I have a confession to make. I also have something to introduce. I call it the Decumulation Dividend. It’s something that could improve your retirement income by thousands of dollars, even as you leave a larger estate behind. At the far extreme, it could increase your retirement income by 62 percent.
But first, here’s the confession.
Years of saving are one thing
Like most financial writers I’ve spent years – decades, actually — looking for ways we can increase our retirement nest eggs. The driving idea was simple: The more money you have when you retire, the better your retirement will be.
No one can argue with that.
The answer I found over those years was pretty simple: Keep as much of the return on your investment as possible. Don’t assume that brilliant investment managers will increase returns or even earn their expenses. History shows, year after year, that they don’t.
That means you can do better by reducing what you pay for investment management. It also helps to keep your investments dirt simple. That’s how Couch Potato investing got started.
To see how much expenses can impact the size of your nest egg, use my calculator on the Dallas Morning News website in this column: https://www.dallasnews.com/business/personal-finance/2019/09/15/new-texas-bill-means-teachers-could-be-better-off-saving-in-a-roth-ira-than-a-403-b-plan/
That’s all well and good.
But years of retirement spending are another
But I ignored something. Life isn’t over when we retire. While we might spend 40 years saving and accumulating for retirement, we can also face 20 or 30 years of spending in retirement.
During that period, however long it is, we’re decumulating. Our savings are in distribution, not accumulation. Investment expenses are just as important while we’re spending in retirement as they were while we were accumulating. In fact, those expenses are actually more important because they have a greater impact in times of market declines.
And then there’s another reality. Many of us don’t arrive at retirement with ideal portfolios. Most of us have made selections from a menu provided by our employer’s 401(k) or 403(b) plan. Some of those plans have better menus than others. But few of those menus are filled with truly low-cost choices.
Lower cost investing can bring a big retirement spending “dividend”
This means most of us have a last opportunity to improve our retirement spending and maybe boost what we leave to our kids. I think of it as the Decumulation Dividend. All we need to do is simplify and reduce our investment expenses. It also turns out that doing this produces big results.
How big? For starters, the benefits are much larger than I anticipated. At the extreme, it could mean that your income during a 30-year retirement is as much as 55 percent larger. For most people, the boost will be smaller but significant.
To explore this notion, I assumed you were 70 and just starting required minimum distributions. Most of us have the bulk of our savings in plans that demand required minimum distributions. Then I entered a nest egg amount and assumed a gross return before expenses. From there I compared the required distributions from age 70 to age 100 for different levels of management expense. I also compared the remaining nest egg at the end of each year. Here’s a table with a range of results.
Measuring the Decumulation Dividend from Expense Reduction |
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| The model assumes an initial nest egg of $1 million and a steady 5 percent return. It then calculates RMDs by year and principal remaining. Reducing investment expenses increases both lifetime distributions and the amount of principal remaining at age 100. Note: For simplicity, the model assumes a constant rate of return rather than probabilistic results from a return that varies. | ||||
| Typical Expenses | Annual Investment Expense | 3. Total income distributed age 70 to 100 | 4. Principal Remaining at age 100 | Total 3+4 |
| Thrift Savings Plan, Exxon Mobile, Index IRA accounts | .03 percent | $1,992,733 | $390,673 | $2,383,406 |
| Expenses for large 401(k) plans | .50 percent | $1,842,105 | $368,189 | $2,210,294 |
| 1.0 percent | $1,696,396 | $317,322 | $2,013,718 | |
| Expenses for many 403(b) plans | 2.0 percent | $1,444,225 | $235,191 | $1,679,416 |
| 2.75 percent | $1,284,505 | $187,512 | $1,472,017 | |
| Source: Scott Burns retirement distribution model | ||||
At the lowest cost of 0.03 percent, a $1 million nest egg becomes $2,383,406 of income distributions and principal remaining at age 100. That’s nearly a million more than a nest egg burdened with 2.75 percent annual expenses, only $1,472,017.
The table also tells us there are significant benefits for almost any amount of expense reduction. If your company 401(k) plan has expenses of 1 percent a year, a rollover to an IRA account with expenses of 0.5 percent will increase your lifetime distribution income by $145,708. It will also increase your remaining principal at age 100 by about $50,000.
Reducing expenses has another benefit. You’ll sleep better.
Why?
Because you’ve made the money remaining in your nest egg larger even as you increased your income. That’s a pretty nice combination.
Related columns:
Scott Burns, “The Simplicity Manifesto,” 03/31/2019 https://scottburns.com/the-simplicity-manifesto/
Scott Burns, “Dirt simple wins again: Couch Potato portfolio, 2018 https://scottburns.com/dirt-simple-wins-again-couch-potato-portfolio-2018/
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Photo: Scott Burns, Luxembourg Gardens, Paris, 2019
(C) Scott Burns, 2019