There is a critical period in retirement planning, a span of roughly 10 years that largely determines the sustainability of your lifestyle throughout your retirement. This 10 year time frame has no set start age, like Medicare or Social Security, because this decisive decade is unique to each individual’s retirement date. For it is that date which marks your transition from the Accumulation Phase to the Distribution Phase of your financial lives, it is when you reach the mountaintop of wealth accumulation, retire, and begin plotting your descent route to see you safely to the journey’s end.
The Decisive Decade spans the most critical period of both the Accumulation Phase and the Distribution Phase. This means that the most important decade in your retirement begins well before your actual retirement does… you may very well be in the Decisive Decade yourself and simply not yet realized it!
That is because the Decisive Decade is, in truth, two separate 5 year periods that sandwich your retirement date, representing the last 5 years of the Accumulation Phase and the first 5 years of the Distribution Phase!
Accumulation Phase – Last 5 Years
The 5 years immediately preceding your transition into retirement are when we emphasize our savings efforts and manage our asset allocation in order to maximize our wealth accumulation as we project our retirement incomes and expenses.
- Asset Allocation
- Catch-Up Contributions
- Income/Expense Projections
The 5 years preceding your retirement have the biggest impact on the size of your nest egg, the total balance of your assets heading into retirement. The size of your nest egg largely influences how much you will have available to spend in retirement, which in turn influences the level of income that you can confidently sustain for the rest of your life.
That is why the emphasis is asset allocation during the 5 years prior to your retirement, so that you can balance safety and growth in a way that maximizes the accumulation of wealth while still allowing you to sleep at night. This means taking the time to review your situation to ensure that your current portfolio allocation is properly aligned with your individual investment time-horizon, financial objectives, and personal risk tolerance.
During this period we must also prioritize our savings efforts in order to provide our retirement self a pay raise! In the traditional career trajectory, our income is lowest and our family expenses are highest in the early years of our professional lives. Then, as the kids grow and the mortgage shrinks, the constraints on your monthly budget are diminished, allowing you the freedom to start really emphasizing your retirement savings. This is precisely why “catch-up contributions” are made available to you starting at age 50, so that our retirement accounts can accept larger annual contributions to “catch-up” now that we (theoretically) have more freedom in our monthly budget.
It is also critical during this 5-year period to identify your retirement incomes and expenses in order to project whether your assets can sufficiently fill the monthly shortfall throughout your retirement. Whether you run your own pension estimations utilizing OPM calculators or request a Retirement Benefits Forecast, it is critical to ‘look before you leap’ into retirement as there are no ‘do-overs’ in either the FERS or CSRS packages.
As we enter the Distribution Phase, understand that we are no longer saving for a distant date in the future, but rather investing for sustainable income today. As such, we must understand that the strategies that got us to retirement may not be the most effective and efficient approach to getting us through retirement because of how different our needs are in the Distribution Phase.
Distribution Phase – First 5 Years
In the first 5 years of retirement we emphasize our budgeting efforts and manage our income allocation in order to maximize the sustainability of our lifestyle throughout our Golden Years.
- Income Allocation
- Distribution Risks
- Allocating Assets by Objective
In retirement, what goes away? Your income! The Distribution Phase starts when you begin relying on withdrawals from your retirement assets to supplement your income and fill any gaps each month. As such, the emphasis for your portfolio in this phase becomes income allocation – positioning your assets to ensure that you have enough income streaming in each month to satisfy your expense budget now and throughout the entirety of your retirement. Remember, reliable income is the outcome that matters most in your Golden Years!
Have you ever heard the adage, “Don’t gamble with the rent money”? When we begin to live on withdrawals from our investments, the risk tolerance of our income generating accounts often changes. We generally minimize the market exposure for assets that have a short time horizon (the amount of time before the asset is intended to be withdrawn as income) because we are depending on that money to be available to us when we need it. Next month’s rent needs to be safe because we know that the due dates of our bills cannot be put off if we had to wait for the market to rebound. In retirement, the intended use and the time horizon of an asset are key factors in understanding which investment strategies would be appropriate to consider for that asset.
This approach defines the amount of risk that’s acceptable to a specific asset based largely on how and when that asset is intended to be utilized within the retirement income plan.
With the new needs and new objectives retirees establish in the Distribution Phase, rebalancing your portfolio in retirement to separate your short-term income assets from your long-term growth assets can help you create a timeline for your incomes. So ask yourself:
- How much of my nest egg is meant to supplement my retirement income at some point during my Golden Years?
- How much of my retirement income is currently guaranteed and how much depends on the future performance of the markets to sustain my lifestyle?
- Most importantly, how comfortable am I with my answers?
There is no single solution that applies to everyone, there are certainly Feds that enjoy monitoring the markets and have the nerves to stomach more risk, but studies have repeatedly found that secure lifetime income is key to retirement happiness. The peace of mind that comes with the knowledge that you cannot outlive your lifestyle affords many the ability to sleep soundly at night through all market conditions!
Unequivocally, the most important part of this 5-year period is understanding the new risks that develop when we become dependent on our retirement assets for regular income. There are a number of risks for your retirement income plan to take into consideration, such as: public policy risk (changes to your FERS/CSRS retirement benefits), taxation risk, inflation risk, and longevity risk. Here is a comprehensive breakdown of the most important risks that federal retirees face in retirement. But paramount during the first 5 years of your retirement is understanding the sequence of returns risk.
Here the fear is that you enter the Distribution Phase of your life during a negative sequence of market returns and are forced to compound those early market losses by withdrawing additional principal to cover your monthly expenses – which leaves substantially less in the account to recover and grow with the market. Just a few years of this compounded depletion can decimate your nest egg and obliterate the sustainability of your retirement lifestyle! We cannot control what the market does after we retire, but if sequence of returns risk is not addressed in your retirement plan, the sustainability of your lifestyle depends on being lucky enough to retire into the right market cycle. This concern is especially alarming today when you consider the fact that the majority of baby boomers are reaching retirement age during all-time stock market highs as part of the second longest bull market in US history.
So if you are in the Decisive Decade, be sure to take the steps to educate and empower yourself. Learn about your benefits, project your pensions, calculate the cost of your current lifestyle, understand the new risks first introduced in retirement, and work to routinely balance your risk tolerance and portfolio allocation – either with professional help or as part of your DIY retirement plan maintenance routine!