Someday You Will Have to Spend Your Nest Egg. Why You Need to Plan Ahead for That.

Retirement planning often focuses on accumulating a nest egg, and for good reason. If you don’t maintain a sufficient savings rate, allocate assets properly, and make tax-efficient investments during your working years, you risk reaching retirement age with insufficient resources.

Yet financial-planning conversations frequently give short shrift to the challenge of properly managing the decumulation phase of one’s life. Some retirees have accumulated a substantial amount of wealth, but instead of spending—and enjoying—the fruits of their labor, they remain stuck in an accumulation mind-set and continue to focus on saving.

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To help my clients overcome this psychological hurdle, I draft a spending policy statement, or SPS. An SPS is similar to an investment policy statement, or IPS, but is specifically tailored for the decumulation phase of retirement planning. An IPS is a document that is a few pages long and outlines parameters for growing wealth. An SPS is usually the same length but serves as a road map for how to use one’s savings prudently and constructively. It includes psychological nudges and motivation to spend one’s money, while also outlining strategies to help minimize the concern of running out of funds during retirement. 

Below are four key components of an SPS and how it has helped my clients:

Start with the end in mind. A good first step to help clients overcome their reluctance to spend in retirement is to assure them that they won’t run out of money. Take the time to clearly define their estate and philanthropic goals. Once the client understands that they can spend money and still accomplish their legacy goals, they will be able to spend more freely.

I have found using a Monte Carlo simulation to illustrate a client’s probability of success to be quite helpful. Monte Carlo methods are used in many fields, including financial planning, to determine the probability of different outcomes that can’t easily be predicted due to random variables. While no simulation or projection is foolproof, it does provide peace of mind for many clients.

Provide a monthly portfolio “paycheck.” A key component of assuring that a retiree won’t run out of money and can also leave a legacy is to establish a safe withdrawal rate. That is the amount of money a person can spend annually without risking running out of funds in retirement.

A common rule of thumb is the 4% rule, which suggests that withdrawing 4% of a portfolio’s balance annually will prevent families from depleting their assets. Although this is a reasonable starting point, an individual’s true safe withdrawal rate will depend on a variety of factors, including age, health, level of assets, and expected investment returns. 

Once a realistic percentage is determined, the account should be set up to withdraw that amount monthly to provide a “paycheck” to the client. The client will be receiving a regular income, similar to when he or she was working. This consistency and certainty of receiving a set amount of money in a checking account brings peace of mind and helps mitigate the anxiety of running out of money. If the safe withdrawal rate is calculated prudently, the probability of outliving one’s funds should be very low. 

Setting dates on bucket-list items. Many families include bucket-list items within their SPS. A bucket list is simply an itemized agenda of experiences or achievements that a person would like to accomplish during his or her life. A wish list of items with no set dates for achieving them, however, likely will remain just a wish. 

I encourage my clients to include dates by which they would like to accomplish their goals. This time frame helps motivate retirees to reach these milestones. Furthermore, if the clients are amenable, jotting down a more specific action plan for how and when they will accomplish each item on their list may offer further encouragement. For example, if clients dream of driving an RV across the U.S., they should indicate when they plan to purchase the RV and put together an itinerary with the dates they will stay in each location. This will help ensure the clients are prepared to achieve these objectives. Goals with no timeline are easier to put off and can lead to the hoarding of more assets.

Establish a framework for giving. For many investors, philanthropic discussions tend to focus purely on tax, financial, or estate planning. This may include discussing the use of donor-advised funds, private foundations, charitable annuities, or creative trust planning. Those conversations are important to ensure that their hard-earned money is distributed effectively and their legacies live on. However, getting caught up in the intricacies and technicalities of how to give away funds can lead to inertia and lack of action.

I have found that what really gets clients excited about giving is focusing on where they want to allocate their charitable dollars. This may include discussing broad categories or naming specific charities they want to support. The SPS should outline the clients’ desired prioritization. For example, they may choose to first support family members who may be struggling, followed by their local community, then any specific causes about which they feel passionate, and finally any other solicitations that pique their interest. Having a systematic approach to philanthropy helps segment charitable funds from noncharitable dollars. It makes dollars more effective, while also serving as a motivation to clients to distribute their funds. 

A prevailing mind-set among many investors is that they should continue indefinitely down the same financial path that allowed them to build their wealth. This is the wrong approach. Making the most of one’s golden years requires a transition from saving to effectively spending money. This shift doesn’t happen overnight and may require coaching and planning. The ability to successfully move into the decumulation stage of retirement will allow families to fully enjoy this stage of life with fewer worries.