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Demystifying Spending in Retirement

For years the retirement industry has been telling people how to save and invest for retirement, but no one has told them how to spend their nest egg once they retire. That approach is changing.

The prospects of retirement are daunting for U.S. workers. The responsibility to accumulate savings has mainly shifted to the individual, and then there is the question of what to do with the money once they actually retire. Unsure of how to spend down the money they spent years saving, most retirees in the U.S. simply sit on it. Regardless of wealth level, most current retirees retain 80% of their pre-retirement assets nearly 20 years into retirement.1  In fact, a third of retirees actually grow their assets in retirement. Those numbers reveal that a vast majority of U.S. retirees aren’t living life to the full potential merited by their assets. Perception plays a big part in this – only one in four retirees feel they’ll have to spend down principal to fund their desired lifestyle, likely because they don’t view retirement as a time to live it up, but rather as an exercise in feeling financially secure.2

Solutions for saving and accumulating assets in preparation for retirement are numerous – but plans for how to spend that money are practically non-existent, according to BlackRock’s Nick Nefouse, Head of Retirement Solutions and Global Head of LifePath®, and Michael Pensky, Portfolio Manager, Global Tactical Asset Allocation. Nefouse and Pensky are two of the authors of “Building a Common Framework for Spending Down Assets in Retirement,” a new paper that expresses BlackRock’s principles of decumulation, a challenge that is complex and involves interconnected risks. The firm has long been a leader in developing 401(k) plan strategies and making such plans more accessible to those who don’t have them. Now it is taking up the mantle of helping U.S. workers spend down their money most effectively in retirement by adopting a holistic view of their entire portfolio. II recently spoke with Nefouse and Pensky about the decumulation initiative.

Why did you see the need to author a common framework for spending down in retirement?

Nick Nefouse: There’s so much out there – so much on saving, investments, plan design, you name it – but there is very little on how to actually spend in retirement, or decumulation. Even the word “decumulation” is a bit of a mystery to most people. We wanted to provide a real baseline for investors that moves past the outdated 4% rule. There’s no single right way to do it, of course, and it’s going to be difficult for investors to achieve 100% of their objectives because there’s likely going to be tradeoffs. But being able to recognize and evaluate those tradeoffs and determine a strategy to convert savings into steady cash flow is going to help investors make informed decisions. We’ve spelled out a starting point and some criteria plan sponsors can use to evaluate options and assess the trade-offs.

It sounds as if you’re trying to bring greater clarity to what is a complex decision-making process for retirees and those nearing retirement. What makes it so complex?

Pensky: The first thing is longevity risk. When people think about how much they need to save, they have a general sense of how long their assets will need to last, but the reality is that the endpoint is unknown – and that is a risk in itself. That’s why decumulation is so important – the decisions you make on how much to spend and when are going to affect your financial well- being for the rest of your life. For most people, the worst thing for them would be to run out of money in their lifetime. For example, many people retire between 62 and 65 – but how long a person lives in retirement can really vary, and it’s not simple to think about how to solve for this.

The second aspect to consider is sequence risk. Longevity risk is relatively easy to grasp, but sequence risk essentially suggests that the pattern in which market returns appear can have a very meaningful impact on your outcomes when you’re spending down your assets. In short, sequence risk means that the timing of when in your lifetime you experience negative returns matters. If you have a negative market return when you’re spending from your portfolio you essentially need to take more units out of your portfolio to be able to spend the same dollar amount – the value of each unit goes down in that scenario. That’s a risk that can lead to scary moments for investors who experience big negative market events early on in their retirement. Ensuring your investments are designed to address sequence risk head-on can help investors be more confident in retirement, and help them take more out of their portfolios to increase their overall cash flow.

According to the paper, there are three bedrock principles of decumulation: maximize spending, minimize spending volatility, and, as you were just mentioning, address longevity risk. It would seem that maximizing spending would be both a wonderful idea and a frightening one at the same time for end investors. 

Nefouse: Each of the three principles is limiting, and no one is any greater an objective than another. For example, if you only maximize spending, you haven’t addressed longevity. And if you only worry about longevity or not wanting to run out of money for the next 50 years, you aren’t maximizing spending.

That’s what makes the challenge difficult – you’re trying to balance three things that are often contradictory. We all want to spend as much as we can, but you want to have the least amount of volatility in that spending, too. The three objectives – maximize spending, minimize spending volatility and addressing longevity risk – are not mutually exclusive. Quite the opposite, they are heavily linked to each other. In fact, as different investors weigh these objectives and trade-offs in a way specific to them, it’s easy to see how different solutions could make sense. Maximizing spending is essentially spending as much as your portfolio can support while being cognizant of all the unknowns you face. That answer will look different for different people.

Going back to the three principles you’re establishing for decumulation. If there were a fourth, what would it be?

Nefouse: Asset location in spending. There are ways to increase your spending or decrease your volatility by just understanding where to spend first, second, and third. For example, spending liquid assets before you tap social security might be beneficial.

Pensky: I would add flexibility. Your decumulation and overall retirement strategy should be sufficiently flexible to address unforeseen scenarios that might emerge. At a high level, that means having a lot of arrows in your quiver to address unexpected circumstances – in other words, you want to have sufficient diversification and types of tools that you’re using within your decumulation framework to maximize flexibility.

How do retirement plan sponsors fit into all of this?

Nefouse: Plan sponsors can help by making retirement income solutions available, and they can educate participants on the importance of thinking about a spending plan before retirement. They can also take a look at plan demographics and think about what those demographics might indicate or mean for the objectives of their participants. This paper and the ones that will follow are about starting the conversation about decumulation with plan sponsors and participants. And it’s a big step forward if we can start it with the idea that you want to maximize spending with the least amount of variability and address longevity.

You mentioned spending volatility. Is that about big ticket unexpected costs, like serious healthcare, for example? Or is it more an everyday concern than that?

Pensky: Spending volatility means people have lifestyles they’re accustomed to and essential expenses to meet, and it’s difficult for them to deal with too much variability in their amount of spending. For example, it would be hard to go from spending $3,000 one month and then have only $400 to spend the next month. It’s not viable, and that’s why the decumulation framework has an explicit objective to create a level of stability in investors’ cash flow while recognizing that some cash flow variability may be necessary to achieve the other two objectives.

It sounds difficult to determine how much to spend in retirement, and you write that it’s getting even more difficult. Why is that?

Nefouse: There’s a few reasons retirement is getting harder – longer life expectancies, lower yields, fear of medical expenses, and a higher reliance on defined contribution plans, which moves the onus off employers and onto employees and individuals. All of this creates a challenging environment. Medical expenses, in particular, are tricky because they are not evenly distributed across all retirees. There’s a small cohort that spends a lot of money on medical expenses, but we don’t know who that cohort is to be able to say they’ll experience more spending – so everybody hoards their capital.

This is part of the reason why we have to think about the decumulation challenge in in its entirety in the context of a whole portfolio approach – and that includes social security, which can be part of the solution. Social security is an asset that many of us get or expect to receive, so let’s think about how it can potentially be combined with other assets to cover some of those expenses.

Another thing we talk about in the unknown cost of medical expenses scenario is adding insurance into portfolios outright – a rethink of the annuity puzzle to start to smooth some of that spending out over your lifetime. This also helps with the objective of reducing spending volatility because insurance can provide a floor for spending alongside social security. In other words, can I buy some lower cost insurance protection in my 50s and 60s that provides a floor for the rest of my life? And if you get to that point, your kids aren’t on the hook for any of those expenses, you’re taken care of, and you’re not leaving any money on the table.

There are four items in what you call the decumulation toolkit -- retirement date, social security eligibility date, labor income in retirement, and investment strategies. What should retirees, those currently in the workforce, and retirement plan sponsors know about each aspect of the toolkit?

Nefouse: Retirement date has gone down in line with the Social Security Administration offering early retirement at 62, so we’re currently in a sub-65 age group of average retiring date. Interestingly, one of the biggest reasons cited for retiring early is loss of job or health reasons. So, retiring is often not a choice people make, but a circumstance thrust upon them. Many may want to work until they are 70, only to find out they cannot or should not.

Social security eligibility date is separate issue. Social security is a form of annuity, so depending on your circumstances, you may want to put off collecting it. This goes back to the whole portfolio solution – understanding how long you’re going to work, your liquid assets, and social security. All three are interrelated – every year you work and put off collecting social security increases the amount of social security you may eventually get and reduces the amount of time your other retirement assets need to support you.

Where does continuing to work after one’s primary career has ended fit in?

Nefouse: For those with that option, we would think of it as part of the toolkit that would essentially change your retirement date. Retirement date and labor income are closely connected. Many people continue to work because they have to, and others do so because they like the activity and being involved in something – it keeps them from being bored and it’s good for their mental health. The final part of the toolkit is investment strategies, which you can look at in one of two ways: liquid assets on their own, or the whole portfolio, which we would argue is really how you want to frame the decumulation challenge: When am I going to retire? How do I optimize social security? How do I spend from my liquid assets? And if I do have other sources of income like employment, what happens to those other sources of income?

Earlier you mentioned the necessity of tradeoffs, and in the paper you worked out four hypothetical investor personality types to illustrate them – scared to spend, overspending, only spend what the portfolio earns in a year, and a dynamic spender who really understands how much they can spend each year. Is one type of investor personality predominant? Or is it a case of everyone is different when it comes to spending?

Nefouse: We’re trying to show it’s impossible to know what’s going to happen. That’s the whole point of sequence risk. There’s risk of not knowing what type of market you’re going to retire into. We’re trying to educate people that they cannot rely on the fact that the market has gone up by double digits for the last five or 10 years. If that stops, are you protected? For example, an equities-only strategy would have looked brilliant since 2008, but that doesn’t mean it was the right answer – nor could you really know it was or wasn’t. Our hypothetical investor case study is designed to illustrate that to achieve better retirement outcomes, investors need to balance our three objectives of maximizing spending, minimizing spending volatility and addressing longevity risk.

It all sounds as if it should be part of the national conversation on retirement challenges in an age when most workers do not have, nor ever will have, defined benefit retirement plans. Does the decumulation discussion merit inclusion at that level?

Nefouse: [BlackRock CEO] Larry Fink talks about retirement as a silent crisis. So, yes, as a firm we’ve made it clear we want to focus on this and force the conversation to address what we do in retirement and what we can do to improve access to retirement savings plans. Since the Pension Protection Act in 2006, we’ve seen great things happen to 401(k) plans. An investor who has access to a 401(k) plan has likely done really well because they tend to be in low-cost, diversified, professionally managed target date funds. If we think about the next 15 years, we need to shift the perception of the 401(k) plan from solely a savings accumulation vehicle to a full lifetime vehicle. That’s the conversation we are starting. Over 50% of Americans have access to a 401(k) plan, but very few of those plans have dedicated decumulation strategies. We’re trying to put that front and center.

Learn more about spending down in retirement and other insights.



1 Employee Benefit Research Institute estimates based on Health & Retirement Study (HRS, 1992-2014). The HRS Survey used a sample of 7,148 retiree households who provided self-reported asset data.

2 “To Spend or Not to Spend?” (2021 edition), BlackRock

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