Four Threats to the Distribution Phase of Retirement

Keep challenges such as inflation, market volatility and more in mind when it’s time for you to shift from saving for retirement to spending.

A pair of mountain climbers carefully make their way down a mountain.
(Image credit: Getty Images)

When discussing the difference between the accumulation and distribution phases of retirement, the classic metaphor used by financial professionals is an ascent up a mountain, with the climb being arduous and the descent being an easy, measured slide down a steep slope. While this metaphor does provide a useful mental image for retirees, it also implies (wrongly) that the trip down the mountain is effortless.

In reality, the distribution phase of retirement can be the most challenging, especially if the retiree hasn't taken into account how they will spend their money. In this article, we'll explore how to make the distribution phase of retirement work for you and discuss points to consider with your financial planner to ensure a high-quality retirement.

Managing risks in the distribution phase

The distribution phase begins when you start drawing from your accumulated income to support yourself. As financial professionals, it is our responsibility to help you make a plan to not only transition from saving to spending, but also to enter and execute the distribution phase without depleting your nest egg too quickly.

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The greatest threats to retirees at this point are failing to consider market volatility and inflation, yearly tax bills and unexpected long-term care and medical costs that may arise from living longer than anticipated.

Planning for market volatility

If you know anyone who retired in 2020, they may have told you stories about how their retirement investments were stable one day and in dire straits the next. This is because they didn't take the economic downturn seriously and didn't have a plan for that eventuality.

Essentially, they were withdrawing money from accounts with shrinking values and no chance to replenish. To avoid this, make sure that you don't have too much invested in high-risk investments and diversify your investments to give your funds a better chance of recovering their value when a crisis impacts the markets (and your money).

Take note of inflation

Overlooking inflation is another danger in the distribution phase. Just because you could hypothetically retire today doesn’t mean the same will be true in 10, 20 or 30 years. Last year, the inflation rate hit an all-time high of 9.1% (the highest since 1981). While it’s since lowered to a more average yearly number of 3.2% (as of July 2023), you can expect plenty of surges and dips like this throughout your lifetime, especially over the next decade.

You can use an inflation calculator to give you a better idea of how far your money will take you when you retire, but the best action is to make sure your retirement fund is protected from tax liability.

Shift from tax-deferred vehicles

The secret to mitigating taxes? Plan ahead. You can lower your tax bill by shifting your retirement nest egg from tax-deferred accounts like IRAs or 401(k)s to Roth accounts. While your tax bill will increase in the year of the shift, you can time it correctly to ensure that this occurs while you still have a paycheck coming in and while tax rates are lower.

Remember that tax rates tend to increase year after year, much like inflation, and one thing is certain: You will have to pay them. It's better to do so while you still have a paycheck coming in and when tax rates are lower, so you won't feel the tax burden as acutely.

Additionally, your retirement funds can continue to grow tax-free until you're ready to use them.

Don't overlook your RMDs: Develop a strategy to take them when it's most beneficial for you.

Understanding sequence risk

They say what you do with your money five years before retirement and five years into retirement have more of an impact on the quality of your retirement than a lifetime of saving. It’s not untrue, but really, it's the timing of the actions you take with your money that matters most. Think again of the trip down the mountain. If it’s raining and icy, it’s probably not a good time to continue your descent.

Similarly, sequence risk is what we call it when withdrawing funds from a retirement account will hurt the overall rate of return. For example, retiring during a bear market can take huge chunks out of your retirement accounts in losses while simultaneously you’re withdrawing money to live. Many financial professionals say that sequence of returns risk is a matter of luck — one can never predict what the market will do, of course. But at our firm, we say it never comes down to luck; it comes down to planning.

To combat sequence risk, you might consider working longer, investing more in government bonds or asking your financial professional to show you some annuity products or life insurance policies with an income rider to help you have more liquidation and income options should sequence risk be at a high when it’s your turn to retire.

The bottom line

Many retirees, and unfortunately some financial planners, too, overlook the fact that their financial portfolio needs much more attention during the distribution phase than it did during the accumulation phase. With no new money coming in from paychecks, there's much less room for error. One misstep could cause you to tumble down the retirement mountain. To protect the quality of your retirement, speak with your financial professional about developing a plan to seamlessly shift from accumulation to distribution.

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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Cliff Ambrose
Founder, Financial Adviser, Apex Wealth

Cliff embarked on his professional journey in the financial services sector right after obtaining a degree in Finance and Economics from Saint Anselm College. He commenced his career as a Financial Adviser at MetLife, where he excelled and was awarded the prestigious Super Starter Award and Leaders Club production accolade in his first year. Cliff's early years in the insurance-broker dealer realm at MetLife and New England Financial honed his skills and transformed him into a consummate expert in the insurance space.