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The Harvest: When Accumulation Becomes Distribution

Published in the Desert Magazine
February 2016

By The Cypress Group

The Harvest: When accumulation becomes distribution

It’s a big transition when you leave the workforce to live off your savings. Moving from an accumulation to a distribution strategy requires a 
change of focus. 

Retirement planning is easy during the accumulation phase. Just stash as much savings as possible into retirement and investment accounts and maximize total returns. All that really matters is what you end up with at retirement. If investment returns vary from year to year, or if returns are made up of interest, dividends, or capital gains, none of it much matters. It’s all a race to grow your savings as large as is needed to meet your needs.   

Then comes the day when you can finally harvest the fruits of your labor and start withdrawing funds. Now the goal is no longer simply to grow the account balance, but rather to provide enough current income to meet your spending needs and plan for estate or charitable objectives, if desired. Success is measured by your happiness and the careful monitoring of withdrawal rates and account values to ensure that your goals are met.  

Attitude Adjustment 

Dollar-cost averaging works in reverse. As you probably know, investing a fixed dollar amount during volatile markets allows you to buy more shares when prices are down. This is a good thing. However, when you are withdrawing fixed dollar amounts from a volatile portfolio, temporary dips can do serious damage because more shares must be liquidated to provide the same amount of cash. 

The sequence of investment returns matters. Under an accumulation strategy, dips in asset values can be made up by a bull market or increased savings. What matters is the average annual total return. During the distribution phase, poor returns in the early years can cripple a portfolio and cause money to run out early. 

Mistakes can be fatal. During the accumulation phase, mistakes in planning, saving, or investing can always be fixed by adding more money, revising the portfolio, working longer, and so on. In retirement, when money is coming out and no new money is going in, there is far less room for error. 

Part of transitioning into retirement is learning some fundamental concepts relating to harvesting your savings. 

In particular, pay attention to the dangers of volatility, excessive withdrawals in the early years, and a longer-than-expected withdrawal period. These potential dangers can undo a lifetime of diligent saving. The worst part is that these mistakes may not show up until it is too late to reverse their impact. 

Income Planning
Planning for income requires careful number crunching and a strategy for actually getting your hands on cash. Here are some popular retirement-income strategies:

Live off the interest (or dividends). The classic retirement-income strategy is to shift from a growth-oriented portfolio at retirement to investments that generate income. These might include bonds and dividend-paying stocks. Your income consists of the actual payments thrown off by the investments. Any assets not needed for current income generation may be invested in equities for inflation protection and long-term growth.

Set up a withdrawal plan. Another approach is to invest for a total return and set up a withdrawal plan starting at, for example, 4% of the account balance. Each subsequent withdrawal would be increased by the annual inflation rate. Under the so-called “4% rule,” the assets are invested in a diversified portfolio of stocks and bonds. 

Draw from a cash bucket. Another strategy is to keep enough cash in a money-market fund to fund two years or more worth of expenses and invest the bulk of the portfolio for total return. As the cash bucket empties, enough long-term assets are liquidated to fill it back up. 

What will be the impact of IRA withdrawals?
If part of your income will come from regular IRA withdrawals, you’ll need to consider the current—and future—tax impact of these withdrawals. It may not make sense to defer distributions from traditional IRAs until the last possible moment if doing so might create such large required minimum distributions that you end up in a higher tax bracket.

Also, consider the income and estate tax consequences of a large IRA that is allowed to grow out of control. Long-term income projections need to be part of your transition planning so you can set up accounts and plan distributions from the outset.

Pay Close Attention
Perhaps one of the biggest differences between accumulation plans and distribution planning is that once you begin drawing income from your investment portfolio, your portfolio requires much closer attention. Not only must you invest the assets in a prudent manner, you must also watch the amount and timing of  the distributions to ensure that your portfolio endures.