72T

[becca]

After being retired for more than 4 years it's time to begin a 72T withdrawal from our IRAs. We have close to $2 million invested. We plan to withddraw $60K per year from one of our IRAs (worth $900K). This IRA will be invested in 50% Stock Index Fund, - the other 50% split evenly between a Short Term Bond Index Fund, Ginnie Mae Fund, and TIPS Funds - all Fidelity funds. Most advice I have seen is to have a portion of the IRA you are withdrawing from in cash and use this for your monthly draw. My question is why not each month just sell $5000 from whatever portion of the account is doing well and take that as the monthly draw. We hate to leave a large chunk of the account just sitting in cash earning hardly any money for a significant length of time. Any advice?

[intercst]

becca asks,

After being retired for more than 4 years it's time to begin a 72T withdrawal from our IRAs. We have close to $2 million invested. We plan to withddraw $60K per year from one of our IRAs (worth $900K). This IRA will be invested in 50% Stock Index Fund, - the other 50% split evenly between a Short Term Bond Index Fund, Ginnie Mae Fund, and TIPS Funds - all Fidelity funds. Most advice I have seen is to have a portion of the IRA you are withdrawing from in cash and use this for your monthly draw. My question is why not each month just sell $5000 from whatever portion of the account is doing well and take that as the monthly draw. We hate to leave a large chunk of the account just sitting in cash earning hardly any money for a significant length of time. Any advice?

-----------------------------------

The advice to keep several years worth of SEPP withdrawals in cash or CDs was to prevent exhausting your IRA account before age 59-1/2 in a bear market. Under the old SEPP rules, this would have resulted in a big IRS penalty and back interest.

In October 2002, the IRS issued new rules governing SEPPs and eliminated the penalty for SEPP programs which must be modified due to a dramatic drop in the value of the portfolio, see link:

http://rehphome.tripod.com/sepp2003.html

With the elimination of this big penalty, you can probably manage your IRA account any way you like. Taking the withdrawal from what ever part of the portofolio is doing well seems fine to me.

intercst

[Ed_B]

Like others on this message board, I am planning to use a 72t exception during ER to avoid the 10% penalty tax on early retirement plan withdrawals. By the time I retire in the summer of 2004, I hope to have about $600k in my 401k plan. This will be rolled over into a traditional IRA at a discount broker. I will then set up the asset allocation that I want, which will be 50% stocks, 15% corporate and US Treasury bonds, 15% REITs, 10% natural resources, and 10% in various cash equivalents. The stock investment will be in low cost diversified mutual funds with some allocation to International stocks but the primary emphasis will be on US dividend paying value stocks. The cash will be in CDs, money market funds, and very short term bond funds. In all cases, the goals will be for reasonable return on the investment, low costs, and below average volatility.

The SEPP will then be set up to withdraw 4.5% per year, paid monthly. This will be kept without changes for the required 5 years. At that time I will re-evaluate the situation and decide if I want to stay with this withdrawal rate or change it. This portfolio should be able to return about 8% annually, with the withdrawal rate plus inflation just under this. If so, then the account should grow slightly during the SEPP withdrawal period.
According to the various on-line 72t calculators that I have tried, this should result in a monthly gross income of about $3100. This combined with my wife's pension of $2800 per month should provide a comfortable retirement.

Vanguard has some excellent info on 72t and how it is calculated. I will do the calculation myself but will have a fee-only financial planner look over the plan, check the calc, and comment on the over-all plan.

We also have about $75k in two Vanguard taxable mutual funds that we are planning to sell to pay off our mortgage. This has been a real topic of discussion at our house lately because the two funds are earning more than the 4.6% interest that we are paying on the mortgage. Still, a home that is paid for is a very attractive asset whether the dollars and cents add up or not. This is as much a psychological issue as a financial one, so we will do whatever feels right when the time comes. If the funds are doing well, we will probably keep them. If they look as if they are pulling back, then we will probably sell and pay off the mortgage... and the cap gains taxes that are due. :P

Anyone see any problems associated with this approach?


Ed_B

[Michael]

Yes, the proposed portfolio withdrawal rate is far too high.

[Stan]

I agree with the idea of paying off the mortgage, which is what I have also done. After all, why would you want to hold any cash investments while paying a mortgage rate that is much higher than can be attained from the cash investments. The way I figure it, if you need extra money for some reason, you can always draw on the home's equity at a later date, possibly through a home equity line of credit.

One thing I would ask about is the 8% assumed return on investments. Is that a little high? I think we can be pretty certain that cash and bond investments will yield less than that, maybe a lot less. Personally, I will be very happy if my stock invetstments yield 8%.

[Ed_B]

Mike:

An interesting comment. If the other asumptions are correct, how can this rate of withdrawal be too high? Remember that this is only going to occur for 5 years. Even under the dreadful conditions of the 1930s this rate would not come anywhere near exhausting the account.


Ed_B

[Ed_B]

Stan:

No, actually, that is somewhat conservative. I have a number of investments that have paid in the 12-14% range recently and these arte not exactly the best of investing times. While this is not the norm, it is possible.

The average return from the US stock market over the past 72 years has been in the 11% area. And that includes some pretty nasty recesions. I see no reason whatever why a well diversified portfolio cannot return an average of 8% with less than average volatility. Assuming that the stock market can continue to provide a 10-11% average return and that bonds can average 5-6%, the 8% figure looks very realistic. This also leaves a cushion of 0.5%, since a 4.5% withdrawal rate + 3% inflation = 7.5%. On top of all of this, is the idea that one can spend principal at a slow rate. I am planning to consume and enjoy my retirement funds, not leave them to Uncle Sam.


Ed_B

[Michael]

Since you are taking SEPP, you are young. A long pay out period (40 years) requires a maximum of about 3 1/2 % withdrawal to meet the 100% SWR (from a properly constructed portfolio).

http://rehphome.tripod.com/mother.html

Since P/E ratios are strongly correlated with future returns, experiment with plugging Warren Buffet's 6% estimated future return for equities into your calculator. Use the current 3% 10 year treasury yield to approximate the return on treasuries for the next 10 years, as Jack Bogle recommends. If the market outperforms, you can always take more out later on. We will probably get a bull for a while in response to the fed's current policies, but since P/E ratios have been under 10 in the past, it is reasonable to figure that they will likely be there again in our future. This reversion to the mean would significantly reduce equity returns, which are already reduced by the historically low dividend yield. Counting on $3100 per month from only 600k is risky. That is my opinion anyway, for what it is worth.

[Ed_B]

Mike:

I understand what you are saying, but trust me... a 40 year payout is NOT in the cards... maybe 20 if I am lucky.

As to being young because I want to do a SEPP... not really. I'm almost 54 and plan to retire at 55. Is that young? Probably not if you're looking at a 15-20 year lifespan beyond that, which my family history suggests is reasonable.

As to the 10 year treasury going to 3%, so? The 10 year treasury was once at 15% in my lifetime but I am sure not counting on seeing that anytime soon. What we are seeing today is a historical abberation and not the norm. While today's crummy market is a short term jolt, I see nothing that says this is going to continue for the indefinite future.

We don't have to look too far on this very board to find a lot of folks who have successfully retired on less than $600k, which BTW is only my half of the family income. My wife has a separate financial plan and one that is considerably more successful than mine. We can invest her IRA pretty much as we choose, rather than in just the limited set of funds available in most 401K plans.

Besides... you're not one of those folks who thinks that they can't possible retire on less than $5 mil or so, are you? If so, don't look now but I'll be 243 years old before that amount is in my retirement fund.

[MRGALT2U]

I read a letter in Sunday's paper from a guy (in his 40s)
whose wife was still working and making $60,000
a year. Their combined retirement funds were
$3,500,000. He was asking if he could afford to retire.
I showed this to my wife who said "He's too stupid to
retire!" I retired at age 49 with a net worth in the
VERY LOW 6 figures. It's now 10 years later. My net worth is up and I haven't had to forgo anything
important for lack of funds.

[Michael]

I would be the last person to suggest waiting another 243 years to retire, since I retired at age 44. I guess my philosophy is centered more around economic security rather than maximizing current expenditures. That is just my personality. You have plenty of money to retire on. Personally, I would feel safer with a lower initial withdrawal rate, but it is your call.

[bongo2]

Ed_B, I don't understand where $3,100/month comes from. 4.5% of $600k = $27k = $2,250/month. As for bond yields rising -- remember that when yields go up the value of the bonds you hold will fall. If you are withdrawing beyond your yield (which you are), then you will be hurt, not helped, by rising rates. If you are putting the money in extremely short-term instruments, then your yield is going to be 1% instead of 3% for now, and your yield gap is much greater. I'm not really sure if you're counting on this money for a long time, or just for five years. Obviously, if you only need the money for five years, or even fifteen, then you can withdraw quite a lot without a problem.

[Ed_B]

Mike:

I'm not disagreeing with your philosophy. I understand that a low withdrawal rate stretches the money out further but we all have to draw a line somewhere and this is where I have chosen to draw it. Put another way... with a 4.5% withdrawal rate, the money will last 22.5 years with ZERO growth. Hmmm... can anyone think of a 20+ year period where the US stock market did not return at least 5-6%? I can't, although I confess that I have not data-mined this topic.

I recall an article in one of the financial mags back in early 2000 where one fellow had ER'd and was withdrawing 10% a year from his retirement savings... and his "financial planner" had no problem with that! Yikes!. I would have a HUGE problem with that but I guess that was where his comfort line was. Heh... he's probably working somewhere as we speak.


Ed_B

[Ed_B]

John, we're in complete agreement on this fellow. $3.5M + $60k in annual income and he can't figure out IF he can retire? I think he better let her handle the family finances and stick to something that he can figure out... like pushing a broom somewhere.


Ed_B

[Ed_B]

Bongo2:

Check out the 72t calculators on the web, such as the ones at:

http://www.finance.cch.com/sohoApplets/Retire72T.html

http://72t.net/ED_Calc01.aspx

Most offer three ways to calculate the 72t withdrawal: 1) life expectancy; 2) amortization; and 3) annuitization. I prefer the amortization method of calculating this and it shows the figure I have listed given a $600k retirement fund and a 4.5% withdrawal rate. Clearly, there is some expected growth in the account and a portion of the monthly payment comes from this growth, not just the principle.

As to bonds, if one is using them for income they are not something that would be sold unless one can anticipate a series of interest rate cuts that would produce substantial cap gains that are more advantageous than the income stream. This depends upon your financial situation as well as the bond prices and interest rates. The current rate of bond interest is at a 40 year low. This is not a number that should be used in long term financial planning, IMHO. A long term average would make more sense and for bonds that number is probably in the 5.5-6% range.

Ed_B

[bongo2]

Ed, I don't know anything about 72T, but it looks like the calculator that you linked me to was asking for an investment return %, not a withdrawal %. If you are taking out 6.2% each year, then that is your withdrawal rate, not 4.5%. This is not unsustainable, but it is somewhat risky in the current low interest rate environment.

Which brings me to the part I do know something about -- bonds. While historical bond yields may be 5-6%, it's the current yield that you're stuck with for the next several years (unless you have your money in extremely short-term bonds). As for selling bonds -- if you are yielding 2-3%, and you are taking out 6.2%, then you are going to be selling bonds unless your equity holding make up the difference. With equities nobody knows what the future will bring, but with bonds, the best you can get is the yield on the bond you buy. Higher yields in the future will only help you when you reinvest the money.

[MRGALT2U]

Re. "nobody knows what the future will bring", exactly
right. So..................try to factor in as much certainty as
you possibly can, in all areas of your life. You can not
reach 100% predictability, but the closer the better
is the way to go for ERs.

[Ed_B]

Bongo2:

Most 72t calculators do not ask for an investment return. They simply assign one based upon their thoughts on the matter. It is clear that both the investment return and the withdrawal rate will determine the changes in the value of the account. There are LOTS of these calculators on-line and they do not all use the same input variables, so of course they do not necessarily give the same results. They should be close, though. Now... my stated goals are: 1) an 8% return; and 2) a 4.5% withdrawal rate for 5 years. This is sustainable and, in fact, I expect my IRA to be worth more at age 60 than it is at age 55. If my assumptions are not correct, so be it. This is my best shot at it now and I can change it after 5 years, so no problem.

Also consider that a chunk of my investment capital is in REITs. One of them paid 11% last year and the other paid 14%. I am not counting on this level of return but see no reason why the historical average of about 7% cannot be earned on these investments. Same for stocks, although the historical average there is in the area of 11% per year. Worst case scenario? My account declines by $40-50k during the 5 years that the SEPP runs. Since we are now out of a bear market and a new bull phase is in the formation stage, it is extremely unlikely that the economic conditions of the last 3 years can be maintained much longer... especially in the face of some serious financial and monetary easing. Don't forget the HUGE amount of cash that is still sitting on the side-lines. This money will come back into the market at some point and when it does it will bid up the price of equities.

As to bonds... I have no bonds at this point and so am not stuck with anything. I used REITs and dividend paying value stock mutual funds to take their place in the investing capital that I control. Could not do as much of this as I wanted with my 401K due to the rather limited investment choices available in that program. We have some good fund choices but the breadth of the investment choices is far more limited than we can have in an IRA.

I would only buy bonds when interest rates are relatively high and the odds favored interest rate cuts. I owned both bonds and GICs back in the 1980s when it paid well to do so. These days? Pfft. I'd far rather hold dividend paying stock funds now. It is not at all difficult to earn 3% in dividends and there is considerably more upside potential to be had when the market recovers.

I suggest that nobody knows what the future will bring in any investment. All can go sour and eat our money. We play the odds, that's all. Besides... the best that we can get is not the rate that the bond pays. We can also get cap gains if interest rates are cut significantly while we hold bonds and then sell them in competition with lower yielding newer bonds.

Ed_B