Best Way to Cover Essential Expenses During ER

[Trooper]

Hi...looking for some advice here.

DW and are planning to retire in one year from now. I will be 57 and DW will be 56. Through an arrangement with my employer we are entitled to no-cost financial planning advice from Fidelity. Prior to the meeting I loaded all our financial info (expenses, assets, SS amounts, etc) into their RIP. In that process I indicated which expenses were essential and which were discretionary.

Overall the RIP says we are good until age 93. However, the model also compares essential expenses with fixed sources of income like pensions and SS. Because we are taking SS at aged 67, the model shows we have a gap between guaranteed income and essential expenses of about $4500 month until SS kicks in.

Fidelity's adviser suggests that we buy an 8-year period certain annuity for about $395K that would throw off the $4500 to cover our essential expenses. How do we evaluate whether that is the right thing to do, whether that is a fair quote for the annuity? DW is fairly risk averse. What other investment options are out there that will accomplish the same goal?

Thanks...

 

[LOL!]

8 years of 4% sustained withdrawal is simply 32% of a portfolio. So why not have 32% of the portfolio in fixed income mixed between short-term bond funds and intermediate-term bond funds? If you feel these bond funds might drop 10%, then add in an extra 10% contingency, so say rounded off to 35% fixed income for your portfolio.

Oh, wait, a 65:35 asset allocation is in the very typical range for early retirees. It seems you probably already have settled on a similar asset allocation and thus do not need to do anything special --- except don't buy an annuity while you are so young.

 

[Animorph]

If the annuity returns better value over the 8 years than an online savings bank or a bond fund or a CD ladder, then it may well be a nice place to put some of your fixed income allocation. Keeping in mind that it is returning mostly just your original principal.

I've been happy to go with the larger withdrawal rate from my normal portfolio to cover those pre-SS years. There is no need to convert assets into "income". Those 8 years will be very much like the next 30 years after that, it's just that your withdrawal rate will be a little higher. On the other hand, these are the critical years for the portfolio, so you may want to stay a little conservative.

In my case, I sell for cash whenever the portfolio reaches my start of year value for coming years. I currently have 2 to 3 years of expenses in cash, depending on how the unexpected expenses run. If the market drops and my cash runs out I'll start selling for cash month to month.

 

[Independent]

Give a similar situation, we put the money into laddered CDs and I-bonds.

I'd check prices on them (recognizing that the I-bonds are CPI-indexed) and compare.

I'm more comfortable with FICA-insured CDs and gov't issued bonds then insurance company annuities.

Some people here would say that you can cover the later years (e.g. 8, 9, and 10) with stocks. That is a little higher on the risk/reward spectrum.

 

[fosterscik]

A quick calculation shows they are offering you an effective annual interest rate on your initial investment of a little less than 3% and then spending down your principle. If you can set up a bond ladder with better terms then you should do that. If safety is paramount (and you trust the solvency of the annuity insurance company) then 3% guaranteed is not terrible in today's interest environment. Given the likely hood that rates will (eventually) rise you should wait as late as possible to commit the funds if you decide to go the annuity route.

 

[brewer12345]

You are talking about essentially a fixed income vehicle, not an insurance risk transfer vehicle. That being the case, I would nix the annuity in favor of a fixed income ladder. There is no need to deal with the inflexibility and carrier risk posed by an insurance company annuity for an 8 year stretch.

 

[Katsmeow]

You could just withdraw more from the portfolio to cover that period of time rather than buy an annuity...

We had a somewhat analogous situation. We needed/need to cover several years of high expenses due to kids in college. Our spending would go way down after they are out. My biggest concern was not wanting to have to sell equities if there was a downturn and I didn't want to have to do so to cover the increased spending.

So I figured out how much more than 4% withdrawal we would need to spend each of the next 3 years. I then set aside that money in a short-term bond fund apart of the regular asset allocation.

 

[Trooper]

You are talking about essentially a fixed income vehicle, not an insurance risk transfer vehicle. That being the case, I would nix the annuity in favor of a fixed income ladder. There is no need to deal with the inflexibility and carrier risk posed by an insurance company annuity for an 8 year stretch.

Thanks Brewer...and thanks to the other respondents as well.
Is your comment because I'm not looking to mitigate longevity risk, but instead principal stability risk?

 

[Options]

Starting 1/15, when I FIRE, I will be using Animorph's strategy as well. That is, taking higher withdrawals until delayed SS @70. As delayed SS is the equivalent of an annuity for me (paying, IIRC, the equivalent of 8%), I see no reason to take out another annuity to cover the gap years. The PF will handle that. For my tastes, I can't justify the high annuity fees, either.

 

[Trooper]

CD Ladder Construction in My Example

In my example the delta between guaranteed income and and essential spending was $4,500/month, or to keep it simple $50K/year.

How would I go about a CD ladder to provide $50K/year for 8 years? Here's my initial stab:

1) 1 year from now (at retirement), pull $200K from savings and purchase 4 $50K CDs, maturing in 1, 2, 3, 4 years from then.
2) At the same time purchase a $200K 5 year CD.
3) When each of the CDs in Step 1 matures, use for spending in that year.
4) When the 5 year CD matures, use $50K for spending in that year, and for the remainder repeat the ladder as in Step 1

Am I close?

 

[brewer12345]

Thanks Brewer...and thanks to the other respondents as well.
Is your comment because I'm not looking to mitigate longevity risk, but instead principal stability risk?

You have it right. I think that a ladder of CDs, bonds or bullet bond funds will do the same thing without giving you one big exposure to a counterparty that you have no way to evaluate and does not have FDIC backing.

 

[brewer12345]

In my example the delta between guaranteed income and and essential spending was $4,500/month, or to keep it simple $50K/year.

How would I go about a CD ladder to provide $50K/year for 8 years? Here's my initial stab:

1) 1 year from now (at retirement), pull $200K from savings and purchase 4 $50K CDs, maturing in 1, 2, 3, 4 years from then.
2) At the same time purchase a $200K 5 year CD.
3) When each of the CDs in Step 1 matures, use for spending in that year.
4) When the 5 year CD matures, use $50K for spending in that year, and for the remainder repeat the ladder as in Step 1

Am I close?

You got it. As an extra plus, if you pick CDs with modest early surrender penalties you can always trade them in for new ones if rates ever rise.

 

[RetireAge50]

I would keep it simple and go with something like Wellington and/or Wellesley. Would not bother with CD's or annuities.

 

[Trooper]

I would keep it simple and go with something like Wellington and/or Wellesley. Would not bother with CD's or annuities.

Thanks Retire, but even Wellesley is still nearly 40% equities. In our opinion too high to be considered for funding essential expenses, but we're all different

 

[pb4uski]

I don't see an annuity paying 2.3% interest rate as being a great solution for you (for your FA, perhaps, but not for you).

+1 with Ha. Unless the $395k or so needed to fund this gap period is all or a high percentage of your total retirement savings, I would just invest my retirement savings in a balanced portfolio and schedule automatic withdrawals for $4,500 a month to cover the gap. You saved the money for your retirement, now you are using it for your retirement. Nothing wrong with that.

If for some reason you decide that you have some assets whose cash flows match those gap amounts, you could use CDs, target maturity bond funds, or even zero coupon bonds.

 

[Cat-tirement]

When I retire next month, DW will continue working for a while. Her income would cover essential expenses, except we plan for her to continue making max contributions to her 401k. To cover the gap while she's working, and then after she retires, I plan to use a combination of:

• After tax savings
• Sell some well appreciated stock, taxed at the 0% LTCG rate
• Since we will both be retiring in the years we each turn 55, we can take 401k distributions even before 59.5
• Funds from selling our house to move to our waiting retirement house, which we can access earlier if needed through a recent HELOC
• I have a pension that starts at 60 and DW has one that starts at 65, each one will cover about a quarter of essential expenses

This will cover us until SS at 70.5 (unless future analysis shows us better off taking SS earlier). I see no need for an annuity in our case.

 

[Katsmeow]

When I retire next month, DW will continue working for a while. Her income would cover essential expenses, except we plan for her to continue making max contributions to her 401k. To cover the gap while she's working, and then after she retires, I plan to use a combination of:

• After tax savings
• Sell some well appreciated stock, taxed at the 0% LTCG rate
• Since we will both be retiring in the years we each turn 55, we can take 401k distributions even before 59.5
• Funds from selling our house to move to our waiting retirement house, which we can access earlier if needed through a recent HELOC
• I have a pension that starts at 60 and DW has one that starts at 65, each one will cover about a quarter of essential expenses

This will cover us until SS at 70.5 (unless future analysis shows us better off taking SS earlier). I see no need for an annuity in our case.

Won't one of you take Spousal SS at FRA?

 

[gayl]

You could just withdraw more from the portfolio to cover that period of time rather than buy an annuity...

We had a somewhat analogous situation. We needed/need to cover several years of high expenses due to kids in college. Our spending would go way down after they are out. My biggest concern was not wanting to have to sell equities if there was a downturn and I didn't want to have to do so to cover the increased spending.

So I figured out how much more than 4% withdrawal we would need to spend each of the next 3 years. I then set aside that money in a short-term bond fund apart of the regular asset allocation.

Thanks Brewer...and thanks to the other respondents as well.
Is your comment because I'm not looking to mitigate longevity risk, but instead principal stability risk?

Also if you don't go with the annuity the nice salesman won't get his commission


Sent from my SAMSUNG-SGH-I537 using Early Retirement Forum mobile app

 

[Trooper]

I don't see an annuity paying 2.3% interest rate as being a great solution for you.

Can I ask how you arrived at the 2.3% interest figure? That's one of the things I don't like about SPIAs...it's hard to get a true ROR that doesn't include return of my own money.

 

[eta2020]

We are facing same issue first 10 years of retirement. That is we can not access 401ks, IRAs and SSs. Those 3 things slowly kick in one after another.

We will only have access to dividend yield of brokerage account. Now I am always fully in equities but now in final working years I will for first time invest in something else then equities.

That is create CD ladder that we will use up first 10 years of retirement to supplement dividend yield of brokerage account. This also allows me to keep all equity funds as they are right now which on long run is a better deal IMO.

 

[scrabbler1]

We are facing same issue first 10 years of retirement. That is we can not access 401ks, IRAs and SSs. Those 3 things slowly kick in one after another.

We will only have access to dividend yield of brokerage account........

This is why I describe those 3 items as my "reinforcements" which I can begin tapping into, in an unfettered manner, when I turn ~59.5, or about 8 years from now and 14 years from when I first ERed back in 2008.

For now, I use most of the monthly dividends from my taxable accounts, reinvesting the rest as well as any cap gain distributions.

 

[pb4uski]

Can I ask how you arrived at the 2.3% interest figure? That's one of the things I don't like about SPIAs...it's hard to get a true ROR that doesn't include return of my own money.

Sure. It is just the internal rate of return implicit in a $395,000 cash outflow followed by 96 $4,500 cash inflows.

I used the RATE function in Excel assuming an 8 year (96 month term), a $4500 per month payment and a $395,000 cash outflow (negative pv). That gives you the monthly interest rate I'll term "mi" which is 0.188%. Then you need to annualize it by taking [(1+mi)^12]-1 which gives you 2.27% and I rounded it up to 2.3%.

However an easier version is to calculate the interest over the 8 years as ($4,500*96 months) - the $395,000 premium paid or $37,000 and divide it by 8 years to get an average interest of $4,625 a year and then divide it by the average principal outstanding (half of the $395,000), which gets you 2.34% which is close enough.

IOW, of the $432,000 you receive over the 8 years, $395,000 is just a return of your principal and the rest is interest on your outstanding principal balance just as if you loaned the $395,000 to the insurance company for 2.27% interest with an 8 year fixed payment schedule (like an 8 year mortgage).

This approach should work for all period certain SPIAs (with no life contingent features).

 

[Trooper]

Thanks pb4uski...i actually understand that!

So if I am comparing between a CD ladder and this SPIA I would need a ladder that generates a > 2.3% ROR. Note that I'm excluding insurance company risk for purposes of evaluation.
Is it possible in today's interest rate environment to generate 2.3% or better using a CD ladder as structured in my previous reply?

 

[pb4uski]

Well, the first and more relevant question is whether it is really necessary to finance your first eight years that way and while in most cases I don't think so, but let's say you insisted on it.

Even an online savings account would pay 1% and would be about as risk free as you can get and have ready access to your funds so if you do explore a CD ladder, substitute online savings accounts until the CD rate exceeds the online savings account rate.

I think it would be challenging to do with a CD ladder with today's rates, but that really isn't a fair comparison since CD rates have no credit risk since they are FDIC insured but you could probably get pretty close (a little less than 2% in my estimation).

See https://personal.vanguard.com/us/funds/bonds/bonddesk

You could probably construct a high quality corporate bond portfolio that would earn close to 2.3% and give you much more flexibility albeit with some work (at least for your broker). The thing I don't like about the SPIA is the loss of control and access to your $395,000 given the minimal benefit over other fixed income alternatives.

If it were me and I were determined to do a ladder I would use online savings accounts for the first two years and Guggenheim Bulletshares for the out years. The return would be a bit lower (about 2% on average) but I could get to my money anytime I wanted to. Or a high quality diversified corporate bond ladder through your broker.

Or put three years into an online savings account and the rest into Wellesley and redeem some Wellesley each year to replenish the online savings account with any gains and skip it in years that are a loss.

 

[GTFan]

We are facing same issue first 10 years of retirement. That is we can not access 401ks, IRAs and SSs. Those 3 things slowly kick in one after another.

Of course you can access your tax-deferred money without penalty, you just have to be willing to do 72(t) withdrawals for a min of 5 years. But I realize that you don't actually need to do this, it's more of an emergency backstop for you (and me).