Accumulation & Decumulation: facing the financial implications of a long life.
Two frequently used terms in any professionally conducted discussion about retirement planning are accumulation and decumulation. The accumulation phase is the pre-retirement period when we work and save for retirement. Upon retiring, decumulation begins.
When saving for retirement, the focus tends to be on asset growth and total returns. But after retiring, the goal is to maintain a standard of living. Put another way, we need to determine the best approach to spending down our assets to protect a lifelong income.
The transition to retirement is about the nature of risk, and the biggest risk we all face is longevity. Since people are living longer, most retirees can only guess how long their retirement will last. As a result, they face a tricky tradeoff between their preferences to live well, while avoiding old age poverty. We have identified three areas of longevity risk for retirees:
1. Market Risk
These risks include investment volatility related to poor market returns and disadvantageous fluctuations in interest rates. Unpredictable tax rates are another. Potentially reduced CPP (QPP) and OAS payments, is a third. And let us not forget the increasing cost of health care. The cost-of-living for retirees may rise faster than the general population, especially as increasingly expensive health care makes up a larger portion of a retirement budget.
2. Inflation Risk
For retirees living on a fixed income, rising prices will slowly erode your purchasing power. Even if inflation averages about 3% per year, your cost-of- living will double in just 23 years. In other words, a fixed income will buy half of what it could at the start of retirement. A lot of retirements last longer than this.
3. Personal Spending Risk
If you’re not careful, the basic budget you prepared for retirement will not adequately reflect actual costs. In addition to health care and long-term care expenses, you may need to support other family members such as adult children or grandchildren.
A well-crafted financial plan, assembled with the help of a trusted advisor, can lead to a more fully funded retirement that neutralizes longevity risk.