Chances are that most of the advice you’ve ever received about retirement has focused on how to save a decent retirement nest egg.
But what about how you should spend that nest egg? After all, what’s the point of working hard for 30-40 years to accumulate a retirement sum if you don’t enjoy it in your golden years and decumulate?
The Merriam-Webster dictionary defines decumulation as “the disposal of something accumulated”. Hence, wealth decumulation just means spending the retirement nest egg that has been saved.
In retirement phraseology, decumulation is when we convert the assets that we have accumulated during our working years into an income stream for retirement.
The overriding concern is – quite naturally – how to balance spending too much, in which case you risk being left with a shortfall later in retirement, against spending too little, in which case you may not enjoy the life that you had hoped for.
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Wealth decumulation – the 4% rule
One approach to decumulation starts with the 4% rule, which was first developed by William Bengen in 1994 as a rule of thumb for withdrawal rates from retirement savings.
You add up all of your investments and withdraw 4% of that total during your first year of retirement. In subsequent years, you adjust the dollar amount you withdraw to account for inflation. By following this formula, you should have a very high probability of not outliving your money during a 30-year retirement, according to the rule.
For example, let’s say your investment portfolio at retirement totals $1 million. You would withdraw $40,000 in your first year of retirement. If the cost of living rises 2% that year, you would give yourself a 2% raise the following year, withdrawing $40,800, and so on for the next 30 years.
If we were to adjust this rule to suit a Singaporean, it would have to take into account money saved in the individual’s Central Provident Fund (CPF) accounts.
Assuming a person was able to set aside the default retirement amount known as the Full Retirement Sum at age 55 in their Retirement Account, then at 65 he or she would be able to receive around $1,600 per month for the rest of his or her life under CPF Life’s Standard Plan. So in total, they would receive about $19,000 per year.
Let’s also assume he or she has at least $500,000 made up of other resources, such as their Ordinary Account balance, matured insurance policies, Supplementary Retirement Scheme investments and so on.
Then applying the 4% rule, this person can withdraw 4% of $500,000 or $20,000 per year for at least 30 years. In total, he or she is therefore able to spend at least $39,000 per year in retirement while adjusting for inflation every year after the first.
Limitations of the 4% rule
Although simple to understand and therefore appealing, the rule has its limitations.
First, it assumes spending patterns remain rigid and follow inflation, which is rarely the case – after all, expenses may change from one year to the next, and the amount you spend may change throughout retirement.
Second, the rule was devised using a hypothetical portfolio invested 50% in stocks and 50% in bonds and is based on how such a portfolio performed between 1926-1976. Needless to say, the past may or may not be a good indicator of future performance.
Third, 30 years may not necessarily suit everyone’s circumstances. For sure it’s better to plan for a longer retirement and yes, we are all living longer thanks to better nutrition and greater awareness of the need for regular exercise to stay healthy. However, depending on when a person actually stops work, 30 years may be either too long or too short.
Fourth, the rule uses a very high likelihood (close to 100%, in historical scenarios) that the portfolio would have lasted for a 30-year time period. In other words, it assumes that in nearly every scenario the hypothetical portfolio would not have ended with a negative balance.
To compensate for the rule’s shortcomings, there is research which suggests that a lower withdrawal rate of 3.3% for a 50-50 stocks and bonds portfolio could be more appropriate today, as the 4% rule may be a bit too aggressive.
Adopting a dynamic withdrawal strategy is another suggestion, such as beginning with a fixed withdrawal rate, but then forgoing the inflation adjustment in the year following a bear market, in order to preserve assets.
Whatever the case, the 4% rule at least offers a starting point when considering when and how to decumulate.
Other things to bear in mind when decumulating
Obviously, when spending in retirement, the assumption is that the person has adequate healthcare coverage, a clear estate plan which involves a will, CPF nomination and in case of loss of mental capacity, has drawn up a Lasting Power of Attorney.
It also assumes you have worked out a realistic projection of what your retirement spending will look like many years in advance during the accumulation phase.
Some spendings can be predicted, like the immediate post-retirement frequent travelling while still healthy and mobile. This would increase travel expenses sharply in the first few years of retirement.
But others, like starting a new business or funding a passion project, may require more resources.
Don’t fall victim to overconfidence
Fund managers PIMCO in 2020 conducted a study into what it called “the decumulation dilemma”. Responses were collected and analysed from 758 U.S. adults aged 55 and older with over US$500,000 in investable assets.
The study found that 55% either had no plan or planned to ignore their assets completely in their retirement.
One source of this misplaced confidence comes from successful investing during the accumulation phase. However, successful accumulation does not guarantee successful decumulation.
So do plan for the decumulation with as much effort as you did for wealth accumulation to ensure a comfortable and enjoyable retirement.
