that, by retirement, the average married couple will have a nest egg of only $228,900. Not too shabby, right? Well, considering that the average cost of medical care for a retired couple during their golden years is north of $200,000, there’s not much wiggle room at all.

Even those with larger nest eggs still have issues and potential hurdles. The chief concern is lower bond yields. Thanks to efforts to stimulate the economy during the Great Recession and COVID-19 crisis, central banks across the world have lowered interest rates to basically zero. There have been a few attempts to raise rates, however they still sit very low. That’s a problem when it comes to income.

You used to be able to buy a portfolio of fixed income investments (bonds and CDs) and simply live off the interest. That’s not true today. Buying a million dollars’ worth of 10-year Treasury bonds would only net you about $16,000 in annual income today, with the average five-year CD churning out just $3,200.

Adding to these headaches continues to be continued advances to medicine. Life expectancy rates have continued to rise; the average American has a good chance of living well into their 80s, while there is an 18% chance that a married couple will see one partner live to at least 95. That means preparing for a retirement that lasts for roughly 30 years!

Turning Savings Into Spending

With these issues in tow—as well as inflation, taxes, and Social Security concerns—turning a nest egg into a steady stream of cash is a complex endeavor. Future retirees need income solutions that will be able to provide a mix of essential spending as well as room for discretionary wants. For advisers and savers, this may mean thinking outside the box. Long held rules, such as traditional 60/40 portfolios and the 4% rule, may need some tweaking.

On the surface, we may need to hold more equities as we age, with dividends and equity income driving more of the return. This certainly helps limit the problem with low interest rates, inflation, and longevity.

Already, many investors have been able to lean on dividends to meet income needs. This could be more important going forward as life expectancies rise. The 4% rule—which dictates an estimated safe withdrawal rate from a portfolio—doesn’t care how you get that needed percentage. The idea was built on the combination of bond interest income, capital gains, and dividends. Getting 2-5% in cash dividends goes a long way to meeting that goal.

But adding equities does add risk. That’s why several asset managers have now expressed the need for insurance solutions—such as annuities—to help with the guaranteed aspect of retirement payments and various risks. Savers seem to be on board as well. More than 87% of pre-retirees surveyed by AllianceBernstein have considered a guaranteed income option appealing for their portfolios. The overall point is that having a swath of annuities will minimize the risk of income decrease during a market downturn. Those with a guaranteed minimum withdrawal benefit (GMWB) rider clause can help reduce longevity concerns.

Check out this article to learn how the passage of the SECURE Act can impact annuities.

What about fixed income? Here again, outside the box thinking may be needed. Looking beyond treasury bonds into corporates, bank loans, junk bonds, preferred stocks, and even taxable municipal bonds can provide additional income opportunities.

Finally, taxes and sequence of withdrawals can go a long way to making sure you have more retirement income for a portfolio. Tax rates vary for different kinds of investments and accounts. However, by timing withdrawals correctly, investors can save significantly on taxes and keep more money for themselves rather than send it Uncle Sam. Both larger and smaller nest eggs can benefit from smart decumulation.

Changing Saving Into Spending Doesn’t Have to Be Hard

There are many variables that can affect drawing a portfolio in our golden years. However, a blend of higher allocations to equities, focusing on dividends, using different varieties of bonds, and adding a dash of guaranteed income can go a long way toward turning a portfolio into a steady stream of savings. The key is to have a plan before entering retirement and getting as many ducks in a row before the paychecks stop.

Use the Dividend Screener to find the security that meet your investment criteria.

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May 19, 2021