Ed Note: This is part one of a two-part series and is an excerpt from Your Complete Guide To A Successful And Secure Retirement.
If we live long enough, our financial assets can go through five phases: accumulation, what we at Buckingham Strategic Wealth call “black-out,” spend down, final spending and legacy. The knowledge required to effectively manage financial assets in the accumulation phase is not sufficient to carry clients through the remaining stages. What follows is the knowledge needed to give your clients the greatest chance of achieving life and financial goals as they pass through the various other stages.
Accumulation Phase
The accumulation phase commences when we begin our careers and start to save and invest. For those who forgo college, the accumulation phase will begin in our late teens. For others, such as doctors and lawyers, it might not begin until our late twenties. This phase is the longest one as it typically continues until we stop working full-time. The goal during this phase is to save and invest as early and as much as possible. Chapters 3 through 10 have provided you with the information needed to develop the right strategy. The strategy should include a focus on which tax-advantaged accounts should be used (traditional versus Roth IRA). Chapter 10 provides a detailed discussion on this issue. The strategies learned in this chapter continue to apply throughout your lifetime.
Each of the following phases are part of the decumulation, or withdrawal, phase. The biggest difference in strategies during withdrawal and strategies during accumulation is that there is a much greater emphasis on long-term tax planning during withdrawal. Taxes are often the single largest expense for investors. Thus, to ensure that you have the greatest chance to meet your own goals, we strive to have the IRS take the smallest share of your financial assets. However, this does not necessarily mean paying the least amount of taxes in any particular year. Instead, the focus is on paying the least over your lifetime and possibly beyond.
During accumulation, taxes are dominated by your salary and/or other sources of income. The tax strategies during this phase relate mostly to how much you can save before tax, how much after tax and where you locate the different types of assets. However, planning during spend down presents different opportunities as you go through phases of low and high tax rates. Therefore, we break decumulation into four distinct phases.
Decumulation Phase
Black-Out Phase. The first phase during withdrawal, which doesn’t exist for everyone, is one with low tax rates. It typically begins with your retirement, when you are no longer generating sufficient income to meet your lifestyle needs, but have not yet chosen to receive Social Security or pension benefits. Thus, you may be in a low tax bracket and can draw on your taxable assets (at relatively low tax rates), or tax- free assets, to provide the desired lifestyle.
We call this phase black-out since the structured sources of income (salary, Social Security, required minimum distributions) are absent, or blacked out. During this phase, many retirees celebrate their low taxes after years of paying large amounts with their salaries. However, as we discuss later, this might not be the best strategy.
Spend-Down Phase. The spend-down phase, so called because this is when you start spending down your tax deferred retirement plan accounts, typically begins in the year you turn 70½ and start taking your required minimum distribution (RMD). It is a period when tax rates can jump back up from the low rates of the black-out period as you start receiving income from RMDs as well as Social Security and possibly pension benefits. An individual’s tax rate will often remain at this same high rate for the rest of his or her life. Although, increasingly, people move into one final phase during their lives.