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Put What Money Where, for ER prior to 59.5
Old 01-25-2014, 04:25 PM   #1
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Put What Money Where, for ER prior to 59.5

Hey all,

Hubs and I are working on our ER plan and we are a bit stuck. Would appreciate any wisdom you've got to share.

Basically we have two pools of money. Tax deferred and Taxable. We plan to ER in our 40s which means we'll be making withdrawals from just the taxable account for a while.

The problem is that all of our bonds are in the tax deferred account, as this makes sense for our tax situation today. (We don't pay taxes on distributions yet)

Today:
Tax Deferred Accounts: Has all of our bonds, REITs, some equities.
Taxable Accounts: All Equities

Scenario:
Let's say we ER, make withdrawals out of the taxable account (containing the stock portion of our portfolio) and the market tanks. Suddenly our taxable account has shrunk, and we will feel leery to withdraw from there. We have assets in bonds but they are locked away.

So what is the solution?

A)Mirror our AA in both our taxable and tax-deferred accounts so that we can always have a balanced portfolio to work with, even prior to age 59.5

B) Don't worry about it. If the taxable account tanks, sell bonds in the 401(k) and rebalance, viewing the portfolio as "a whole" even if some of it isn't accessible.

C) Some other solution?

I suppose we are realizing that our "accessible" dollars for the first phase of retirement are the most volatile dollars, and we're trying to figure out how to deal with that.

Appreciate any insights.

SI
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Old 01-25-2014, 04:52 PM   #2
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I went through exactly the same period of wondering what to do about this as you currently are, and I'm sure it's a common issue with many ER's.

I didn't choose option A) because I don't want to hold any tax-inefficient investments in my taxable accounts. My portfolio is simple, consisting solely of a total market domestic equity fund, a total market international equity fund, and a total market bond fund (and 1 1/2 - 2 years' expenses in a savings account).

My somewhat fuzzy plan is to re-balance on an occasional basis and attempt to keep my desired AA, without holding any bond funds in the taxable account. If the market tanks too much, and looking at the taxable account gets too scary, I'll avoid looking at it, and choose just to look at the overall balance in order to help myself feel a bit better! My initial concern was that if the market got hairy, I might run out of money in the taxable account before I was old enough to withdraw from the IRA's without use of the 72(t) exception. It doesn't look like that will now happen (fingers crossed), but there is still plenty of opportunity for the taxable balance to get frighteningly low.

I've got 28x annual expenses in the taxable account alone, and need this to get me through at least the next 12 years (hopefully more), so I think things will be OK. (Famous last words - I'm furiously touching wood as I type this.)
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Old 01-25-2014, 04:53 PM   #3
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Have you considered making rule 72t distributions from your tax deferred accounts? The ability to do that could avoid having to make the decision about what assets to keep where.

72T – How a 72(t) Works | 72t Distribution | 401k Rollover | IRS 72t
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Old 01-25-2014, 07:50 PM   #4
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I would choose (b), with the caveat that as soon as I stop working and was in a lower tax bracket, I would convert a bit of my IRA to a Roth every year. 5 years down the road, you have a lot more flexibility.
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Old 01-25-2014, 08:58 PM   #5
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I think this may be a non-problem because money is equally exchangeable. You can simply sell however many taxable stocks (and even harvest the loss) as needed and at the same time exchange bonds (in tax advantaged) for an equivalent amount of similar securities, just being careful of the wash rules. You end up with the equivalent portfolio of selling however many stocks and bonds as you wanted to, despite the barrier between taxable and tax advantaged.

The catch could be that you deplete taxable sooner than you wanted, in which case you need to fall back on 72t. But the problem of which asset types are in which account isn't so much of a problem since tax advantaged accounts can buy and sell without tax consequences.
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Old 01-25-2014, 09:57 PM   #6
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I spent some time thinking about this last year. I have checked out at 40, but the bulk (80%) of our assets are tax deferred. I know that I eventually have to get the money out, but 72T is somewhat inflexible and I do not want to chain myself to an irrevocable set of withdrawals for the next 19 years. So the plan is to supplement our taxable portfolio with some part time work/DW's small business earnings and make it to age 50. At that point a 72T would not have to go for that long and I would be more comfy with it.

All that being the case, I have my assets allocated differently between taxable and tax deferred. The taxable is likely to be consumed sooner, so its invested about 40/60 with a lot of the 60 in cash, CDs and I bonds. The tax deferred assets are "old man money" and are closer to 80/20, with the total coming up at 65/35.
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Old 01-25-2014, 10:01 PM   #7
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Thanks for the comments everyone. I'm avoiding the 72(t) if at all possible because it's pretty inflexible. The Roth conversion is an angle I hadn't fully considered.

It sounds like there is no magic wand on this one. Major Tom - you've got a great multiple of expenses in taxable - knock on wood I think you'll do great!

I'm leaning towards option B, but it sounds like a piece of this is figuring out simply how fat our taxable account is going to be. If equities tank - and our taxable pool is much smaller than our tax deferred pool, we could run into problems....

Some more to think about.
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Old 01-25-2014, 10:03 PM   #8
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All that being the case, I have my assets allocated differently between taxable and tax deferred. The taxable is likely to be consumed sooner, so its invested about 40/60 with a lot of the 60 in cash, CDs and I bonds. The tax deferred assets are "old man money" and are closer to 80/20, with the total coming up at 65/35.
Interesting, I think this is the approach my husband is leaning towards, whereas I tend to prefer one portfolio with a simple AA across all accounts. Thanks for giving me another angle to consider.

SIS
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Old 01-25-2014, 10:16 PM   #9
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Interesting, I think this is the approach my husband is leaning towards, whereas I tend to prefer one portfolio with a simple AA across all accounts. Thanks for giving me another angle to consider.

SIS
Ah, but I do have one AA across all accounts, 65/35. I just twiddle the total allocation to reduce the chance I have to do a premature 72T.
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Old 01-26-2014, 08:46 AM   #10
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I don't understand the total aversion to bonds in your taxable account after retirement. Between standard deduction and personal exemptions, you can have over $20k in income that isn't taxed. This would allow your taxable account to have up to $600k in bonds paying 3% or so and pay no tax. Such an amount of bonds would allow you have some security in your spending for a long time. As a WA resident, you don't pay state income tax.
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Old 01-26-2014, 12:10 PM   #11
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Anybody planning to retire in their 40s probably has decent income and the distributions from bonds may get taxed at relatively high rates.

What we did is mainly focus on equities at first but as we got closer to our date started redirecting new money into fixed income. Paying tax on 2% yield is not too bad if only for a few years (e.g with 200k x 2% yield * 30% tax = $1300) however this may change if rates go up. There also I-Bonds (20k/year) and muni bonds -- I wish I had started investing in I-bonds much earlier (but I was too much of a noob).

I agree with other posters that 72t is too inflexible for a long ER. Our plan is to spend down taxable and do roth conversions. After 10 years when we are in our 50s we may rethink/be more comfortable with 72t

Another option if you own a home and plan to downsize is use the proceeds from the sale to fund your fixed income bucket at retirement.
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Old 01-26-2014, 12:12 PM   #12
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Between standard deduction and personal exemptions, you can have over $20k in income that isn't taxed.
I was about to challenge you on this, but while typing, realized that you are talking about couples. For an individual, the 2014 standard deduction is $6200 and the personal exemption $3950 for a total of $10150 of income allowed before Uncle Sam starts chomping at the bit. Not as much as for couples, but I suppose it would allow me to carry some bonds in my taxable. As bond funds are less tax efficient than index equity funds, I had decided to "play it safe" and keep the bond funds out of my taxable. Truthfully, it's because I didn't want to make the effort to sit down and study the data on my bond fund (VBTLX) in order to figure out how much I could hold in a taxable account before having to cough up some of it in taxes.

Thanks for the thoughts.

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Major Tom - you've got a great multiple of expenses in taxable - knock on wood I think you'll do great!
Don't be too impressed. I live on very little, so a 28x multiple is a lot less for me than it would be for most people!
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I'm leaning towards option B, but it sounds like a piece of this is figuring out simply how fat our taxable account is going to be. If equities tank - and our taxable pool is much smaller than our tax deferred pool, we could run into problems....
That's what I'm doing. If things go south, it could be a bit frightening but as I said earlier, I won't check the account as often and when I do, will try to look at the overall balance instead of just the balance in taxable
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Old 01-26-2014, 01:26 PM   #13
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Ah, but I do have one AA across all accounts, 65/35. I just twiddle the total allocation to reduce the chance I have to do a premature 72T.
Right! OK, this is starting to make sense to me now.
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Old 01-26-2014, 01:42 PM   #14
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Anybody planning to retire in their 40s probably has decent income and the distributions from bonds may get taxed at relatively high rates.

What we did is mainly focus on equities at first but as we got closer to our date started redirecting new money into fixed income. Paying tax on 2% yield is not too bad if only for a few years (e.g with 200k x 2% yield * 30% tax = $1300) however this may change if rates go up. There also I-Bonds (20k/year) and muni bonds -- I wish I had started investing in I-bonds much earlier (but I was too much of a noob).
Agreed. We don't mind having bonds in taxable *after* ER but building up a big chunk in there now will give us dividends, and our current tax rate would eat them up handily.

I know next to nothing about I-Bonds. Will look them up.
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Old 01-26-2014, 01:56 PM   #15
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One other option to consider is to have low expenses and each do something you enjoy part time. That way you can cover all your expenses just with each of you working a few months of the year or a couple of days a week each and not have to touch your portfolio.
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Old 01-26-2014, 04:09 PM   #16
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One other option to consider is to have low expenses and each do something you enjoy part time. That way you can cover all your expenses just with each of you working a few months of the year or a couple of days a week each and not have to touch your portfolio.
PT work is likely (we like our jobs - just not being tied to them) although I'm trying to build a plan where working remains optional.

Our expenses in ER are probably going to be in the 75k range inclusive of taxes. Healthcare & condo fees will take a big bite, with about 25k/yr for eating out, travel, and all other non-essentials. Having a "fluffy" budget is part of the plan. Travel expenses while we're younger can become extra healthcare expenses as we get older. At least that's the idea.

Good suggestions!
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Old 01-26-2014, 06:25 PM   #17
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I don't understand the total aversion to bonds in your taxable account after retirement. Between standard deduction and personal exemptions, you can have over $20k in income that isn't taxed. This would allow your taxable account to have up to $600k in bonds paying 3% or so and pay no tax. Such an amount of bonds would allow you have some security in your spending for a long time. As a WA resident, you don't pay state income tax.
Why waste $20K tax-free space on bond income when one can convert $20K to a Roth IRA and pay no taxes on the conversion?

It's probably better tax-wise to pay expenses with tax-free return-of-capital and even selling equities at a loss (more tax-free other income offset by up to $3K of the loss), so that one can maximize Roth conversions.
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Old 01-26-2014, 06:44 PM   #18
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I did A), but with pretty much no bonds, so that doesn't really count.

If the taxable account is pretty healthy now, you can leave it in equities. When you sell some taxable equities, sell some bonds in the tax deferred account and buy equities with the proceeds to keep your AA in balance.

If the taxable is a little iffy for stretching until 59.5 I'd go ahead and hold some bonds in your taxable account. It won't kill you.

And you have a nice backup plan. If the taxable account runs out prematurely you can do a 72t. By that time it should only be for a short period, so not too much of a commitment.
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Old 01-26-2014, 07:06 PM   #19
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I have all fixed Income in my IRA and taxable accounts that I am living on are equities. I have chosen B. If I have to sell equities at a loss then so be it, I'll have a loss carryover to offset future gains.

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Old 01-26-2014, 07:35 PM   #20
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I did A), but with pretty much no bonds, so that doesn't really count.


And you have a nice backup plan. If the taxable account runs out prematurely you can do a 72t. By that time it should only be for a short period, so not too much of a commitment.
It has been a while since I looked, but I think that 72(t) withdrawals must go for 5 years or until 59-1/2, whichever comes later.
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