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Appreciation vs income
Old 06-28-2007, 12:10 PM   #1
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Appreciation vs income

OK,I'm 47, the house is paid off and I have $1M saved, $400k in after tax and $600k in tax deferred accounts. Up to now I've been 80% in index stock funds (S&P, international, and midcap). I need $30k/year to be comfortable and I want to start taking out some income.

Any ideas as to how to do this, I'm a complete novice when it comes to income vehicles.
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Old 06-28-2007, 12:12 PM   #2
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I don't have any advice. Just want to say congratulations, great job!
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Old 06-28-2007, 01:18 PM   #3
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Originally Posted by nun View Post
OK,I'm 47, the house is paid off and I have $1M saved, $400k in after tax and $600k in tax deferred accounts. Up to now I've been 80% in index stock funds (S&P, international, and midcap). I need $30k/year to be comfortable and I want to start taking out some income.

Any ideas as to how to do this, I'm a complete novice when it comes to income vehicles.
the 400k in taxable accounts- what is it invested in? Are you married or single? Is there any other income?

What income has the 400k generated the last two years (gross amount)?

My suggestion would be to use the capital gains and dividends on the 400k to generate as much of the 30k as possible each year.

Then either use 72T to tap into tax favored accounts, or sell a portion of the 400k to generate the 30k.

The cap off tax bracket by converting tax favored account to a Roth.

If you are single this means transfering to an income of 31850 per year (capping out 15% bracket).

If you are married filing jointly, this means transferring an income of 63700 per year (capping out 15% bracket).
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Old 06-28-2007, 01:38 PM   #4
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Don't worry about generating income. Simply sell enough of your total assets to result in 30K after taxes. Take it from whichever asset classes appreciated the most during the year.

You might decide to reduce the stock percentage of your portfolio simply to reduce the volatility, but that's only to sleep better at night.

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Old 06-28-2007, 01:59 PM   #5
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the 400k in taxable accounts- what is it invested in? Are you married or single? Is there any other income?

What income has the 400k generated the last two years (gross amount)?

My suggestion would be to use the capital gains and dividends on the 400k to generate as much of the 30k as possible each year.

Then either use 72T to tap into tax favored accounts, or sell a portion of the 400k to generate the 30k.

The cap off tax bracket by converting tax favored account to a Roth.

If you are single this means transfering to an income of 31850 per year (capping out 15% bracket).

If you are married filing jointly, this means transferring an income of 63700 per year (capping out 15% bracket).
The after tax is invested in the same was as the tax deferred 80% stock index funds, the rest in REIT, Bond Index and a bit in MM.

I'm single and there's no other income, the income/earnings and divs last year from the after tax money was 3% or $12k

I'd already decided to do a ROTH rollover up to the 10 or 15% income limit as my taxable income might end up being quite low
after deductions and if I sell some after tax investments to get me up to by $30k budget requirement.

I feel a bit worried about having so much in equities if I'm not getting a wage so what are good options, I've seen Wellesley mentioned is that worth looking at?
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Old 06-28-2007, 02:18 PM   #6
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I'm single and there's no other income, the income/earnings and divs last year from the after tax money was 3% or $12k
If I remember correctly, the average CPI for the last 12 months ending in May 2007 was around 2.5%.
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Old 06-28-2007, 02:21 PM   #7
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if you drain dividends and capital gains, then sell off equities in taxable accounts, you will see your bond percentage raise gradually without any other transactions.

I might suggest opening a money market, direct all dividends and capital gains to that. Then put 216k into one IRA (and the balance of 384k into another). The 216k should be invested in something without much equity exposure, then 72T the 216k. Let the 384k grow until you hit 59.5. Convert portions of this to a Roth as appropriate.

This should do the following:

18k would be taxable at ordinary rates. Standard exemptions may allow the net tax rate on this to be 0%. Or real close to 0%.

12k would be subject to low 5% tax rates (if income above is at 0%, I believe capital gains and dividends are taxed at 5%).

The cap out whatever rate you are at (10% bracket) with a Roth conversion.
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Old 06-28-2007, 02:26 PM   #8
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If I remember correctly, the average CPI for the last 12 months ending in May 2007 was around 2.5%.
Yes I tried to edit my post as 2.5% is the number I finally calculated, but was past the 15 min limit
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Old 06-28-2007, 02:39 PM   #9
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Yes I tried to edit my post as 2.5% is the number I finally calculated, but was past the 15 min limit
nun, I think you misunderstood me. What I was trying to say was after taking inflation into account, your after tax investment is only returning 0.5% (3 - 2.5). But now with your new 2.5% number the return is 0%.
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And I would keep
Old 06-28-2007, 02:41 PM   #10
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And I would keep

(30k -12k)*n, where n is a few years, in MM so you only need to sell in up years.
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Old 06-28-2007, 03:19 PM   #11
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Yes I tried to edit my post as 2.5% is the number I finally calculated, but was past the 15 min limit


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nun, I think you misunderstood me. What I was trying to say was after taking inflation into account, your after tax investment is only returning 0.5% (3 - 2.5). But now with your new 2.5% number the return is 0%.
I am assuming the 3% or 2.5% you quoted here did not include the appreciation in your portfolio. If so, you are in good shape.
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Old 06-28-2007, 03:19 PM   #12
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nun:

People often assume they need to generate interest income off of their portfolio to accommodate their annual withdrawal needs, but that's the WORST way to do it:

1. Inflation will eat you alive!! You need your portfolio to grow (on average) 2.5% after taxes per year to beat inflation. If you have fixed income investments you aren't likely generate enough income to take your 3% plus plough 2.5% AFTER TAXES back into your portfolio.

2. Fixed income is by far the least tax efficient investment. This is really just an issue for taxable accounts.

Instead, you need to focus on total return, and take whatever dividends the portfolio throws off as well as realized some capital gains (very tax efficient) for annual withdrawal needs.

The portfolios that show high survivability over a long period of time after inflation with a 4% withdrawal have at least a 60% equity allocation. So obviously these portfolios are NOT relying on income generated/interest/dividends. And a higher equity allocation is more tax efficient as most of the capital appreciation is not taxed until you sell the asset/equity mutual fund.

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Old 06-28-2007, 03:31 PM   #13
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if you drain dividends and capital gains, then sell off equities in taxable accounts, you will see your bond percentage raise gradually without any other transactions.

I might suggest opening a money market, direct all dividends and capital gains to that. Then put 216k into one IRA (and the balance of 384k into another). The 216k should be invested in something without much equity exposure, then 72T the 216k. Let the 384k grow until you hit 59.5. Convert portions of this to a Roth as appropriate.

This should do the following:

18k would be taxable at ordinary rates. Standard exemptions may allow the net tax rate on this to be 0%. Or real close to 0%.

12k would be subject to low 5% tax rates (if income above is at 0%, I believe capital gains and dividends are taxed at 5%).

The cap out whatever rate you are at (10% bracket) with a Roth conversion.
Thanks this sounds like a good plan.

I already have a MM and I'll start depositing dividends and capital gains there from my after tax investments.

For the 72T would you recommend a Bond Index fund or something super conservative like a MM. Also do I really need to 72T, couldn't I just sell after tax investments and leave the tax defered to grow. That way maybe half of my
annual budget would be tax free and with deductions my taxable income would be even lower allowing me to roll more over to a ROTH
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Old 06-28-2007, 04:02 PM   #14
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I've just read my last quote and I think I'm departing from my original question a bit.

Maybe I should just reallocate taxed and tax deferred accounts to be 60/40 and keep them that way by periodic rebalancing.

I'll tansfer dividends and captial gains from the after tax to a MM.

I'll sell from the after tax accounts to make up the rest of my $30k budget and do ROTH rollovers up to the 15% tax limit.

Starting with $400k in after tax I should have sufficient to easily fund myself until 59.5 when I can start thinking about taking some out of the ROTH and IRAs
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Old 06-28-2007, 06:30 PM   #15
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You indicated your portfolio is 80% stock... I assume that other 20% is in some sort of fixed security or fixed security mutual fund (e.g., bonds, MM). You are using a 3% WR Rate. Did you run FireCalc? What did it say about survival? 20% of $1MM is $200k. 200k/30k = 6.67 (years) before you need to draw down on the stock funds (if the stock market is having problems).

My plan is to have at least 10 years of income in fixed instruments... I am using a 4% WR rate. I have a 60/30/10 (stock/bond/cash) allocation. That mix at FIRE of 55 is a mix that will help me to sleep ok. As we age, I will probably shift the allocation more to fixed a little at a time.
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Old 06-30-2007, 01:09 PM   #16
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if you drain dividends and capital gains, then sell off equities in taxable accounts, you will see your bond percentage raise gradually without any other transactions.

I might suggest opening a money market, direct all dividends and capital gains to that. Then put 216k into one IRA (and the balance of 384k into another). The 216k should be invested in something without much equity exposure, then 72T the 216k. Let the 384k grow until you hit 59.5. Convert portions of this to a Roth as appropriate.

This should do the following:

18k would be taxable at ordinary rates. Standard exemptions may allow the net tax rate on this to be 0%. Or real close to 0%.

12k would be subject to low 5% tax rates (if income above is at 0%, I believe capital gains and dividends are taxed at 5%).

The cap out whatever rate you are at (10% bracket) with a Roth conversion.
Thanks for the advice, but is doing a 72T really necessary or a good idea. I have $400k in after tax investments and I have 12 years until I'm 59.5. The $400k puts off $10k a year income/dividends and assuming something like a 6% annual return I can sell enough to make up the rest of my $30k annual budget without reducing my principal. My tax deferred investments can have more time to grow and I don't have the bother of doing a 72T. Also my taxable income should be pretty low and I'll be able to do some fairly cheap ROTH conversions up to the 10 or 15% income tax levels.
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Old 07-02-2007, 09:42 AM   #17
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Thanks for the advice, but is doing a 72T really necessary or a good idea. I have $400k in after tax investments and I have 12 years until I'm 59.5. The $400k puts off $10k a year income/dividends and assuming something like a 6% annual return I can sell enough to make up the rest of my $30k annual budget without reducing my principal. My tax deferred investments can have more time to grow and I don't have the bother of doing a 72T. Also my taxable income should be pretty low and I'll be able to do some fairly cheap ROTH conversions up to the 10 or 15% income tax levels.
The dividends come out more tax efficient than 72T withdraws. It is possible by doing a combination of dividends and 72T you will lower your overall tax bracket over your whole life.

If you cash out the taxable accounts first, you will have low taxes until age 59.5. Real low.

The withdraws from IRA type accounts at age 59.5 would then be taxed at much higher levels.

Combining the plans (72T+ dividends) you get to take advantage of the 0% tax bracket. Single filers can have 7800 of income, (tax bracket 10%), plus the single exemption (not sure what that is, but probably close to 5200 or 7000). So the exemption effectively makes tax bracket 0%, and you did not deplete your taxable accounts as much.

If you bump this up (31850 caps 15% bracket), you could withdraw around 12k in dividends, plus 18k from 72T, and be paying low taxes on most of the 18k. Then you could convert the difference of 18k and 31,850 to a Roth, and the amount you converterted would never get taxed again.

Based on current tax law at least.
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Old 07-02-2007, 11:58 AM   #18
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Rather than do a 72T, just convert the amount you'll need 5 years from now from the IRA to the Roth. Then you can remove it from the Roth if you need it 5 years after the conversion, tax and penalty free.

I think that this is a better plan than 72T's for anybody who has 5 years of expenses covered in their taxable account. For the first 5 years, live of your taxable while you move 1 years expense to your Roth each year. At the 5 year mark, you take your first years conversion and pull it out of the Roth Tax/Penalty free, and convert another year into your Roth:

So if you need 30K to live on for each year you would do:
1 -> take 30K out of taxable, convert 30K from IRA to Roth.
2 -> take 30K out of taxable, convert 30K from IRA to Roth.
..
5 -> take 30K out of taxable, convert 30K from IRA to Roth.
6 -> take 30K out of Roth, convert 30K from IRA to Roth.

I would bump the conversions of 30K to be the maximum you can convert to trigger the least amount of taxes. (stay in the lowest tax bracket). Using this method gives you all the benefits of a 72T, but then you don't lock yourself into a 72T.

The two downsides I've been able to find over doing this vs. 72T is that some states tax conversions, but not 72T's, and you are paying taxes 5 years before you use the money. But for 30K I doubt either of those will be a problem.

Now if you were doing a 72T vs. Roth conversion for 120K or more, then it might pay to research that issue more.

Laters,
-d.
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Old 07-02-2007, 11:59 AM   #19
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The dividends come out more tax efficient than 72T withdraws. It is possible by doing a combination of dividends and 72T you will lower your overall tax bracket over your whole life.

If you cash out the taxable accounts first, you will have low taxes until age 59.5. Real low.

The withdraws from IRA type accounts at age 59.5 would then be taxed at much higher levels.

Combining the plans (72T+ dividends) you get to take advantage of the 0% tax bracket. Single filers can have 7800 of income, (tax bracket 10%), plus the single exemption (not sure what that is, but probably close to 5200 or 7000). So the exemption effectively makes tax bracket 0%, and you did not deplete your taxable accounts as much.

If you bump this up (31850 caps 15% bracket), you could withdraw around 12k in dividends, plus 18k from 72T, and be paying low taxes on most of the 18k. Then you could convert the difference of 18k and 31,850 to a Roth, and the amount you converterted would never get taxed again.

Based on current tax law at least.
One question. If I went the 72T route I thought I'd have to include all my IRA money in it, can you 72T a fraction of your IRA?

Also if I don't do the 72T and use my after tax accounts the tax deferred money with have 12 years to compound and I'll probably still only be in the 15% tax bracket when I start taking out my IRA money. I think I need to do a spreadsheet to figure this out
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Old 07-02-2007, 03:57 PM   #20
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One question. If I went the 72T route I thought I'd have to include all my IRA money in it, can you 72T a fraction of your IRA?
You can't. However, you can split a large IRA into multiple smaller IRA's and then do a 72T from one of the smaller IRA's, which is very nearly the same thing.

If you want to get fancy, you can even do multiple 72T's with different parameters from multiple IRA's as long as each 72T series of withdrawals comes from a unique IRA or set of IRA's and you don't switch your withdrawals mid-stream.

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