Withdrawal Strategy Thoughts..Comment?

[panhead]

So, I've been thinking and reading more and more about withdrawal strategies in retirement. I had originally thought that tax advantaged and taxable accounts should be thought of separately if one is going to ER because of the access problems before 59.5 of the advantaged accounts. Now, after reading plenty, I am finally convinced that I am wrong about this. The key is you need a large taxable account to go with your tax advantaged account. If you have $1M and say 60/40 allocation with 400k in tax advantaged (all bond funds) and $600k in taxable stock funds If you need to sell bonds to generate your cash flow for the year because stocks have gone way down, you sell stocks (at a loss) in the taxable port to get the $$ you are withdrawing each year. Then in the advantaged you sell bonds and buy back into a stock fund (similar or exactly the same as the one you sold) to get your allocation back to where you want it, after taking your annual withdrawal. This is the same effect as just selling bonds as you bought back into the stock fund at the lower price. If you turn off Dividend ReInvestment on both accounts, you can effectively spend the dividends generated from both taxable and advantaged before you are 59.5 by using this method. So, up until now I have kept my tax advantaged portfolio at about 70/30 and my taxable portfolio closer to 60/40. My original thinking was that the increased risk on the advantaged side would pay off b/c I wouldn't need it for 16 years or so. Now, I'm considering this to be foolish, and that I should implement things as Bogleheads recommend, all bonds in advantaged accounts (reits as well), and the balance in muni funds and stock allocation in taxable. While working, rebalance with cash, if retired, withdraw as outlined above.

Do I FINALLY understand this methodology? In practice, does anyone here do something like this? I'm making some changes to my portfolio and am trying to nail down how I can access the WHOLE portfolio before 59.5. Again, it looks like the key here is that you need substantial taxable assets to make this work, likely 50% or more of total port value....
I also know I could use 72t, but this appears much more flexible....

Comments?

 

[donheff]

Yes, that is how I do it. Taxed is 100% equities.

 

[FIRE'd@51]

If you have $1M and say 60/40 allocation with 400k in tax advantaged (all bond funds) and $600k in taxable stock funds If you need to sell bonds to generate your cash flow for the year because stocks have gone way down, you sell stocks (at a loss) in the taxable port to get the $$ you are withdrawing each year. Then in the advantaged you sell bonds and buy back into a stock fund (similar or exactly the same as the one you sold) to get your allocation back to where you want it, after taking your annual withdrawal.

One caveat - if you want to take a tax loss on your stock sale you have to wait 31 days to buy the same stock back in your tax-advantaged account or it will be considered a wash sale.

 

[jerome len]

If you have a chance, take a look at today's issue of the Wall Street Journal. Their feature story is on withdrawal from your investments in retirement. They are discussing alternative and challenges with the 4% strategy that so many focus on. It's not really focused on your questions but has some interesting ideas, especially on annuities, which I personally don't intend on ever buying.

Good luck with your strategy.

 

[pb4uski]

I think you got it. Bonds and other investments that throw off income in tax advantaged accounts and investments that throw off less income in taxable accounts. Also, IF you can use the foreign tax credit you would want any international equities in taxable accounts.

I have one nuance of a difference from what your wrote. I actually take my taxable investment dividends in cash (autotransfer to my bank account) but keep my tax advantaged accounts on dividend reinvestment (since they are mostly bonds they pay dividends monthly) and then just catch up on everything when I rebalance annually. Since the reinvested dividends are in a tax deferred account there is no CG implication to worry about.

 

[LOL!]

I think you got it, but I think you may be exagerrating the size of the taxable account needed.

First, let's make the assumption that a taxable account will drop only 50% in value as that has happened in 2000-2002 and 2008-2009. Second, you will not need your taxable account after you reach age 59.5 at least in terms of avoiding early withdrawal penalties.

So say you are age 55, then you need 5 years of living expenses in taxable and perhaps double that (in case market drops 50%), so you need 10 years of living expenses. If your expenses are 3% to 4% of your portfolio, then that means you need only 30% to 40% of your portfolio in taxable and in equities. That's less than 50% and drops each year you get closer to age 59.5.

Of course, if you retired with a 401(k) and reached age 55 in the year you left your company, the 401(k) may be available for withdrawals without penalty, too.

And if things go to hell-in-a-handbasket, you can always do the 72(t) SEPP thing if needed. Or you can withdraw contributions to a Roth IRA at any time.

So I will suggest you don't need more than 30% in taxable and you have a contingency plan just in case. However, it is nice if you have lots of money in both taxable and tax-advantaged.

 

[Packman]

I leanred about 10 years ago that having a decent balance in a taxable account was going to be important is you want to retire much before you are 59.5. I see a lot of people maxing out 401k's and IRA's, which is fine for normal retirement age. But having both accounts really allows flexibility in ER.

My whole career, I had few options with tax strategy. But now in ER, I have many options to reducing income tax. They better not change the tax law for a while!

 

[pb4uski]

....My whole career, I had few options with tax strategy. But now in ER, I have many options to reducing income tax. They better not change the tax law for a while!

+1 one of the nice surprises of ER. When I was w*rking, I just filled out the forms and wrote a check and didn't have much tax planning opportunities. Now, I almost have too many opportunities - 0% capital gains or Roth conversion? or both?

 

[photoguy]

I also know I could use 72t, but this appears much more flexible....

If necessary, I will definitely swap assets between taxable/retirement as you describe. But this isn't really a replacement for 72t which serves a separate function (net withdrawal out of retirement accounts).

 

[panhead]

Thanks for all the responses. I'm re-doing my portfolio (there's a review thread from me here somewhere) and wanted to bounce this off the board. I see the comments a lot about having to have bonds in your taxable portfolio so it can add stability to the taxable side. As long as the taxable side is of substantial size in relation to tax advantaged (Tho I agree LOL, that it may be less than I originally assumed) that this thought process is flawed. I originally looked at the bogleheads view of looking at everything as a single portfolio as being only for people retiring at 59.5 and later (or close to this). I see many others on this board looking at it this way too.

Photoguy: fundamentally, this method seems to accomplishes the same thing as 72t but without the constraints. Although you are not actually selling the bonds in your tax advantaged account and directly taking the income, the net result is as if you had. Again, long term this requires the taxable chunk to stay alive for it to continue to work, or else you would need the actual 72t to directly draw on your advantaged accounts, but if you are about 50/50 taxable/deferred, it would require a catastrophic event to completely decimate your (mostly equites) taxable account.

Now (this might be better off in a new thread) my only concern is that keeping only bonds in the advantaged accounts severely limits their growth potential. The only reason this bothers me is that I have considered using my advantaged accounts to buy a SPIA when I am about 60. With the limited growth, this amount may not be enough (with SS) to put a floor under my expenses. I know I can buy one with taxable funds as well, but my very brief look into this seemed to show poor tax treatment when purchasing a SPIA with taxable funds.

 

[grasshopper]

+1 one of the nice surprises of ER. When I was w*rking, I just filled out the forms and wrote a check and didn't have much tax planning opportunities. Now, I almost have too many opportunities - 0% capital gains or Roth conversion? or both?

Of course the new iron in the fire is MAGI, and the HC mandates. I think I have come to the conclusion to just man up with my private HC. I am 62 and only have 2 years after 2014 to wait for Medicare. By the way this year I did Roth conversions and big time LTCG, and ended up with a $7 federal tax on over 90k of income. At least I am not one of the 47%.

 

[panhead]

Oh yeah, 51 mentioned wash sales, this is a very good point to consider, but if one is able to stay in the 15% tax bracket then CG and Divs are not taxed correct? So, if the only interest you are recieving is from the bonds in your advantaged (or munis in your taxable) then you still wouldn't incur any tax except at the state level, if this applies. Do I have this right? That being said, I suppose if you were still careful about the wash sale rules, you could carry the tax loss forward until you did need it.

Great comments, thanks for the feedback!

 

[FIRE'd@51]

Oh yeah, 51 mentioned wash sales, this is a very good point to consider, but if one is able to stay in the 15% tax bracket then CG and Divs are not taxed correct? So, if the only interest you are recieving is from the bonds in your advantaged (or munis in your taxable) then you still wouldn't incur any tax except at the state level, if this applies. Do I have this right? That being said, I suppose if you were still careful about the wash sale rules, you could carry the tax loss forward until you did need it.

The wash sale rule only applies to losses. They are handled by adjusting the basis of the stock you buy that triggers the wash sale. Adjusting the basis in a tax-advantaged account is of no help, since all distributions are taxed as ordinary income.

 

[panhead]

The wash sale rule only applies to losses. They are handled by adjusting the basis of the stock you buy that triggers the wash sale. Adjusting the basis in a tax-advantaged account is of no help, since all distributions are taxed as ordinary income.

Yes, this makes sense. I was thinking of my original example, I sell a stock fund in my taxable account at a loss, but re-buy something similar (not exactly the same) in my tax advantaged account. In this case I can use the loss to reduce my taxable income (up to $3000 or so when filing single i believe). I understand the selling at a loss in an advantaged account is of no consequence tax wise. Now, do the wash sale rules still apply if I sell in a taxable account and buy a very similar fund in my advantaged account? In other words, because the advantaged account is sheltered, does the IRS allow you to use the loss from the taxable sale even if you buy a substantially similar fund in tax advantaged less than 31 days later? .....I doubt it, but I've never thought about the question.

 

[pb4uski]

.....I see the comments a lot about having to have bonds in your taxable portfolio so it can add stability to the taxable side. As long as the taxable side is of substantial size in relation to tax advantaged (Tho I agree LOL, that it may be less than I originally assumed) that this thought process is flawed. I originally looked at the bogleheads view of looking at everything as a single portfolio as being only for people retiring at 59.5 and later (or close to this). I see many others on this board looking at it this way too.

....Now (this might be better off in a new thread) my only concern is that keeping only bonds in the advantaged accounts severely limits their growth potential. The only reason this bothers me is that I have considered using my advantaged accounts to buy a SPIA when I am about 60. With the limited growth, this amount may not be enough (with SS) to put a floor under my expenses. I know I can buy one with taxable funds as well, but my very brief look into this seemed to show poor tax treatment when purchasing a SPIA with taxable funds.

I don't get your last paragraph. If you buy a SPIA in your tax-deferred accounts and receive the SPIA benefits then the SPIA benefits are 100% taxable income since they are a pension distribution (like any other tax-deferred distribution). If you buy a SPIA with taxable funds, then only a portion of the SPIA benefits is taxable income (and most of it would be a return of your principal and not included in taxable income).

Growth potential is a function of your overall AA. Once you decide the target AA, then the question becomes about how to allocate that AA across taxable and tax-deferred accounts in the most tax efficient manner. In doing that, investments that generate income that is taxable should go into tax-deferred accounts and investments that generate less taxable income should go into taxable account.

In my case, my tax-deferred accounts include my entire bond allocation and some of my domestic equities and the taxable accounts hold the remainder of the domestic equities and international equities.

 

[karluk]

Now, do the wash sale rules still apply if I sell in a taxable account and buy a very similar fund in my advantaged account? In other words, because the advantaged account is sheltered, does the IRS allow you to use the loss from the taxable sale even if you buy a substantially similar fund in tax advantaged less than 31 days later? .....I doubt it, but I've never thought about the question.

In a word, yes. When I first became aware of this issue, the IRS rules were ambiguous and it was possible to find knowledgeable experts on both sides of the issue of whether wash sale rules applied when selling from a taxable account and buying substantially similar securities in a tax sheltered account before the end of the waiting period. In recent years, however, the IRS has clarified that wash sale rules DO apply in this situation, so you have be careful about buying similar, but not too similar, securities in the tax sheltered account.

 

[scrabbler1]

+1 one of the nice surprises of ER. When I was w*rking, I just filled out the forms and wrote a check and didn't have much tax planning opportunities. Now, I almost have too many opportunities - 0% capital gains or Roth conversion? or both?

I had never heard of the concept of "bunching" one's itemized deductions until I ERed in 2008. Having total control over the flow of income tax payments via the estimated taxes route enabled me to simply move my 4th quarter estimated state income tax payment from late December to early January in alternating years. This increases my itemized deduction every other year while enabling me to take the standard deduction in the off years. I will effortlessly save $450 in every 2-year cycle.

 

[panhead]

PB: please look at this:
http://www.fsdfinancial.com/SPIA_INFO_LBL.pdf

I just started looking at SPIAs, but what this seems to say is that if I buy a SPIA with after tax dollars then every distribution I receive from it will have a portion taxed at my income tax rate. This portion is based on the original investment/expected return. My point, is that if I am using after tax dollars invested in stocks and muni bonds to generate income, and I am in the 15% tax bracket, my taxable income from dividends/interest/CG is -0- in the current tax environment. If I buy the SPIA, it appears I will have to pay 15% tax on at least a portion of this money, until my complete after tax investment is returned in full, then the full distribution is taxed as income.

Now, if I use tax deferred accounts to buy the SPIA (obviously not tax exempt, ie ROTH) then each distribution will be taxed at my income rate, which it would be even if I was just withdrawing from it, so the tax liability is the same, the only difference is that you can't alter the distributions after buying the annuity to reduce your tax liability. But...the same distribution, either thru an annuity or simply withdrawing from the account, would be taxed the same.

Does this make sense?

 

[panhead]

In a word, yes. When I first became aware of this issue, the IRS rules were ambiguous and it was possible to find knowledgeable experts on both sides of the issue of whether wash sale rules applied when selling from a taxable account and buying substantially similar securities in a tax sheltered account before the end of the waiting period. In recent years, however, the IRS has clarified that wash sale rules DO apply in this situation, so you have be careful about buying similar, but not too similar, securities in the tax sheltered account.

Karluk, thanks for the info, I believed this would be the case. No reason the IRS would give us a free ride!

 

[panhead]

I had never heard of the concept of "bunching" one's itemized deductions until I ERed in 2008. Having total control over the flow of income tax payments via the estimated taxes route enabled me to simply move my 4th quarter estimated state income tax payment from late December to early January in alternating years. This increases my itemized deduction every other year while enabling me to take the standard deduction in the off years. I will effortlessly save $450 in every 2-year cycle.

Thanks scrabbler, this is interesting, I'll need to look into it. Taxes are something I'm currently trying learn more about.

 

[pb4uski]

PB: please look at this:
http://www.fsdfinancial.com/SPIA_INFO_LBL.pdf

I just started looking at SPIAs, but what this seems to say is that if I buy a SPIA with after tax dollars then every distribution I receive from it will have a portion taxed at my income tax rate. This portion is based on the original investment/expected return. My point, is that if I am using after tax dollars invested in stocks and muni bonds to generate income, and I am in the 15% tax bracket, my taxable income from dividends/interest/CG is -0- in the current tax environment. If I buy the SPIA, it appears I will have to pay 15% tax on at least a portion of this money, until my complete after tax investment is returned in full, then the full distribution is taxed as income.

Now, if I use tax deferred accounts to buy the SPIA (obviously not tax exempt, ie ROTH) then each distribution will be taxed at my income rate, which it would be even if I was just withdrawing from it, so the tax liability is the same, the only difference is that you can't alter the distributions after buying the annuity to reduce your tax liability. But...the same distribution, either thru an annuity or simply withdrawing from the account, would be taxed the same.

Does this make sense?

I understand and agree with all you said, but I'm struggling to see what it has to do with the concern you expressed earlier of keeping bonds in your tax-deferred accounts.

If we assume that over the years that the return on bonds will be less than the return on equities, I can see that if you had equities in your tax-deferred accounts that when the time comes to buy the SPIA that you would have more to buy the SPIA and higher SPIA benefit payments. However, you would also have a much lower taxable account as a result of paying out 15% taxes on interest on the bonds in your taxable accounts.

 

[panhead]

I understand and agree with all you said, but I'm struggling to see what it has to do with the concern you expressed earlier of keeping bonds in your tax-deferred accounts.

If we assume that over the years that the return on bonds will be less than the return on equities, I can see that if you had equities in your tax-deferred accounts that when the time comes to buy the SPIA that you would have more to buy the SPIA and higher SPIA benefit payments. However, you would also have a much lower taxable account as a result of paying out 15% taxes on interest on the bonds in your taxable accounts.

Yes, I agree, unless I use a Intermediate Term muni bond fund in taxable (which I am planning on doing) instead of TBM, this will keep taxes at bay. You hit the nail on the head about my concern: That keeping equities entirely out of deferred will likely limit it's growth and thus if I want to buy a SPIA using only this, I will likely have less in here to spend. In other words, I definitely want to keep the majority of my bonds in tax deferred, that is common sense. What I'm struggling with is if I should keep an equity component in my tax deferred to enhance growth for the future possibility of buying a SPIA. I'm leaning toward the fact (as you seem to agree with above) that the benefit of trying to increase growth in the deferred portion for this purpose simply doesn't make sense and further complicates things. If I need a bigger floor under income, I can use taxable $$ and take (what seems to be a reasonably small) tax hit.

Thank you very much for posing these questions, it's really helping me work thru my thought process on this.

 

[Gotadimple]

Panhead,
Thus far, your discussion has focused on taxable and tax-deferred (meaning 401-K or Traditional IRA). In addition, you could consider a Roth IRA. Then as you construct your withdrawal, you have four sources to draw from (taxable, deferred, Roth, SPIA).

Taxes are not a concern with a Roth (other than paying them up front when you deposit or convert from tax-deferred).

-- Rita

 

[panhead]

Rita: Yes, I agree that the ROTH also plays a part here. In my specific circumstances, I have very little in ROTHs to date (like $5k) and I am currently not in a situation to do conversions as I'm working and in the 28% tax bracket. I'm doing the backdoor ROTH conversion thing and will continue to do so while I have income. I'm not sure what I'm going to invest in inside the ROTH. To date, I've been using it as a ego stock trading account, and have successfully proven to myself that I am no good at picking stocks. My current thinking is I'm going to buy VNQ (vanguard REIT index ETF) and add to this holding each year with the backdoor conversion.

Also, my taxable account is roughly twice as large as my deferred account, thus all of this conversation. 60 is a long way off for me (17 years) but my current thinking is I will likely buy a SPIA in the amount that it + (estimated) SS will be my required floor income. Whether or not that will leave anything in the deferred account or not, remains to be seen. If it does, I will do ROTH conversions as appropriate from a tax perspective.

All of this needs to be factored in, but my current concerns are setting my Asset allocation (which I've done) and determine if there really is a disadvantage to keeping all of my Fixed Income in deferred accounts (This discussion has led me to believe there is not). I'm doing a complete portfolio makeover in the next coming months, so that's why all the questions.

Regards,

Pan

 

[Accidental Retiree]

I need to print this thread out. Thanks, Panhead, for your post. It gave me more to think about.