Pre-Retirement Then Post-Retirement Income Transition Planning

[LongTerm]

I'm planning on retiring at 58. I'm 50 now. I have approximately 750K in taxable accounts (within that approximately 35% in a muni-bond fund and 65% in stocks with significant unrecognized capital gains). I have an additional 1.3M in tax advantage accounts with 97% in a 401K and 3% in a Roth IRA with all of the funds in stock funds).

My income today is more than adequate and so my investment strategy up to now has been to try and concentrate on capital gains appreciation and avoid taxable income to try and reduce taxes as much as possible. According to Turbo Tax my 2013 effective federal tax rate was 20.92%. I live in Illinois so there's an additional income tax there of 8.98% on income over 64K.

My question to the ER community is how to best plan for the transition from pre-retirement income (MegaCorp) to beginning to live off of my investments when I do retire in 8 years.

It doesn't seem to be a wise move to retire and all at once shift my investment assets to income generating investments to fund all the fun I'm planning on having after I retire. I would be forced to recognize significant capital gains. On the other hand, the last thing I want to do now is move money into income generating investments so that income will be readily available then. With the bulk of my investments in accounts I can't touch till I'm 59 1/2, I'm thinking it is a lot better now to be have a plan laid out than to be surprised on 4/15/2022.

I recognize that this is a nice problem to have.... but I'm not exactly sure of all the factors I should be considering. I'd appreciate if folks could give me some ideas of things I should be thinking about.

Thanks

 

[aim-high]

A relative newbie and not yet ER'd, but I'll take a shot at answering.

It seems the general idea here is to invest for Total Return according to your asset allocation and then harvest cash for the next year during rebalancing. I don't think most people here try to invest specifically for income but according to their individual risk tolerance and asset allocation comfort level.

 

[pb4uski]

+1 with aim-high. It seems like you think that there should be a big shift in your asset allocation once you retire and I don't think that is necessary. However, your current AA of 87/13 is a bit aggressive for your age. What I would suggest is targeting contributions in you tax-deferred accounts to fixed income (especially if your employer offers a stable-value fund that pays a decent return) and the new money will gradually reduce the overall equity exposure you currently have without any tax cost.

My AA didn't change at all when I retired. I was mostly equities until my mid to late 40s and then began buying fixed income with new money until I ultimately reached my overall desired AA 60/40 in my case). I'm still 60/40 as I am quite comfortable with equities and they act as an inflation hedge.

If your income in retirement is within the 15% tax bracket, qualified dividends and LTCG are tax-free.

The real question is given you have over $2m available, why wait until 2022?

 

[heeyy_joe]

You will need a big chunk of cash to fund PPACA premiums from age 58 to 65. Good to plan now.

 

[MBAustin]

One of the things we did a few years before ER was to stop reinvesting dividends and capital gains and instead depositing them into a short-term municipal bond fund (to avoid additional taxes) which then became the initial "bucket" for covering our expenses. (I know there is a lot of disagreement about the "bucket" method but it works for us to minimize stress about cashing out equities at the "wrong" time.)

 

[LongTerm]

You will need a big chunk of cash to fund PPACA premiums from age 58 to 65. Good to plan now.

We are maxing out our HSA but it is in a MegaCorp plan that is very conservative. Plus I believe it can't be used for insurance premiums.

Part of my reason for the question is the realization of how much we will need to meet our expenses. Especially 58 to 59 1/2.



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[pb4uski]

You will need a big chunk of cash to fund PPACA premiums from age 58 to 65. Good to plan now.

My employer COBRA was ~$900 a month for two of us. Since I retired my health insurance costs have ranged from $425 a month to $683 a month for two of us and are $425 a month today.

I'm not sure if I would consider $36-$57k for 7 years of health insurance to be a "big" chunk of cash in the whole scheme of things.

 

[dtbach]

I'm with pb4uski on his suggestion. Just start buying more bond/stable value in the next 8 years to bring your AA to something less aggressive. You may need 30-35 years of income so don't get too conservative. Many on this board keep about 3 years worth of expenses in cash or short-term notes. That way you can go through bear markets without having to sell equities when they are down.

 

[Options]

Pretty aggressive AA for a portfolio that's already won the game. Perhaps take some chips off the table to reduce sequence of returns risk during initial years of retirement? Pfau, Kitces, Bernstein, Otar, others all argue against an aggressively high equity allocation as you near the PF distribution phase.

 

[Senator]

Keep maxing out your 401K, and at 50, you can do an additional $5,500. $23K total. Do the same with your HSA. If you cannot afford to do that, you will likely not be able to retire when you want. Start living on less.

Having said that, get investments that grow relatively tax free for now in your after-tax accounts. Minimize taxes and maximize savings. You can sell stocks when you are not working and have a lower income, yet it may be what you are used to after maxing out savings accounts.

I am 54, I have quite a bit of cash (25%), and mostly S&P stuff. I also have quite a bit of rental property. I am continuing to buy S&P, and stay in the market for the foreseeable future, for many reasons. When I need the cash, I will sell what I need.

 

[rayinpenn]

Pretty aggressive AA for a portfolio that's already won the game. Perhaps take some chips off the table to reduce sequence of returns risk during initial years of retirement? Pfau, Kitces, Bernstein, Otar, others all argue against an aggressively high equity allocation as you near the PF distribution phase.

Allow me To offer an alternative view point. At 50 you could Easily live another 30 years that is a lot of time for inflation to damage the after inflation fixed income component of your portfolio. Too many people worry about the variability of the portfolio value where their focus should always be on the variability and growth of the income of the portfolio. Yield should be your focus!

A simple example the REIT IDV pays a 4.5% dividend lets say you have a cool million and a half at retirement. Your dividend income is $67'500 (nice tax rate in that too) coupled with you social security you are all set. 10 years later inflation rears its ugly head and your cost of living is 80k ... But guess what your dividends have risen as well and you are doing just fine.. Had you locked that money up in fixed income vehicles you would be in trouble...

My example though simplistic is to point out I do not agree with that maxim your age in stock...I have lived long enough to have seen a 100% diversified equity retirement (yeah prices varied but the income stream did not)

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[pb4uski]

To be fair though rayinpenn, the discussion was for the OP to transition from 87/13 AA at age 50 to something like 60/40 at age 58 by investing new money in fixed income and letting the equities ride.

While you are comfortable with 100% equities in retirement, you are unusual and a small minority of ERs would be comfortable with an equity allocation of 80% or more and would prefer the portfolio stability offered by a significant portion invested in fixed income.

 

[tinlizzy]

I'm with pb4uski on his suggestion. Just start buying more bond/stable value in the next 8 years to bring your AA to something less aggressive. You may need 30-35 years of income so don't get too conservative. Many on this board keep about 3 years worth of expenses in cash or short-term notes. That way you can go through bear markets without having to sell equities when they are down.

But if you keep that much in cash/short term notes to avoid a sale when equities are down, you would miss a 30% run up like last year, so wouldn't it just be a wash.


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[LongTerm]

To be fair though rayinpenn, the discussion was for the OP to transition from 87/13 AA at age 50 to something like 60/40 at age 58 by investing new money in fixed income and letting the equities ride.

While you are comfortable with 100% equities in retirement, you are unusual and a small minority of ERs would be comfortable with an equity allocation of 80% or more and would prefer the portfolio stability offered by a significant portion invested in fixed income.

I started the discussion due to lack of clarity on my part of how to most efficiently begin taking money out of my investment portfolio. I've spent all these years trying to figure out ways to get the most into it... I've not thought enough about the best ways to get money back out

I am trying to plan how to maximize my Total Return by extracting money from a combination of Taxable and Non-Taxable assets that have different implications to taxes (dividends, interest, capital gains). Although I recognize my AA is aggressive now, that is actually intentional. What I'm trying to figure out, is what factors I should consider in changing my AA that would improve my Total Return.

I completely max out the available Tax Advantage investments I (and my wife's) can contribute to (401Ks with the 50+ catchup additional limit, backdoor Roth IRAs, HSA). I also invest in a ESPP for MegaCorp stock and flip that pretty consistently once I've held the stock for more than a year to get LT cap gains.

But I'm very leery about holding much in Fixed Income. Bonds don't sit with me well.... I'd rather own the companies themselves, rather than the paper the companies are using to grow... and I absolutely do not want more taxable income if I can avoid it to reduce my tax burden now. My consension to fixed income is my municipal bond fund, but that's lost about 5K in value due to slightly increasing interest rates. I expect the fund to drop 10% in value for every 1% of interest that municipalities are issuing their bonds at. With these artificially low rates, sooner or later, rates will rise and holding bonds of any kind will see significant discounts. In other words...

I'm a conflicted investor..that's for sure.

 

[dtbach]

But if you keep that much in cash/short term notes to avoid a sale when equities are down, you would miss a 30% run up like last year, so wouldn't it just be a wash.


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But keeping some "powder dry" so to speak, can work great in your favor when there is a sharp downturn. That is when you can pick up some awesome deals when stocks are "on sale".

 

[rayinpenn]

But if you keep that much in cash/short term notes to avoid a sale when equities are down, you would miss a 30% run up like last year, so wouldn't it just be a wash.


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1. I do not care about day to day prices. Trying to time the market is a fools game if the pros can't consistently do it how can you do it?
2. Since I am in reinvestment mode any dip in prices is just an opportunity to buy more cheaply.


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[pb4uski]

....I'm very leery about holding much in Fixed Income. Bonds don't sit with me well.... I'd rather own the companies themselves, rather than the paper the companies are using to grow... and I absolutely do not want more taxable income if I can avoid it to reduce my tax burden now. My consension to fixed income is my municipal bond fund, but that's lost about 5K in value due to slightly increasing interest rates. I expect the fund to drop 10% in value for every 1% of interest that municipalities are issuing their bonds at. With these artificially low rates, sooner or later, rates will rise and holding bonds of any kind will see significant discounts. In other words...

I'm a conflicted investor..that's for sure.

Putting interest rate risk aside for a moment, the role of fixed income in a portfolio is to provide some stability and reduce the volatility of the portfolio. If you don't mind volatility, then you can ave a higher equity allocation.

Interest rate risk can be addressed through use of stable value funds and CDs, lower duration bond funds and to a lesser extent fixed maturity bond funds or individual bonds.

What you seem to be more focused on is tax efficiency and how to structure withdrawals to minimize taxes. If you retire at 58, you'll have up to 12 years to do Roth conversions at low tax rates to reduce taxes once SS starts.

I'm in a somewhat similar situation to you. I retired at 56 and at that time had about 40% of our retirement in taxable accounts that were mostly equities and 57% in tax-deferred accounts. Since we keep within the 15% tax bracket (~$94k in total income in our case) our qualified dividends and LTCG are tax-free.

Our first year I took a bunch of LTCG and paid 0% tax. From here on we are now doing substantial annual Roth conversions and only paid 7% federal on last year's conversions. I suspect that we'll chip away with annual Roth conversions each year and slowly reduce our taxable and tax-deferred balances and increase our tax-free accounts between now and when we turn 70.

 

[nun]

I'm 52 and 6 months into ER. I approached income generation by simply moving $100k from equities into a stable value fund so that I wouldn't be forced I sell in a market down turn. So far I've just been spending money from my bank account and I will top it up in another 6 months from whatever investments have done well over the last year or from the stable value fund if things have tanked.

I'm also gong to be buying into my state's DB pension plan and maybe single premium fixed annuity might work to provide some retirement income for the OP.

 

[rayinpenn]

Our OP has 2.1 million today, more then enough for most people to retire very comfortably today. In eight years 3.5 million?

1. A diversified portfolio yielding 3.5% on 2.1 million would be $73,500 annually with a low tax rate to boot. No social security withholding, no other corporate reductions just fed & state tax.
2. 1.3 million of it is in a 401k so he can buy and sell that without taxable consequences
3. Annuities are way too inefficient and costly ...

He/she can use all earnings over the next 8 years to buy equities to increase his AA in equities

As others have suggested I plan on keeping 3 years spending in short term bond funds. My thinking is even the worse downturn should come back in three years.


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[nun]

3. Annuities are way too inefficient and costly ...

Not all annuities are the same. An quality SPIA might be appropriate for a portion of the OPs income needs.

 

[antsinfla]

Your early retirement

Perhaps your biggest long term concern for the future will that of inflation and taxation. I would suggest you take a look at indexed universal life (IUL) as a part of your overall asset allocation as well as your retirement and income plan. This will provide for (amongst other benefits) tax free income during your retirement years, as opposed to the taxable income you will receive from your tax-advantaged (deferred) accounts.

Congratulations to you and your wife for achieving what you have so far toward your financial independence

 

[nun]

Perhaps your biggest long term concern for the future will that of inflation and taxation. I would suggest you take a look at indexed universal life (IUL) as a part of your overall asset allocation as well as your retirement and income plan. This will provide for (amongst other benefits) tax free income during your retirement years, as opposed to the taxable income you will receive from your tax-advantaged (deferred) accounts.

Congratulations to you and your wife for achieving what you have so far toward your financial independence

Why would the OP need any sort of life insurance policy? Far better to avoid all the fees and manage his own accounts. If he wants some guaranteed income an SPIA might be appropriate.

 

[WannabeRetired]

I probably shouldn't jump to this conclusion so quickly, but that post by "antsinfla" felt like an advertisement for whole life insurance policies.

 

[MichaelB]

I probably shouldn't jump to this conclusion so quickly, but that post by "antsinfla" felt like an advertisement for whole life insurance policies.

You know what they say about first impressions ...

 

[antsinfla]

Yes a SPIA may be appropriate as part of his retirement income strategy in the future when interest rates are higher. The income from a SPIA is mostly tax free as it is a largely return of principal.

The life insurance aspect of the IUL (if priced accordingly) is secondary to the fact that this is both a tax deferred (after tax contributions) and a tax free income retirement vehicle.

The average expense ratio for a well priced IUL would average less than 1% over a 20 year period (a declining scale) - compare this to the average equity mutual fund at 3.2%.

That said, if he is so inclined toward "avoiding all fees" to the risk management part of his portfolio - by all means. For the "safe money' I would look to transfer the risk to those who manage risk for a living.