Withdrawal Strategy Variation

[Rich_by_the_Bay]

I posted something like this under a "what do you think of annuities instead of..." topic, but realized I am more interested in the overall strategy rather than the annuity piece, so here is a re-framing of my question (besides, the term "annuity" is like a reply-repellant ):

Most here talk about the 4% rule and its variants but I didn't see much about the "buffer account" approach:

• sock away about 5-6 yrs of anticipated income needs as liquid, cash-like investments (even a 5-year ann&*#ty payout)
• remainder of nest egg will be in 60/40 or 65/35 stocks and bonds, well spread out
• the 5-year income "buffer" fund gets replenished periodically from either stocks or bonds, or both mostly from whichever does better that year.
• When everything is down, youdrill deeper into my income escrow where I can wait it out for that 5 years if necessary.
• the accounts get reallocated back to desired proportions annually or so

.
Nothing new here - it's a widely written-about strategy (e.g. DeMuth/Stein and others) which feels right to me.

Hard for me to see a big down side, and there seem to be some advantages (e.g. the buffer account allows you to stay a bit more "aggressive" in your investment piece, and more patient when it takes a long slide). I guess it needs a pretty good nest egg to avoid having too much tied up in the conservative buffer acct.

Anyone doing a plan like this (with or without annuities)? Any traps in it? Somehow it rings true for me.

 

[SteveR]

R_I_T,

Welcome to the board.

Your 5 year income buffer plan is what I am also working to myself. I have 4 years of it so far and by the time I ER it will all be in place. The plan is for 5 years of funds to provide a buffer between my pension and IRA 72(t) for a few years. By then, the mortgage will be paid off and we will be debt free with no college expenses, lower tax bill and lower expenses overall. We don't want to work until then so our buffer will carry us until we can do IRA withdrawls after the 72(t). SS will be taken early and will lower our IRA draws to preserve the stash until we crash.

Our spending will be much higher for the first several years of ER with a rapid drop in 3 years, 5 years and 8 years out. After that it will stabilize before it drops again due to "old age issues". The plan is to spend down some of the IRA early to avoid huge tax bills after age 71 with RMDs. If we don't spend down one of the roll over IRAs we are going to have a huge income that we won't be able to spend and may end up giving to the government in estate taxes when we are both gone. Better to spend some of it early than to have to give 40% or more of it to the various taxmen later. Then again, we could die before that happens so why wait to have fun and do what we want to do other than w@rk?

 

[Jarhead*]

I posted something like this under a "what do you think of annuities instead of..." topic, but realized I am more interested in the overall strategy rather than the annuity piece, so here is a re-framing of my question (besides, the term "annuity" is like a reply-repellant ):

Most here talk about the 4% rule and its variants but I didn't see much about the "buffer account" approach:

• sock away about 5-6 yrs of anticipated income needs as liquid, cash-like investments (even a 5-year ann&*#ty payout)
• remainder of nest egg will be in 60/40 or 65/35 stocks and bonds, well spread out
• the 5-year income "buffer" fund gets replenished periodically from either stocks or bonds, or both mostly from whichever does better that year.
• When everything is down, youdrill deeper into my income escrow where I can wait it out for that 5 years if necessary.
• the accounts get reallocated back to desired proportions annually or so

.
Nothing new here - it's a widely written-about strategy (e.g. DeMuth/Stein and others) which feels right to me.

Hard for me to see a big down side, and there seem to be some advantages (e.g. the buffer account allows you to stay a bit more "aggressive" in your investment piece, and more patient when it takes a long slide). I guess it needs a pretty good nest egg to avoid having too much tied up in the conservative buffer acct.

Anyone doing a plan like this (with or without annuities)? Any traps in it? Somehow it rings true for me.

Rich:  First off, welcome to the forum. (It has helped me get through winter days when playing golf, or fly-fishing hasn't been possible).

Regarding strategy:  Withdrawel is a whole different ball-game than accumulation.(Especially if there is not a pension, or an inheritence to lighten the load).

My wife and I have been in the withdrawel stage for close to 20 years now.  (Retired after most of the heavy lifting was over with the kids.)

One important factor that is discussed, but not fully appreciated is "tolerance for risk".  Most folks, (especially young posters) that are working and accumulating, are going to have a higher tolerance (understandibly), than someone that is in withdrawel stage.

We've had plenty of practice in this area, and
one thing for sure, you get an opportunity to get to know yourself, (investment wise).

Regading your "bucket theory", especially at my age makes a lot of sense to me, and I (about 2 years ago) re-adjusted my thinking even more so.

You will get a feel of what you want to do when you "pull the pin", and how much you have to spend to allow you to do so.  (Once you've figured that out, the investment part becomes a
lot easier).

Letting the "big-dogs" run, (equities) is easier to do, if you have 15 years or so of your situation covered by conservative (Tips, CD's, I Bonds, etc.).

Knowing that you're not going to live forever is also important.  (My wife and I keep that thought upper-most in our planning).

Good luck to you, and look forward to more of your posts.

Jarhead

 

[Nords]

Anyone doing a plan like this (with or without annuities)? Any traps in it? Somehow it rings true for me.

Sure, works fine, like you mention it's very popular-- we learned about it through Frank Armstrong's website. He uses 5-7 years' expenses in a short-term bond fund and the rest in equities.

We keep a year's expenses in a money market, a year's expenses in a CD, and the rest in equities. I have a govt pension and we tolerate high volatility so it works, and the high-equity portfolio is the only way I know to beat inflation over many decades.

The "trick", if there is one, is to avoid overspending early in ER, especially in a bear market. On the other hand a number of studies are attempting to justify higher SWRs during the early years in anticipation of much lower spending during your 80s.

 

[peteyperson]

Hey Rich,

It is fun to play with such ideas.

You're really talking about having 20% in cash equivalent investments, then splitting the other 80% between stocks and bonds. The problem with cash is the linkage to inflation, after taxes. You're lucky if it keeps up. It also drags the performance of the portfolio down as a whole.

Will you do better in more aggressive stocks like small cap value and far less in large cap, if you have less stocks because of holding more cash and bonds too? Depends on the numbers, but it may well come out about the same. If so, would risking the loss to inflation of the cash portion and accepting increased risk of underperformance from a more focused equity portfolio (rather than heavily diversified thru all asset classes: small large, US, int'l., EM, EM debt, global RE, energy, etc.) balance? Maybe greater focus will increase the likelihood of longer periods of underperformance, or that income from energy trusts and the like will come at the expense of a substainable real return on the investment making long-run survival problematic.

Like I say, fun to play around with it.

Petey

I posted something like this under a "what do you think of annuities instead of..." topic, but realized I am more interested in the overall strategy rather than the annuity piece, so here is a re-framing of my question (besides, the term "annuity" is like a reply-repellant ):

Most here talk about the 4% rule and its variants but I didn't see much about the "buffer account" approach:

• sock away about 5-6 yrs of anticipated income needs as liquid, cash-like investments (even a 5-year ann&*#ty payout)
• remainder of nest egg will be in 60/40 or 65/35 stocks and bonds, well spread out
• the 5-year income "buffer" fund gets replenished periodically from either stocks or bonds, or both mostly from whichever does better that year.
• When everything is down, youdrill deeper into my income escrow where I can wait it out for that 5 years if necessary.
• the accounts get reallocated back to desired proportions annually or so

.
Nothing new here - it's a widely written-about strategy (e.g. DeMuth/Stein and others) which feels right to me.

Hard for me to see a big down side, and there seem to be some advantages (e.g. the buffer account allows you to stay a bit more "aggressive" in your investment piece, and more patient when it takes a long slide). I guess it needs a pretty good nest egg to avoid having too much tied up in the conservative buffer acct.

Anyone doing a plan like this (with or without annuities)? Any traps in it? Somehow it rings true for me.

 

[Rich_by_the_Bay]

You're really talking about having 20% in cash equivalent investments, then splitting the other 80% between stocks and bonds. The problem with cash is the linkage to inflation, after taxes. You're lucky if it keeps up. It also drags the performance of the portfolio down as a whole.

You're right about that, and for many, 5 years of income buffer will be alot more than 20% of their assets at retirement.

This is what makes me wonder if a 5 year payout annuity might be a good idea to replace the buffer part; it would pay about 5.2% rather than money market rates. Each 5 years you would buy a new one from proceeds on the investment side.

 

[SteveR]

You're right about that, and for many, 5 years of income buffer will be alot more than 20% of their assets at retirement.

This is what makes me wonder if a 5 year payout annuity might be a good idea to replace the buffer part; it would pay about 5.2% rather than money market rates. Each 5 years you would buy a new one from proceeds on the investment side.

The major issue with this would fees. Annuities will rob you at gun point. If you want simple, just create a CD ladder with your annual income needs in a CD that will mature in the year you need the cash. You can keep them going as you sell assets to keep the ladder going. There are no fees and you only lose out on interest if you cash them in early. Otherwise, it is easy and safe and you don't pay all those nasty annuity fees.

 

[Rich_by_the_Bay]

The major issue with this would fees. Annuities will rob you at gun point.

Good points about the laddering, but regarding fees, most immediate annuities don't seem to involve any fees. Of course they are folded into the yield but you know what those numbers are.

I just ran a few over at Fidelity and immediateannuities.com. The seem to pay out at a legitimate 5.1 to 5.2%, period. Isn't that higher than what a conservative bond ladder would pay on average?

I think the ins companies make their money because they pay 5.2%, then invest your money and make 10%. The difference is what the buyer is willing to pay for reassurance of at least 5.x% for funds they feel they should not expose to risk. I'm not a big annuity fan, but wonder if this isn't a case where it may work nicely: 5.3% today would run a bit ahead of inflation even after taxes.

Tell  me where I can learn more about bond ladders. Thanks.

 

[bamsphd]

I like
http://www.fpanet.org/journal/articles/1993_Issues/upload/16341_1.pdf
as a primer on bonds, and it includes a second on bond ladders. Though
there are certainly much simpler articles out there.

The short version is: Pick some number of years (or other time unit
such as months or quarters). Purchase that number of bonds, each
maturing one year (month or quarter) apart. As bonds mature use
the proceeds to buy a new bond one year (month or quarter) farther
in the future than your longest maturity bond. In the event of a
market meltdown, instead use the maturing bond to buy food, fuel,
and other things considered necessities.

I would add that the difference in interest rate between
a higher-yield bond and a treasury bond simply reflects the
return of principal you will more frequently lose investing
in a higher-yield bond than in the bond issued by the government
owning the dollar printing press.

Personally, I am setting up a five year ladder of TIPS, and keeping
a roughly one year money market/short-term bond fund reserve
to handle small emergencies and to ease buying each new rung
of my ladder. I invest 4% of my assets each year in a single
treasury auction. (See http://www.treasurydirect.gov/) That keeps
my purchase costs at zero, and minimizes my costs if I need to sell early.

You might also want to consider inflation protected savings bonds
for your emergency funds.

 

[brewer12345]

Good points about the laddering, but regarding fees, most immediate annuities don't seem to involve any fees. Of course they are folded into the yield but you know what those numbers are.

I just ran a few over at Fidelity and immediateannuities.com. The seem to pay out at a legitimate 5.1 to 5.2%, period. Isn't that higher than what a conservative bond ladder would pay on average?

I think the ins companies make their money because they pay 5.2%, then invest your money and make 10%. The difference is what the buyer is willing to pay for reassurance of at least 5.x% for funds they feel they should not expose to risk. I'm not a big annuity fan, but wonder if this isn't a case where it may work nicely: 5.3% today would run a bit ahead of inflation even after taxes.

Tell  me where I can learn more about bond ladders. Thanks.

Little secret: insurance companies don't back annuities with anything other than bonds. So what they can afford to pay the annuitant is based on bond yield minus (expenses, expected defaults, requirements to put up capital, profit, etc.). So unless the issuer of an annuity period certain (pays out for X years, not lifetime) is writing unprofitable business, you will be geting less than you would have by just buying bonds. Trust me, you DON'T want to be a creditor of an insurer that writes unprofitable business.

Do yourself a favor and cut out the middleman: just buy the bonds and CDs yourself.

 

[Rich_by_the_Bay]

Trust me, you DON'T want to be a creditor of an insurer that writes unprofitable business. Do yourself a favor and cut out the middleman: just buy the bonds and CDs yourself.

Hmmm. Makes sense and a bond ladder doesn't sound quite as complicated as I thought. Might be a little tricky to figure out the average yield, though. What about CDs versus Bonds - is there a big spread between their yields, carefully shopped?

 

[brewer12345]

Hmmm. Makes sense and a bond ladder doesn't sound quite as complicated as I thought. Might be a little tricky to figure out the average yield, though. What about CDs versus Bonds - is there a big spread between their yields, carefully shopped?

Which bonds? Which CDs? There are bonds that yield 20%, but I suspect you wouldn't want to bet next year's budget on them. There are also bonds that yield, say, 1% over comparable treasuries and have very low default risk (issued by companies you would recognize and respect).

If you shop around, you can find CDs that yield 1/2 to over 1% better than treasuries. If you are FIREd and have a modest taxable income, CDs probably make the most sense. If you are in a high income bracket, munis might make more sense.

 

[Rich_by_the_Bay]

Which bonds? Which CDs?

Well, since I'd use them as a substitute for cash (i.e. money market), I guess I'd need the most solid flavor I could get, like treasuries (?). I assumed all CDs were FDIC insured, so probably would shop yields.

Considering that annuities would return a guaranteed 5.1% or so at age 60 today, they would have to beat that at 5 year maturity to be attractive by comparison, no?

I got homework to do - thanks for indulging me .

 

[brewer12345]

I see 5 year CDs yielding 5.75% and shorter maturities yielding not much less.

 

[Outtahere]

Crusing thru the banks in my area today I found an 8 month CD for 4.25. I have a distribution due the end of the month,if the deal is still on I'm going to dump it there.

 

[Cut-Throat]

Crusing thru the banks in my area today I found an 8 month CD for 4.25. I have a distribution due the end of the month,if the deal is still on I'm going to dump it there.

Why bother with a CD for 4.25 when Emigrant Direct on-line Savings is paying 4.25%?

 

[Outtahere]

lol duh you're right and I have an account there.....and No I haven't been smoking...............

 

[HFWR]

And why not?

 

[Rich_by_the_Bay]

I see 5 year CDs yielding 5.75% and shorter maturities yielding not much less.

Bankrate.com shows about 5.1% best rate this evening, as an example.

 

[cute fuzzy bunny]

You can get close to that with a money market account. Unless you think MM rates will drop in the next 8 months...

 

[MJ]

Don't forget my short term standby Corus bank

Right now 6 month cd 4.8 % or 1 year 5.09%

http://www.corusbank.com/

 

[MDW]

The five year plan has been my goal for several years. I don't remember reading about it anywhere, I think I decided one day that if the economy goes sour it will straighten itself out within five years.

My plan is a five year CD ladder with an emergency pool in MM. If the market does extremely well in one year I would add another year to the ladder as extra insurance.

 

[brewer12345]

Bankrate.com shows about 5.1% best rate this evening, as an example.

If you shop around, there are better rates. Check out www.penfed.org

There are also other alternatives, like OSM (stick that ticker into yahoo finance or similar). This is a bond issued by Sallie Mae that pays CPI + 2%. Could be less or more than 5.1%, but you avoid the risk that inflation eats away all your yield.

There are also I-bonds, which pay CPI plus something (1%?), wth no state tax on the interest and federal taxes deferred until you cash in the bond.

Or there are exchange-traded preferred stocks that pay attractive cooupons that are taxed as qualified dividends (15% federal tax). The ones issued by highly rated issuers have very little default risk, and you can even find some that are floating rate payers, so you don't take interest rate risk.

Or there are things like AHL's exchange-traded preferred. This thing pays 5% and change in yield, with the payouts taxed as qualified dividends. Att the end of 3 years, you get a new preferred stock worth par plus any appreciation in the issuer's equity over a set price. If the issuer's stock goes down over that time period, you don't take the hit.

As you can see, there are lots of flavors of bonds out there. Of the ones I described, some are riskier than others, but I do not regard as any of them as being as risky as a junk bond or an equity.

 

[cute fuzzy bunny]

Brewer - in the lower tax brackets, qualified dividends are taxed at only 5%. In 2007 it drops to zero unless congress makes any changes.

I can speak from personal experience that tweaking your income to get into one of the low brackets, and then taking your yields as qualified dividends is a very, very good thing.

 

[free4now]

This is a great thread... I really appreciate all the people describing actual bond-type investments they have found. As someone who is going to stop working soon I need to figure out exactly how to get my living income.