Decumulation: turning retirement savings into retirement income

Retirement can be the most rewarding time of your life. The key is to have a strong decumulation plan. What is decumulation? While the term might not be familiar to you, the concept certainly is. It’s basically the financial term for how you’ll spend your money in retirement. You’ve saved carefully for years. Now’s the time to think about spending your savings to live the life you want.

Converting retirement savings into income will look different for everyone. It all depends on how you’ve saved up during your working years. You may have some money invested in:

• an employee pension plan,
• RRSPs, TFSAs, or
• other retirement income plans.

Figuring out when and how you’ll use those savings takes careful planning.

Why do you need a decumulation plan?

A decumulation plan is a plan to spend your money wisely in retirement. Imagine your retirement savings are blocks. Paycheque by paycheque, you take a small block of money and stack it on the pile. When you retire, you can knock over your savings all at once. Or you can carefully remove the blocks one at a time. A strategic decumulation plan will help you remove the blocks gradually and intentionally.

Are you tempted to take all the money and run? It could end up costing you in the long term.

But it could also cost you in the short term.

You would have to include all the money in your plan as income for that year. And pay taxes on that money, possibly pushing yourself into a higher tax bracket. The tax bill on that income could be higher than it would be if you withdrew the money over many years. And paying tax on the withdrawal will leave you with a smaller nest egg. And if that nest egg is now invested in a non-registered account, you’ll pay taxes every year on any growth that money makes.

In short, keep these two important factors in mind when planning retirement income: taxes and time.

How can a decumulation plan help you pay less tax?

The money you earn in your career is taxed as income. You may have received a tax break for contributing to retirement income plans like RRSPs. Similarly, most of the money you get during your retirement is considered income and is subject to tax. Retirement income includes:

• Money originally in your registered retirement savings plan (RRSP). While your money is in an RRSP, you’re putting off paying the tax on it. When you take it out, you’ll pay tax. Chances are, your tax rate will be lower. That’s because most retirees’ income is lower in retirement. But you will pay tax.
• When you stop contributing to your RRSP, you have a few choices. You can take the full amount in cash and pay a massive tax bill. Or, you can spread out the tax bite by converting it to a registered retirement income fund (RRIF). The government requires you to withdraw a minimum percentage each year from your RRIF. This way, you’re certain to pay the deferred tax. That percentage rises over time, until you have taken out the last dollar in your RRIF. Another option is to buy an annuity. Either way, you only pay tax on the amount you receive each year.
• Interest and growth in non-registered investments and savings accounts. Your tax rate will depend on the type of investment.
• Canada Pension Plan (CPP)/Québec Pension Plan (QPP) and Old Age Security (OAS) payments. Your payments will be higher if you delay CPP and OAS until after age 65. You can defer CPP and OAS until age 70; in Quebec, you can defer QPP until age 72. Conversely, you can start receiving CPP/QPP payments as early as age 60, but your payments will be lower.
• Company pension plan payments. That includes defined benefit plans as well as defined contribution plans.
• Income from freelance, consulting or part-time work.

It doesn’t include money you take from your tax-free savings account (TFSA). Why not? Because you paid tax on that money before you put it in. Remember that any growth on that money isn’t taxed.

Having to pay tax means you have the good fortune to have some savings. But you don’t want to pay more tax than necessary. That’s where an advisor can help. Together, you can decide when and how much to draw from your savings. And you can decide when to start getting CPP and OAS to supplement that income. That way, you can keep your total annual income meeting your needs. It can also help you avoid an unnecessarily large tax bill or clawbacks to OAS.

If your net income exceeds a certain amount ($90,997 in 2024), you must repay part of your OAS. This clawback is referred to as a recovery tax. Smart decumulation planning can help you avoid having to pay back some or most of your OAS payments. Talk to your advisor about smart ways to spread out your income in retirement. You’ll keep more of that money in your pocket.

How can a decumulation plan help your money last?

The second main reason to have a decumulation plan is time. The average Canadian retiring today at 65 can reasonably expect to live roughly another 20 years. You’ll want your money to last at least that long. You can count on CPP payments for your retirement. But CPP alone isn’t usually enough to live on.

That’s where your savings and investments come in. Your advisor can help you project how much you‘ll need to take out of your RRIF and other savings. They’ll work with you to understand:

• what your needs might be,
• whether you’ll have enough to live, and
• provide recommendations if you need to course-adjust.

Want another way to help ensure your savings last throughout your retirement? Consider adding another guaranteed income source, like an annuity, to your plan.

How do you make a decumulation plan?

The first thing you need to know, is what kind of lifestyle you want to live and what you can afford. “Start by doing a retirement needs analysis.” That’s the advice of Ralf Soeder, a Sun Life advisor and financial planner based in Oakville, Ontario. An analysis will help you estimate:

• how much you have in registered and non-registered accounts
• how much you will get from CPP/OAS and company pensions
• how inflation will affect your savings
• how much retirement income you will need to support the lifestyle you want
• how many years you will need it to last, and
• how to set up a plan to spend it smartly.

Remember that a retirement income plan needs to change and evolve as your life does. Your advisor is there to help make it happen. You might want to help your child buy their first home. Or get the opportunity for that trip of a lifetime. Knowing a flexible plan is within reach will offer you peace of mind.

Which retirement income sources should you tap in first and why?

“There aren’t any hard-and-fast rules for the order of your decumulation plan,” says Soeder. “Everyone’s situation is unique.” You may opt for early retirement and receive a company pension as your income. But you may have to wait until you are 60 to start receiving CPP and 65 to receive OAS.

On the other hand, you may want to continue working well past the age of 60 and can defer collecting additional income. Either way a good plan considers the following:

• Generating the lowest tax bill over the course of your retirement
• Avoiding the OAS clawback
• Covering potential future health-care costs
• Planning for travel, entertainment or other lifestyle expenses

Your advisor will help you make a plan that best suits your needs and wants.

How can you manage the emotional side of spending your savings?

Retirement can be daunting. You’ve worked hard to watch your investments grow. It can be hard to shift gears as you start spending those savings. You hopefully have plenty of savings to last you well into retirement. Even if you have enough to leave a legacy for your family, you could still be concerned about:

• market volatility,
• inflation,
• or both.

“On the one hand, you want to preserve your capital with the least risky investments possible,” says Soeder. “On the other, you need higher returns – and therefore, higher volatility – to keep ahead of inflation.” One way he recommends to deal with this is a “cash wedge strategy.” That involves parking from 2 to 4 years’ worth of living expenses in easily accessible, very conservative investments. You live on that, and replenish it each year from the returns from your more volatile investments. That way, you’re protected from market downturns in the short term. You can also still benefit from market growth over the longer term.

“Make a decumulation plan that addresses your concerns,” says Soeder. “Your retirement can be the most comfortable and satisfying stage of your life. The key is to have a plan.”