Understanding decumulation

What is decumulation?

Decumulation in retirement refers to the process of gradually drawing down, or spending, the assets that you have accumulated during your working years. This can include your retirement savings, investments, and any other sources of income that you have during retirement. A key challenge of decumulation is ensuring that you can maintain your standard of living throughout your retirement years without running out of money during your lifetime.  Assuming you are not one of those fortunate enough to have a well funded or public sector, defined benefit arrangement where the problem of providing lifetime income will sit with the scheme, the risks of decumulation cannot really be avoided and there are pros and cons with all of the approaches you might use to manage or mitigate them.

During periods of market volatility and rising costs, the effects of decumulation can accelerate, which could force retirees to have to adapt their retirement plan.

In this instance, there are several additional drivers of decumulation for retirees to contend with. Chief among them is the biggest cost-of-living squeeze in 40 years, which has been fuelled by exorbitant energy bills and a double-digit spike in inflation. To deal with the substantial increase in normal day-to-day lifestyle costs, many pensioners have needed to drawdown extra income or cut back in areas of discretionary or lifestyle spending to balance the books.  Timing can have a big impact.  Getting the same returns in the wrong order can result in very different outcomes and you never know what you’re going to get.  If you start drawing from your investments when investment values have fallen then unless you have created a cash buffer, you’re not going to be making the best of starts.

“There are millions of retirees who did all the right things. They saved and accumulated wealth through their working life. They did some cash flow forecasting with a financial adviser, looked at the valuation of their available assets and thought, ‘I’m set for a comfortable retirement,’” says Mark Rodgers, Independent Financial Adviser at Ascot Lloyd. “Then through no fault of their own we get this big spike in inflation and all of a sudden those cash flow forecasts go out the window and your income and available assets are no longer sufficient for your desired lifestyle. 

“Therefore, you have to start spending that wealth as capital as opposed to generating income, which does two things: it reduces the value of your assets and, because they’re then worth less, it reduces the income those assets will produce now and in the future. It can be a vicious spiral downwards when you start doing that, but many people have felt left with little choice.”

Volatile markets during decumulation

The volatility of equity (shares) and gilt (government debt) markets recently has added further risk to decumulation. We all know investments can go down and as well as up, and it has been an unfortunate reality that a difficult year for the markets has coincided with such a large spike in the cost of living, intensifying the pressure on our pockets. It goes without saying that in the market conditions through 2023, some investments would have suffered from the economic downturn more than others.

Whilst the risks of decumulation exist ,there are numerous avenues that savers can explore to mitigate these risks.

Firstly, it’s important to note that the cost-of-living crisis will come to an end. The Bank of England has said the headline rate of inflation reached its peak in October 2022. Many of the supply bottlenecks which initially caused inflation to rise are now easing and, though the cost of living squeeze is likely to grind on through the first half of 2024, the Bank then expects inflation to fall. This does not mean that prices will fall (disinflation) but it may mean that prices stabilise and revert to more pedestrian rates of increase. Until then, there are certain lifestyle decisions, as well as efficiencies in your home, such as reviewing subscriptions and memberships, turning down the boiler by a degree or two, or brand shifting you may also wish to make to reduce your expenses and you may also want to look to optimise your income. We explore this last point more in this article

Opportunities for growth during decumulation

Secondly, while there are undoubtedly assets which struggle through periods of recession, there are always others which will do much better, and recessions can often present a good time to buy into certain markets while they are down. However, the most important factor is ensuring that you can always meet your essential expenditure needs throughout retirement.  This may at times mean making the choice to defer or reduce some planned spending, or indeed retirement itself, to a point where you have a lower but more sustainable income.  Retirement is a marathon and not a sprint and if you forget the race you’re running, you may not finish.

Higher inflation also means better saving rates than we’ve become accustomed to over the last 15 years, and it has fuelled somewhat of a comeback for the annuities market. With annuity rates higher than they have been in a long time, a trusted Independent Financial Adviser will be able to explain all of the benefits and drawbacks of purchasing the right sort of annuity to support your retirement.  For example bridging between your desired retirement date and when you receive the state pension, or securing a minimum guaranteed level of income for life to cover those expenses that are always going to be present like your groceries, energy and housing costs (either rent or maintenance and council tax).

De-risking decumulation

Crucially, a financial adviser will also ensure you are taking advantage of all available tax reliefs and allowances. During times such as now when decumulation is a greater threat to your portfolio, making savvy tax decisions is even more important. This includes looking at annual Individual Savings Allowances, Capital Gains Tax, married couple’s tax allowances and using any tax-exempt savings arrangements appropriately.

“I just did an annuity quote for a client at 6% says Mark Rodgers. These rates are not atypical and if you have some health and lifestyle factors to be considered this can further improve your potential annuity income.  So when the chips are down in other markets, let's have a look at alternative ways that perhaps haven't been on your agenda previously. That's the point of having financial advice: to come up with something else when external factors affect Plan A.  Always bear in mind though that inflation will erode the spending power of any level annuity over time, so this has to be considered when compared to maximising the immediate income amount.”

“It can be easy to get suckered in by negative headlines, but there are always opportunities.” Have you got investments or pension funds that you have not looked at for the last five years? Speak to your financial adviser for an objective and most importantly bespoke view of your individual circumstances. We provide expert advice but, almost equally as importantly, reassurance.”

If you are worried about decumulation and would like to speak to one of Ascot Lloyd’s Independent Financial Advisers about a plan for growth, click here to request a call back.