Income strategy and tactics

[nun]

I'm 4 or 5 years from ER so I'm thinking about income strategies. I was thinking of taking 5 years of expenses and setting up a CD ladder that I'd replenish with dividends and capital gains in the good years. My question is should I set the ladder up in tax deferred or after tax accounts?

My inclination is to do it in the tax deferred accounts as that's where most of my bonds and other fixed investments are.

 

[LOL!]

Of course you should minimize your taxes which means keep your fixed income in a tax-sheltered account. Use tax-efficient investments in your taxable account.

Principles of Tax-Efficient Fund Placement - Bogleheads

 

[Telly]

I don't get it. How will establishing a CD ladder in a tax-deferred account help create income for a person who is ER'd and <<age 59.5?

 

[kaneohe]

Telly.....I'm sure LOL will have a better explanation but my impression is something like this: Put the income generating CDs in the tax-deferred side to defer the taxes as long as possible. Create income by selling capital assets in the taxable account which should have less tax liability
(capital gains rate). The objection may be that you have to sell when the market is down. Buy the equivalent or similar asset in the tax-deferred side ( from cash or similar assets) to maintain the equivalent position that can participate in up markets.

 

[CuppaJoe]

I don't get it. How will establishing a CD ladder in a tax-deferred account help create income for a person who is ER'd and <<age 59.5?

I don't get it, either. I'm ER'ed (age 63 now) and taking my 4% WD from an after tax CD/savings account, I'll do that until age 65 when I will get that additional tax exemption for being an even older geezer. At age 65, I'll re-think the tax issue. The interest on that CD/savings account isn't worth considering tax-wise, especially now since all my 5.37% CDs have rolled over into nothingness. My health insurance premiums, medical expenses and other deductions are high enough that I expect to pay minimal (if any) taxes this year.

Edit: I have only one year's expenses in that CD/savings account. About five more years may come from other after tax accounts, or a combo of taxable and after tax, depending on my tax situation.

 

[mathjak107]

Telly.....I'm sure LOL will have a better explanation but my impression is something like this: Put the income generating CDs in the tax-deferred side to defer the taxes as long as possible. Create income by selling capital assets in the taxable account which should have less tax liability
(capital gains rate). The objection may be that you have to sell when the market is down. Buy the equivalent or similar asset in the tax-deferred side ( from cash or similar assets) to maintain the equivalent position that can participate in up markets.

my highest priority accounts for not spending are those nice accounts with capital gains in my taxable account... why spend that money before other money?

that money is a gift from the tax gods,... that money gets a step up in basis if left over when you crap out. when thats passed on noooooooooooo taxes are ever paid no matter how much the gains..... to me thats golden and gets spent last along with roths.

my order is spend my taxable non capital gains stuff first, tira stuff next, then those nice capital gained stuff in the taxable account, roth last


just starting planning all this out and read ed slotts book and this is his order if your interested in passing wealth.

 

[LOL!]

kaneohe gave a good explanation. This is explained further in these white papers:
https://institutional.vanguard.com/iip/pdf/WP_TotalRet.pdf
http://www.vanguard.com/pdf/s556.pdf

And also at this link: Placing Cash Needs in a Tax-Advantaged Account - Bogleheads

mathjak's order of spending from Ed Slott is consistent with Optimal Retirement Calculator and Retirement Decision Support System . However, for tax efficiency if one can help it, one may not have any "taxable non-capital gains stuff" because you have all that in a tax-sheltered account. Some folks do not have enough space in tax-sheltered accounts to keep only tax efficient investments in taxable accounts though.

Anyways, it's a great idea to keep the CDs in a tax-deferred account even if under age 59.5 (or at any age).

 

[mathjak107]

.. i prefered to keep my contributions to the faster growing assets in the 401k and tira where i can convert them over to a roth once i get them .

i saw no point in low paying bonds and no paying money markets to be taking up money that could represent higher growing assets in my retirement money.

we have aabout 60% of our money outside of retirement plans mostley from the sale of a family real estate business and about 40% in tax defered....

about 1/2 the taxable account is in cash and the other 1/2 stock funds
.
we have everything figured as a whole and divided up already into ray lucias 3 bucket system

our portfolios have been slowly migrating the last few years from following fidelity insights growth model for decades as well as our own version of harry browns permanent portfolio concept into the more conservative fidelity insight capital preservation and income mix..
we are now 100% in that mix
both saw over 10% annual average growth over the last 20 years,

our goal is to eventually pass on the roths and pass on the capital gains stuff in the taxable. we are hoping to use little of those assets ...


we are still dwelling on the best structure here as we are retiring in about a year and a half... ill be 58 and marilyn 60.

 

[LOL!]

Do the <long-term> math. If your goal is not to spend your money and to pass it on, then you probably should be doing something different from someone who needs the money to live on and wants to minimize taxes for themselves.

Your plan works because you die. That's OK with me.

Another possibility is that you give away your money now. Why wait to die?

 

[mathjak107]

it hurts my hair!

because gains on cash and bonds are sooooooooooo low they arent really counting for much figuring the last few years

 

[LOL!]

And I suppose all those "gains" in stocks are really counting for much? With equities in taxable, we have gotten too much mileage out of tax-loss harvesting. We probably won't be paying cap gains taxes in our lifetimes. In essence, we have created tax-sheltered space where none existed before. You gotta love the tax code.

 

[mathjak107]

people look at ira and 401k money in a strange way. what i mean is because we are dollar cost averaging in over decades we have newer money and older money.... the older money we invested from the 80's is up as much as 1100 % since then .it was up as as much as 1300% before the drop.

the newer money i put in hasnt paid its dues yet. it still has years left to the point where market cycles let it grow too... im sure the money i contributed over the last decade will have lots of growth to it in another 5 years or so but it still needs time before i can really see what its doing.

if you just take the entire 401k and ira totals i have the growth looks puny, but most of that consists of newer money since i started maxing out my 401k the last few years so it dilutes the gains of the more mature money at this stage.


the newer money will have its day in the sun too but needs about 12-15 year cycles as well to guarantee those nice juicy gains, hopefully.


the other thing is people will buy google at 88 bucks, sell it at 300 and talk about how well they did with google even though it went on after that to 800.00. but if the same person bought it at 88 bucks, held it to 800 and it fell to 300 they would talk about how poorly they did in google. for some reason we all think our bench mark is always the high of something even though its like trying to catch market tops and bottoms something we can never do reliably


follow that thought? good now you can explain it to me ha ha ha

oooch my hair is hurting again

 

[mathjak107]

And I suppose all those "gains" in stocks are really counting for much? With equities in taxable, we have gotten too much mileage out of tax-loss harvesting. We probably won't be paying cap gains taxes in our lifetimes. In essence, we have created tax-sheltered space where none existed before. You gotta love the tax code.

i thought that also and we sold one of our investment co-ops in nyc this year so there goes all those carry overed losses....

 

[mathjak107]

Do the <long-term> math. If your goal is not to spend your money and to pass it on, then you probably should be doing something different from someone who needs the money to live on and wants to minimize taxes for themselves.

Your plan works because you die. That's OK with me.

Another possibility is that you give away your money now. Why wait to die?

bingo , thats why its so hard to figure out... if we structure for cutting out uncle sam as much as we can while alive its a different structure if we want to cut uncle sam out on the inheiratance side. i realized it when you said it. thats why its so confusing every time i run it thru my head.

 

[Spanky]

You gotta love the tax code.

The only tax code I love is zero income tax and zero tax on capital gains.

 

[mathjak107]

must be some secret code lol

 

[LOL!]

The only tax code I love is zero income tax and zero tax on capital gains.

It works for me as well. See, e.g.
Taking Advantage of the 0% Capital Gains Tax Rate - Retirement Watch - InvestorsInsight.com | Financial Intelligence, Advice & Research / Investment Strategies & Planning for Individual Investors.

But there is a lot of confusion and misunderstanding about the 0% tax rate.

...

The 0% tax rate is tricky. But there are many retirees who qualify for it, and they should review asset sale strategies.

 

[Dawg52]

Some folks do not have enough space in tax-sheltered accounts to keep only tax efficient investments in taxable accounts though.

Me in a nutshell.

And I suppose all those "gains" in stocks are really counting for much? With equities in taxable, we have gotten too much mileage out of tax-loss harvesting. We probably won't be paying cap gains taxes in our lifetimes

Ain't that the truth. Oh well......such is life.

 

[donheff]

Thanks Mathjack and LOL. I got my allocation into the right places to minimize taxes but I was about to head in a potentially wrong direction on withdrawals. DW went to part time a couple of years ago and will probably pull the plug in January so we will begin to draw down. I was planning to hit the taxable accounts first to minimize taxes. My pension is fully taxable so we will start out in a fairly high bracket - no 15% room for us. A ways down the road we would deplete taxable and end up hitting the tax deferred accounts 100% in any event. But I was assuming I should minimize taxes as long as I can. Now I need to go back and consider the inheritance implications which I wasn't considering. That was pretty dumb since we set up trusts and split assets to minimize estate tax. If things go well we hope to leave a large chunk to our kids. That will make up for the impact on them of the socialist policies I am always advocating around here

 

[donheff]

Well, maybe I was right all along. I looked at ORP and realized I read that once before. I think the concept, like other withdrawal strategies, essentially involves filling the 15% regular income brackets with income-taxable IRA money and filling out the balance with capital gains. Since the low brackets will be filled by my pension, hitting taxable accounts first and taking the CGs will minimize the early year withdrawals. That will protect more of our portfolio for longer allowing the funds additional time to grow. That increases the odds that the portfolio will last the duration in the event of a serious downturn. Still leaves less for the kids if the market performs well but better that than I take the risk. Besides, the more conservative approach better insures that we can keep both houses which will get a bump up for the kids

 

[kaneohe]

.. i prefered to keep my contributions to the faster growing assets in the 401k and tira where i can convert them over to a roth once i get them .

i saw no point in low paying bonds and no paying money markets to be taking up money that could represent higher growing assets in my retirement money.

our goal is to eventually pass on the roths and pass on the capital gains stuff in the taxable. we are hoping to use little of those assets ...

MJ107......until this yr, this was my idea too. I just learned from LOL here and the bogleheads that this might be backwards. I have never done a simulation to compare the after-tax consequences of each strategy. Have you? My positions are probably like yours since I haven't done anything....still thinking and learning.

I know that if you have an annuity, the after tax returns are very strongly affected by rates of return, time in annuity, and tax rates.....that calculation I have done......but I never combined that w/ an allocation of fixed income.

......and you are completely correct that my late-at-night (my excuse) explanation was not worded clearly.....I left out non-capital taxable assets which might come before capital, unless of course you had a tax loss to exploit. Since I do specific shares sales, I could pick shares w/ no or minimal gains if I didn't have losses.

 

[nun]

kaneohe gave a good explanation. This is explained further in these white papers:
https://institutional.vanguard.com/iip/pdf/WP_TotalRet.pdf
http://www.vanguard.com/pdf/s556.pdf

And also at this link: Placing Cash Needs in a Tax-Advantaged Account - Bogleheads

mathjak's order of spending from Ed Slott is consistent with Optimal Retirement Calculator and Retirement Decision Support System . However, for tax efficiency if one can help it, one may not have any "taxable non-capital gains stuff" because you have all that in a tax-sheltered account. Some folks do not have enough space in tax-sheltered accounts to keep only tax efficient investments in taxable accounts though.

Anyways, it's a great idea to keep the CDs in a tax-deferred account even if under age 59.5 (or at any age).

OP here. This is what i was thinking and here's some more info on my situation. I'm 48 and the mortgage will be paid off in 4 years time. I own a two family and get $2000/mth in rent from the place.

I have $200k in after tax accounts that is mostly index equity funds, and $400k in tax advantaged accounts that is a mix of index bond and equity funds. My total asset allocation is a fairly conservative 50/50.

As I get closer to ER my plan is to set up a 4 year CD ladder in my tax advantaged accounts with $80k. The $24k annual rent and an extra $20k will cover my expenses. The rent will put me in the 15% tax bracket so I'll get a reduced dividend and capital gains tax rate (if things stay the same). In good years I'll take $20k in dividends and gains from my after tax accounts. In bad years I'll buy use one CD to buy $20k of equities in my tax advantaged accounts and sell the equivalent equity funds in my after tax accounts.

Am I doing this right? Thoughts? comments?

 

[kaneohe]

In good years I'll take $20k in dividends and gains from my after tax accounts. In bad years I'll buy use one CD to buy $20k of equities in my tax advantaged accounts and sell the equivalent equity funds in my after tax accounts.

Am I doing this right? Thoughts? comments?

you may have meant this anyway but just to be sure I didn't lead you astray.....good yrs, 20K in divs & CG distributions and, if necessary, sale of assets (possibly selected to minimize gains)
.........bad yrs.........just be sure you don't violate wash sale rules.

 

[nun]

you may have meant this anyway but just to be sure I didn't lead you astray.....good yrs, 20K in divs & CG distributions and, if necessary, sale of assets (possibly selected to minimize gains)
.........bad yrs.........just be sure you don't violate wash sale rules.

Sure, I hope to be around $400k in after tax accounts when I ER so a good chunk of the $20k will come from distributions, but I'll have to realize some gains by selling too. The whole wash deal is a pain, but if I have to sell an S&P index fund I'll either wait a couple of months before I buy it again or buy something like an international index fund to avoid the "substantially identical" issue.

 

[LOL!]

The wash sale rules only come into play if you sell at a loss, so after this year, you probably won't have many losses. Also it is pretty easy to find a similar, but not substantially identical, replacement fund. For example, sell S&P500 fund and buy Vanguard LargeCapIndex fund.