Starting fixed income ladders

[woolybully]

I have some questions on how to maintain a fixed income ladder, how to rebalance with stock and fixed income securities and some other small questions. I'll start with my situation:

I have about $700K in my company's 401K plan, that is held by Vanguard. Of the total, I'm keeping 40% in fixed income mutuals - 15% VFIIX, 15% VBMFX and 10% VIPSX. The rest is in various large, mid, small and international cap index funds (ratio is 15%, 12%, 10% and 15% respectively). The other 8% is in company stock (I learned from the Enron debacle and changed from 85% Company stock to 8% over the last year). I contribute 2% of salary each year, company matches with another 8% (4 to 1 match). When I retire at the end of 2007 (I'll be 53 then), I should get a lump sum from the pension of about $450K (unless Congress screws me). I have two IRA's worth about $150K total today. If I assume the fixed income return is 3.5% and the stock return is 8%, I should have about $1600K when I retire and add everything up. I'm planning on withdrawing about $60K/year (that's under the 4% SWR).

I plan on creating a 5 year fixed income ladder when I retire. I can't do it before because the 401K doesn't allow anything but mutual funds. The ladder would be worth about $300K depending on how it's funded. Overall, I plan on using a 40/60 fixed/stock allocation (+/- 10%). I'll probably keep the stock portion in something like VTSMX. I'm ignoring Social security in my estimates. I have relatively little in after tax savings - at the time of retirement, including my house equity, after tax holdings should account for about 10% of my total. I have an only daughter starting college this fall, but I've saved other funds for that and am not including that in retirement estimates (one reason I'm still working).

The general plan is to create a five year ladder. Each year, as the one of the securities matures, it will be moved to a MMF that will transfer money to my checking account monthy. At the same time, I'll buy a new 5 year security and rebalance the entire portfolio to maintain the 40/60 allocation. I'll also make adjustments for inflation at that time too. When I retire, I will create a SEPP plan and move enough money to handle the SEPP yearly distributions into one or more IRA's. The rest will be in other IRAs. I'll put the ladder in the SEPP IRAs.

Questions follow in follow up message:

Thanks in advance for your help and advice.

 

[woolybully]

From previous message

So the questions:

1) what kind of securities for the ladder - bonds, corporate (AAA rating), CD's or what? Does it really matter? It seems that I should buy the security(s) that has low risk with the highest YTM at the time of purchase, since they will be held to maturity.

2) what about funding the ladder with zeros? The cost of the ladder is lower and leaves more to be invested in other fixed income securities. But these have to be purchased in the secondary market, right?

3) if I don't do zeros, and I want $60K/year, should I buy a security with a face value of $60K or account for what it would earn till it matures? That reduces slightly the initial investment in the ladder. Buying a security with the required face value, means that all of the ladders interest payment will be available for buying next year's 5 year security, reducing the problem of rebalancing (see 5, below).

4) if I want the total of fixed income to be about 40% and the total of the ladder is about $300K, then there will be $340K left over to invest in fixed income. What security(s) to use for this portion? And the face values? I was thinking about face values of $1K, $2K, $4K, $8k, and so on. Perhaps several of each face value. This way I can sell any amount. This ties into the problem of rebalancing, below. I can probably do a bit more risky fixed income securities here too. I probaby want TIPS too. Too many choices. See 5, below.

5) How do I rebalance each year? I need to purchase a new 5 year security and also redistribute funds to maintain the 40/60 allocation. Depending on how the market did for that year, I may have to sell some of the fixed income, non-ladder securities and move it to the stock portion. Moving from the stock portion is easy since it's in a mutual fund. But I still have to come up with roughly $60K for the 5 year security and also move funds. How should the fixed income non-ladder portion be structured to allow the easiest rebalancing? Or is the fact that money is coming from the fixed income portion to fund each year's living expenses going to mean that there is a net flow of funds from the stock portion to the fixed income portion?

6) finally, with my after tax portion low, I'm going to run into a problem. I want to buy a ranchette in Colorado and build a house on it - I'm allocating $350K for that. I'd rather not keep a mortgage so it seems that I'm going to have to pull out a rather large chunk (about $150K) initially to cover that. What are some ways of handling this? If I retire at the end of 2007 and start the SEPP in 2008, I can take the funds from IRA's not associated with the SEPP and just eat the 10% penalty and extra taxes. That would mean I'd have a 10% penalty on $150K and total taxes on $210K. Are there other ways? Perhaps a 3 year $150K balloon mortgage and take only $50k/year above the living expenses? Another less palpable option is to work another year and a day to the start of 2009, the year I turn 55. I think I can then take money from the 401K without the 10% penalty and then transfer the rest to an IRA. I really don't want to work that extra year, but my estimates indicate that doing so increases my net worth about $160K total - about what I need.

I know I haven't mentioned MMF's - I don't really care for them. I know that have very low risk, but they also have very low returns. I can't stand seeing my money sitting there doing nothing. So I will always want my money working for me either in fixed income securities or mutual funds (stock or bond).

Also, I'd like to keep things simple so my wife can understand how it all works and be able to handle the details. That makes it easier for her to handle things should I move on to the great retirement community in the sky before she does.

 

[Mr._johngalt]

WoolyBully, you are obviously a thinker. That's good.
Very important to REs. Even with my meager pile,
those left behind in the event of my demise would have an awful time
figuring out how everything (investments etc)
was set up. This is not so much due to me being
secretive, but mostly heavy use of smoke and mirrors
in order to retire in the first place
as welll as poor recordkeeping. I am the
world's worst and I used to be an accountant.
Go figure!