Much of what you read in the popular press about retirement savings focuses on the “magic number”—how much money you’ll need to save to retire comfortably.

However, just as important is having a plan for how to spend down that sum once you do retire—a process called decumulation.

You’ll need money to live on and, depending on your age and the type of account, the government requires you to withdraw some money (referred to as required minimum distributions (RMDs)) from individual retirement accounts (IRAs) and defined contribution (DC) plans.

In his Benefits Magazine article “The Descent: Asset Decumulation After Retirement,” author Richard J. Hudson wrote that “managing withdrawals and sustaining income poses risks that are greater than those encountered while accumulating wealth.”

Yet many retirees and preretirees lack a decumulation plan. A recent survey from Corebridge Financial showed that only 14% of retirees have a detailed strategy to manage their RMDs. Less than one-third (29%) of preretirees age 55 or older have a plan for withdrawing money in retirement, but 63% said they expected to develop one.

Hudson, an actuary with First Actuarial Consulting, Inc., in New York, New York, described the risks that deplete retirement savings and offered strategies for addressing them.

Four Risks to Consider

Hudson outlined the risks that retirees face when they begin spending their retirement account balances.

• Longevity risk: This is the danger of outliving your savings. About half of 65-year-old retirees can expect to live another 20 years, but you might be one of the lucky ones and live into your 90s, requiring a bigger sum of money.

• Sequence-of-returns risk: If you experience negative investment returns early on in retirement and are withdrawing from your portfolio, “you lock in losses and reduce the principal from which further growth can occur. Even if the market recovers, the portfolio may never fully rebound,” Hudson wrote.

• Negative cash flow: Once you retire, you’re no longer contributing to your account, so you’ll have negative cash flow. You have to be prudent in understanding your living expenses and planning your financial needs.

• Liquidity risk: Holding too much of your retirement savings in assets that can’t be sold quickly and converted into cash may put you a bind if an unexpected expense arises.

Four Decumulation Strategies

Hudson described several strategies to help mitigate these risks, including the following.

• Systematic withdrawals: With this strategy, you set a rule for how much you will withdraw from your portfolio annually. A common example is the 4% rule, but some experts believe that is outdated and should be reduced to 3%. Hudson said that participants should build in some flexibility to allow them to withdraw less money if needed.

• Lifetime income products: Buying an annuity can help retirees generate guaranteed income source for life and protect against the risk of outliving their savings. Those approaching retirement may want to look into the cost of annuities and watch the interest rate environment to see when the best opportunity arises to purchase.

• Tax-efficient withdrawal sequencing: The order in which you withdraw from taxable, tax-deferred and Roth accounts can affect lifetime tax liability. Having a strategy for when you withdraw from each type of account can help smooth taxable income to help minimize the tax burden and preserve more wealth.

• Diversification and bucketing: Investing your money in different asset classes will provide protection against concentrated risks in a specific asset category. Using a bucket strategy, retirees can set aside investments in cash or bonds for near-term expenses and keep investments in equities for long-term growth. During market downturns, retirees can use the cash and bonds to cover expenses and leave equity investments untouched. When the market recovers, they can replenish the cash and bonds by selling a portion of the equity investments.

Conclusion

Hudson concluded: “Planning is essential to understanding your expenses and how your income sources will be used to over those expenses in retirement. After you construct a basic plan, it is also crucial to develop contingency plans to deal with unplanned expenses. Taking these steps will ensure that your path is smoother and more predictable.”