Cracking the Nest Egg: Decumulation Strategies in Retirement

MAY 27, 2014
James M. Dahle, MD, FACEP
Physicians and other high-income professionals may spend 20 to 40 years accumulating money inside tax-free (Roth), tax-deferred, fully taxable accounts, and even cash value life insurance.
By the eve of retirement, many of them are quite well-versed in the advantages and disadvantages of the various types of savings, investing, and retirement accounts with regards to the accumulation of money. However, very few have given a great deal of thought to the process of actually spending the money.
It is not that they cannot think of vacations to go on, toys to buy, and grandkids to spoil. It is simply that they have not determined the best way to take their accumulated nest egg and, in a tax-efficient manner, ensure it lasts longer than they do while maximizing their ability to spend and the money they can leave behind to heirs and their favorite charities.
This article will discuss some of the main themes of the decumulation phase (as opposed to the much more straightforward accumulation phase) and give the individual investor some guidelines to determining how best to withdraw and spend his or her money.
Guarantee your needs
An immediate annuity—particularly an inflation-adjusted immediate annuity—should play a role in the decumulation stage of most investors. Immediate annuities are similar to the increasingly rare employer-provided pension, whereby the employer pays you a certain amount every month in retirement until the day you die. Social Security is a similar form of annuity.
Many investors are not aware they can purchase their own annuity from dozens of insurance companies. Basically, you take a lump sum of money and give it to an insurance company in exchange for a guaranteed payment every month for the rest of your life.
Since pensions, Social Security, and annuities are guaranteed, they allow you to spend more of your money each year. A good general guideline for how much of a balanced portfolio you can spend each year in retirement, while having a reasonable expectation that the money will last, is 4%. So a $1 million portfolio can be expected to provide an inflation-indexed income of about $40,000 per year. However, if you annuitize a lump sum at age 70, you can enjoy an income of over 8% on a nominal basis, or over 6% on an inflation-indexed basis. In short, by annuitizing you can safely spend 50% to 100% more in retirement!
The basic concept here is that you guarantee your income needs using guaranteed sources of income like Social Security, a pension, or an immediate annuity. Then, you use your remaining portfolio of stocks, bonds, and real estate to provide for your wants,­ vacations, new automobiles, college money for the grandkids, charitable giving, and inheritances. Along these same lines, one of the best deals in annuities out there, at least for single people and the higher-earner in a couple, is to delay Social Security to age 70, at least if you enjoy good health.
Determining how much of your portfolio to annuitize can be difficult, but an honest assessment of your true spending needs should get you most of the way there. Also, be sure to consider the maximum annuity size your state insurance guaranty corporation will back in the event of insurance company bankruptcy. The guaranteed amount is state-specific, but typically in the $100,000 to $300,000 range. If you desire to annuitize more than this, you may wish to purchase annuities from more than one company.

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