You’ve helped your clients invest and save for retirement. What can your firm do now to guide clients on how to draw down on their assets and create a longer runway in retirement?
What is Accumulation? What is Decumulation?
One of the main reasons clients engage financial advisors is to help them invest in ways that will let them achieve their desired lifestyles in retirement. This is the “accumulation” phase of an investor’s life. Channeling income into taxable and tax-advantaged accounts and investments is critical to accumulation, but it’s only half the solution.
Once clients stop working, they enter a phase called “decumulation.” And many retirees will fail to harvest the full benefit of their accumulated wealth.
The accumulation phase of clients’ lives involves understanding and managing three types of wealth to maximum benefit before retirement:
Financial wealth: Assets created by an individual through intentional decisions. Financial wealth includes:
- Taxable accounts: investment and business assets, non-sheltered mutual funds, and exchange-traded funds (ETFs).
- Tax-deferred accounts: traditional retirement accounts like 401(k)s and individual retirement accounts (IRAs), annuities, and pensions.
- Tax-exempt accounts: Roth accounts, health savings accounts (HSAs), and cash-value life insurance.
Retirement wealth: The present value in today’s dollars of an individual’s retirement cash flows from Social Security and defined benefit pension plans. These are assets that individuals can tap for income in retirement.
Net home equity: Leverage magnifies the return on a homeowner’s initial investment over an extended period. Home equity is measured by its current market value, less its outstanding mortgage debt. Reverse mortgages and downsizing strategies can convert the equity to income for retirement.
The decumulation phase begins when an individual starts withdrawing or taking income from accumulated assets, usually when they decide to retire fully or partially from work. Old (and outdated) strategies for guiding clients in decumulation involved withdrawing a percentage from all available invested assets annually (often 4%) or liquidating assets in a proscribed order (taxable assets followed by tax-deferred assets and then tax-free assets).
Both approaches have at least one significant flaw. They overlook the considerable impact of investment taxes on net returns during the accumulation and decumulation phases. LifeYield offers firms an API (advanced programming interface) library of solutions that can be deployed individually or, for the greatest impact, in concert to minimize taxes on a household portfolio over time and optimize timing of filing for Social Security benefits.
What Is Decumulation in Retirement?
Retirement decumulation involves turning accumulated assets into retirement income. Typically, the retirement decumulation phase begins with an event – retiring from work, transitioning to part-time employment, death of a wage-earning spouse, a divorce, etc. Those events make it necessary for a client or household to begin liquidating assets to make up for income and provide financial security.
During the retirement decumulation phase, the challenges include identifying the most tax-efficient asset sales and withdrawals, coordinating asset sales with Social Security and other government benefits, and protecting wealth and retirement income from inflation. Only an integrated set of strategies at the household level can meet these challenges.
LifeYield offers retirement decumulation solutions to maximize post-tax retirement income that can be integrated with an advisor’s proprietary systems without replacing technology or requiring new database development. What’s more, LifeYield tax-efficiency APIs can be applied to assets that aren’t under an advisor’s management but must be factored into a plan for decumulation and retirement security.
What Is a Retirement Decumulation Strategy?
A retirement decumulation strategy is a blueprint for drawing down on a client’s assets over time. It must be tailored to clients’ (and spouses’) individual circumstances and aim to achieve what retirees say they want most: Confidence that they will not outlive their assets.
Some of the things that advisors need to talk about with their clients as they prepare a decumulation strategy include:
- What are their fixed expenses for housing, food, insurance, utilities, property taxes, clothing, etc.?
- Will they work part-time and, if so, for how long?
- Do they have any health issues that will affect their lifestyles or their expected lifespans?
- Will they sell a home and downsize? Will they relocate?
- Do they expect to need to help support parents, children, or grandchildren?
- What are their goals for legacies to family or charity?
- Do they have other goals or plans that will require budgeting, such as travel, vacation home, new car, boat, etc.?
These may not be comfortable conversations for advisors who are used to working more with data, capital market assumptions, Monte Carlo scenarios, and other aspects of financial planning. But they will help advisors know information that will be important to decumulation planning:
- What income expectations do clients have for retirement?
- Can their assets cover those expectations for as long as they may live?
- Will clients need to consider significant actions, such as a home sale or downsizing, or other lifestyle changes (e.g., less travel) or spending (e.g., fewer or smaller gifts to children) now or in the future?
A decumulation strategy emphasizes examining expectations, evaluating assets, and counseling clients when they may need to adapt their plans to produce the best results.
What Is Decumulation Planning?
A decumulation plan applies a decumulation strategy to a client’s circumstances. It is concrete and actionable, helping to keep clients on track and well-informed. A good plan is coherent, transparent, and realistic, based upon a solid strategy and bullet-proof tools. And it is responsive to changes in markets or clients’ circumstances, such as health issues or death, that invoke a need to revisit and revise the decumulation plan.
A decumulation plan for clients includes:
- A tax-efficient guide to converting assets into the income they need, year by year, in retirement.
- A target date for Social Security filing to optimize benefits.
- A close-the-gap plan if clients need to source income during a period when they choose to defer Social Security filing (to realize greater lifetime benefits) or won’t yet qualify to receive benefits from a pension.
This bears repeating: Clients want to know the steps to convert their assets into income. They want to see how their investments will fund their expectations for income for each year. As their retirements progress, they also expect check-ins with their advisor on the viability of their decumulation plan:
- Is it still on track?
- Do they need to adjust it for conditions like inflation or recession?
- Are there tax law changes that affect their plan?
How Do Taxes Affect Decumulation?
There are three main variables that advisors can use to improve outcomes for their clients: Cost, risk, and taxes. And of those three, taxes have the most significant effect on an investor’s returns. That comes as a surprise to some. But it shouldn’t.
Advisors can benefit their clients (and their reputations) by paying attention to how they can raise the tax alpha of client household portfolios. Tax alpha is a vital contributor to a successful decumulation strategy, too.
Tax alpha is a portfolio’s excess after-tax return minus the excess pretax return. “Excess” is the difference between the returns of an actively managed portfolio and a passive benchmark. High tax alpha implies that an account manager is skilled at reducing the bite of taxes on a portfolio’s performance.
Essentially, tax alpha is the lift in returns investors get by implementing tax-efficient investment strategies.
Achieving tax alpha has several adjacent welcome effects: Clients retain more of their gains and savings to put toward their financial goals, including retirement. Advisors and firms keep more assets under management, generating higher fees because they lower the outflows needed to pay taxes.
Paul R. Samuelson is LifeYield’s chief investment officer and co-founder. His work is the basis for the algorithms that are the engines that power the LifeYield tax-smart APIs for financial firms. Samuelson has written about tax alpha and identified these five drivers of success in achieving it.
- Tax-Smart Asset Location: Investors can lower tax drag and boost wealth by locating assets in the most tax-saving account registrations (taxable, tax-deferred, or tax-free). Using household portfolios enhances the power of the technique. LifeYield has an API that performs this asset location function, scores the tax efficiency of each alternative, and suggests specific trades in a particular sequence to achieve the best results. For example, holding low-return assets in traditional IRAs counterbalanced by high-return assets in Roth IRAs can have a surprisingly beneficial effect.
- Multi-Account Tax Harvesting: It makes sense to offset capital gains by selling investments at a loss. It makes further sense to consider all household accounts when pairing winners and losers. LifeYield supports multi-account tax harvesting, thereby helping clients reduce taxes, avoid wash sales, and spread gains over several years to benefit from lower capital gains tax rates in retirement. LifeYield can operate at the tax-lot level to optimize the deductions for charitable giving. Moreover, the software can help isolate stocks in a separate account created for the spouse with a shorter life expectancy, providing a way for the surviving spouse to benefit from the basis step-up and lower capital gains.
- Tax-Aware Transitions: It’s surprising how ill-prepared some investors approaching retirement are for the mental shift from accumulation to decumulation. While investors understand that investing involves risk and market volatility, they may be less familiar with the need for portfolio rebalancing when transitioning from accumulation to decumulation to defuse highly concentrated (and risky) positions. The best way to adjust asset allocations is at the household level because it reflects the client’s actual exposure to risk. Furthermore, this rebalancing should minimize taxes. LifeYield supports these requirements.
- Multi-Account Rebalancing: Nowadays, most investors deal with multiple advisors, custodians, and accounts. Without multi-account rebalancing, the asset allocation may be considered only at the individual account level instead of at a client’s household level. The result is suboptimization due to the gap between clients’ asset allocation and target risk tolerance. LifeYield is a pioneer in household-level rebalancing, allowing for optimized asset allocation, asset location, tax harvesting, and tax-aware transitions.
- Optimal Retirement Income Sourcing: The transition from accumulation to decumulation is critical for clients as they face important decisions regarding the sourcing and sequencing of income. Questions arise regarding the timing of annuitization, Social Security, Roth conversions, required minimum distributions, etc. The “4% Rule” is a blunt objective wholly inadequate to the task. LifeYield Retirement Income Sourcing creates a strategic roadmap for asset sales and benefit streams to deliver the necessary income over the client’s life expectancy while reducing unnecessary taxes. Advisors can use LifeYield to create customized withdrawal plans at the household level to ensure clients have sufficient funds to realize their financial goals.
How Does LifeYield Help You Develop and Communicate a Decumulation Plan?
The LifeYield Retirement Income Sourcing API enhances a firm’s financial planning system. It uses all the inputs from planning to create tax-efficient decumulation plans that quantify the value – in dollars – of being tax efficient when using strategies like asset location, withdrawals, required minimum distributions (RMDs), Roth conversions, product choices, and Social Security optimization. All of these strategies used together are the recipe for a long, prosperous retirement.
Retirement Income Sourcing supports how to address “what-if” scenarios with clients by providing multiple options for determining the sequence of tax-smart withdrawals over time. It produces federal and state tax breakdowns incorporating all relevant factors. And as a stateless API, Retirement Income Sourcing can be configured to match any firm’s preferences, assumptions, and need for detail.
Retirement Income Sourcing allows you to personalize each client’s retirement strategy at scale without disrupting your technology investment.
What Else Can I Expect from LifeYield?
Firms must weigh the benefits of adopting new technology with its costs. LifeYield meets this challenge in critical ways:
- LifeYield works with your current financial planning and asset management technology. Firms can selectively adopt LifeYield APIs as a comprehensive solution that heightens the value of a firm’s financial planning process and software. LifeYield adapts to your firm’s preferences and evolving capabilities at any level of detail. Your company retains management of the data and the client experience.
- LifeYield’s tax-efficiency methodology has been independently examined and affirmed by consulting firm EY, which found that it improved after-tax returns for a typical household by up to 33%.
- LifeYield is a dependable partner. We have more than 14 years of experience creating APIs that improve tax alpha and optimize Social Security benefits. Currently, we have $3+ trillion in assets under management, and we are proud of how we have helped major financial firms enhance the value they provide to their clients and their shareholders.
Let us show you how LifeYield can improve client outcomes and increase your asset under management and your earnings.