Advice requested for after tax ER

[nun]

How do people arrange their finances when they ER 10 to 15 years before they reach 59 1/2 if they don't want to do substantially equal payments from their IRAs etc. I'll have enough total savings to retire in a couple of years, but a lot of it is locked up in the 401k and IRAs. I'll have to live off my after tax savings, but I won't have enough to put 5 or 6 years of income into fixed income and be able to replenish spending form 4% withdrawals of my after tax stock investments. Should I just draw down my after tax principal, I calculate that it won't all be gone before I'm 59 1/2 and can tap into the tax deferred money.

 

[rogersteciak]

Re: Advice requested

How do people arrange their finances when they ER 10 to 15 years before they reach 59 1/2 if they don't want to do substantially equal payments from their IRAs etc. ... Should I just draw down my after tax principal, I calculate that it won't all be gone before I'm 59 1/2 and can tap into the tax deferred money.

This is not advice per se, but rather an explanation of what I am doing.  Unlike you (who is 45-50 years old and planning on using your taxable investments to cover your living expenses until you are 59 1/2, and then using tax-advantaged investments to cover your living expenses from then on), I am 55 years old and planning on using my taxable investments to cover my living expenses until I am 70 1/2 and then using my tax-advantaged investments to cover my living expenses from then on.  I haven't factored social security into my calculations (so that it becomes a fallback if it turns out I need it).  I'm also planning on doing some consulting projects from time to time that will create additional income (which hasn't been factored into the spreadsheet either).  And if I have to begin using my tax-advantaged investments before age 70, that's easy to do (so long as I'm 59 1/2 years old when I do it).

My advice is to put all the numbers into a spreadsheet that goes out as far as possible (i.e., age 120, since that is the current maximum human life expectancy for people alive today) and then try various scenarios -- inflation rate, unexpected large expenses, investment CAGRs, and so forth and see how your model behaves under various life situations.  If you feel confident your money will last longer than you will under a variety of scenarios, go for it and retire now.  Otherwise, start developing back-up plans in case your projections leave you with little wiggle room should some of the tighter situations (i.e., high inflation, low CAGRs) develop in the years ahead.

I use an inflation rate of 3%, a taxable investment CAGR of 5%, and a tax-advantaged CAGR of 7% for planning purposes.

 

[nun]

In writing my question I figured out my answer, that's what's good about writing things down - it often clears the mind, and also thanks to Galeno's CD ladder

What I'll do in the 10 years of ER without direct access to my tax deferred investments is this.

First I'll sell my house and use some of the equity to buy a smaller place outright to remove the need to pay a mortgage. Then I'll put 6 years of living expenses from my after tax savings into a ladder of fixed income stuff. As my current expenses, excluding mortgage, are about $25k/year I'll put

$50k in a MM,
$50k in a 2 year CD with 1 year to go
$50k in a 2 year CD with 2 years to go

The rest of my after tax money (around $150k) I'll put in a couple of index funds, US and international and maybe some in a REIT fund. I'm assuming 3% return on the FI and 7% on the stocks

Next I'll allocate my tax deferred investments so that the asset allocation of my entire portfolio, taxed and tax deferred, is 25% fixed income and 75% stock funds.

At the end of the year I'll calculate 4% of the value of my total stock portfolio, sell that amount form my after tax stock funds and buy a 2y CD. I'll let half of the maturing 2y CDs go to MMF and I'll buy another 2y CD with the other half. I'll then divide the entire FI balance by 72 and that's my monthly draw for the year. I anticipate 4% of my stock portfolio will be a little more than my annual $25k expenses.

Selling 4% of my after tax stock investments will eat into my principal, but a quick speadsheet calculation, assuming 3% inflation and 15% tax, shows that they won't run out before I reach 59 1/2 and I'll still have the 6 years income in the fixed income. Then I can start using the tax deferred investments to replenish the FI investments.

What do you think, am I on the right lines?

 

[youbet]

nun,

The only thing you said that made me a little neverous was that you're assuming a steady 7% return on your equities. While, IMHO, 7% is a good swag for average equity returns over time, I'd assume large year to year variations. Go back and run your spread sheet with huge equity losses the first two or three years, followed by nice gains for a few years, then big loses again, etc. Be sure to begin with large loses. Plug numbers in so that the average annual return is about your 7% number.

Having large variation in returns over time is more likely to occur than every year being close to 7%. And the timing of the ups and downs can have a surprisingly large impact on the sustainability of your portfolio.

 

[nun]

nun,

The only thing you said that made me a little neverous was that you're assuming a steady 7% return on your equities. While, IMHO, 7% is a good swag for average equity returns over time, I'd assume large year to year variations. Go back and run your spread sheet with huge equity losses the first two or three years, followed by nice gains for a few years, then big loses again, etc. Be sure to begin with large loses. Plug numbers in so that the average annual return is about your 7% number.

Having large variation in returns over time is more likely to occur than every year being close to 7%. And the timing of the ups and downs can have a surprisingly large impact on the sustainability of your portfolio.

Good point, in the years with stock gains below those of the FI portion of my portfolio I wouldn't sell the stocks, I'd just spend more of the FI money. That way I can ride out down years. Of course I hope that I have my math right and the courage to see my after tax savings going down without that ability to top them up before 59 1/2