WR calculation

[Scuba]

In 2019, I will begin taking distributions from an asset that I've always included in our net worth - the value of a deferred comp plan investment. I decided to estimate our WR for 2019 and wasn't sure which approach is more correct:
- Should I exclude the distributions I'll be taking from withdrawals (numerator), and exclude the asset value from the denominator?
- Or should I include the distributions in the numerator and include the asset in the denominator?

I calculated it both ways - the first way our estimated WR is 3.4% and the second way it's 4.1%. Not sure which way is more valid, but I'm thinking probably I should exclude both the withdrawals and the asset. I haven't included an estimated NPV of the pension I haven't started yet or SS payments in our assets, so I suppose perhaps I should not include the deferred comp balance either.

Please comment. Thanks!

 

[flintnational]

Scuba, if I understand your question, I would include the deferred comp account value in your assets. The distributions should be handled in one of two ways. They should be added to assets if you reinvest them or they should be added to spending if you spend them (don't double count). From a WR standpoint, I would treat the deferred comp like all of your other investments.

 

[RunningBum]

Is this a payment you will receive yearly for the rest of your life? If so, I would exclude it from both. If not, I'd include it in both because you would otherwise be taking that much extra each year you receive it.

I'm doing the same thing with my pension and 75% of my SS. I'm including the NPV now, which let's me take a larger (and I think fairer) distribution now, and less distribution from my assets later once I can supplement with my pension and SS. Once I start those, for simplicity I'm going to take them out of the calcs.

I'm a little curious why it is 0.7% difference, unless it isn't a payment you'll get forever. That seems like a lot. Should they be very close?

 

[Scuba]

The deferred comp payout will be taken over 7 years so after that, the asset will be exhausted assuming performance is as expected. It's paying out a fixed amount per month so it could last a bit longer or a bit shorter. I have the first 18 months of payouts in a stable value fund and the rest in a balanced fund that is usually about 70% equities.

I haven't included my pension or SS numbers in assets at all.

 

[donheff]

I don't think OPs post provides enough info to understand the question. When you say, removing the payout from withdrawals and assets results in a lower WR (3.4%) is this a long term calculation of a rate that will pay all expenses for life? Or is this a rate that will cover the delta for 7 years during which the payouts will reduce expenses and after which the WR will need to be raised to account for the loss of income?

 

[Scuba]

All I’m trying to do is calculate an estimated WR for 2019. The way I see it, I can either include the deferred comp cash flow stream as part of my withdrawals and include the current value of the entire deferred comp account in my asset total, OR I can exclude both the income stream and the asset. I did the calculation both ways and it was 0.7 points different, which made me wonder how others would do the calculation.

Think of it as a 7 year pension. Based on another recent thread, it sounds like most advocate leaving the income stream out of withdrawals and the asset value out of assets. This is the way I’ve handled pension and SS in our NW calculations, but I have always included the value of the deferred comp account in our assets.

 

[target2019]

Keep doing what you're doing? I'd lean more to that approach, as you need to account for the amount, even if for only seven years. If you use it, it will bleed off in paying expenses. If not, it will add to the investable amount you hold throughout this year.
I think of SWR as a guideline. Maybe use both of your calcs in the spreadsheet. Use a number between?
Just thinking about this because of the other thread.

 

[audreyh1]

All I’m trying to do is calculate an estimated WR for 2019. The way I see it, I can either include the deferred comp cash flow stream as part of my withdrawals and include the current value of the entire deferred comp account in my asset total, OR I can exclude both the income stream and the asset. I did the calculation both ways and it was 0.7 points different, which made me wonder how others would do the calculation.

Think of it as a 7 year pension. Based on another recent thread, it sounds like most advocate leaving the income stream out of withdrawals and the asset value out of assets. This is the way I’ve handled pension and SS in our NW calculations, but I have always included the value of the deferred comp account in our assets.

I only include my portfolio of investable assets in my WR rate call and do not understand why someone would do it the other way. So you either have extra income for 7 years or you reduce your withdrawal amount for 7 years as you have additional income. Firecalc lets you model with additional income sources, so maybe it handles this case. Ultimately the issue is to stay within some safe withdraw rate from your portfolio of investable assets so you don’t draw it down too quickly, and Firecalc helps you choose this.

The Trinity studies etc. have always looked at it this way: you need around $X in annual income. Subtract your guaranteed income streams. The remainder $Y is what you need to withdraw annually from your investment portfolio. Is that sustainable? i.e. does it have reasonable portfolio survival characteristics given a selected AA and time frame? If yes, you are good to go, if no, either reduce your budget or keep working and growing your retirement portfolio.

 

[big-papa]

The deferred comp payout will be taken over 7 years so after that, the asset will be exhausted assuming performance is as expected. It's paying out a fixed amount per month so it could last a bit longer or a bit shorter. I have the first 18 months of payouts in a stable value fund and the rest in a balanced fund that is usually about 70% equities.

I haven't included my pension or SS numbers in assets at all.

I'm in one of these now and just got a payout for 2019. Since I'm still working, I take the payout and reinvest it in my taxable account.

If I were retired, however, and I was receiving this payout and it was being used for spending purposes, then it becomes a part of my total payout. Withdrawals from other assets would be reduced accordingly.

For this, your pension, your portfolio, and SS, you can do an NPV calculation with excel to find the NPV of current assets plus all future income streams. You can then calculate your WR based on that number. Then update the number each year. If you do this, you might find that you are withdrawing more funds earlier and you may find that your total amount to spend is "smoother" over the years. No big jumps when SS or your pension kicks in. But it does mean that you are physically withdrawing more from your portfolio until SS/pension kicks in than you would have otherwise and some people may have issues doing that - even if it's just for a few years. And some people like the big jumps in spending ability.

 

[donheff]

All I’m trying to do is calculate an estimated WR for 2019. The way I see it, I can either include the deferred comp cash flow stream as part of my withdrawals and include the current value of the entire deferred comp account in my asset total, OR I can exclude both the income stream and the asset. I did the calculation both ways and it was 0.7 points different, which made me wonder how others would do the calculation.

Think of it as a 7 year pension. Based on another recent thread, it sounds like most advocate leaving the income stream out of withdrawals and the asset value out of assets. This is the way I’ve handled pension and SS in our NW calculations, but I have always included the value of the deferred comp account in our assets.

I think you are just mixing things up. It made sense to include the comp in your portfolio calculations before you pulled it because you were trying to calculate how much cash flow you could safely generate from your portfolio. The comp amount was available to meet those expenses. But now that you selected the annuity you are in a different situation. Now you have an income stream for 7 years that will reduce your expenses (as if you had a part time job for 7 years). Now you calculate the SWR from the reduced portfolio with an eye to meeting reduced expenses for 7 years and normal expenses thereafter.

 

[RunningBum]

Let's say you want $80K/yr and are going with a 4% WR. And say you've got $40K coming in from a pension or some source like this deferred compensation.

If you've got a pension for life that starts right away it's easy to incorporate. You've got $40K covered by the pension, and you need an additional $40K, so you'd need $1M in invested assets to cover it.

But if the deferred compensation only lasts half your remaining life, it's not that simple. If you have that same $1M in assets, it works well to take 4% or $40K with the $40K in deferred comp, until that runs out. Then you still want that $80K, but now you've got to take 8% from your portfolio. That's very risky, and if you start out with that as your plan the success rate is certainly lower than the classic 4% WR.

Ignore the deferred comp perhaps? Then you need $2M for $80K/yr expenses. But those first years you only really need $40K because you've got $40K from the deferred comp. You keep the other $40K invested. When the deferred comp ends, you take the full $80K. You've got a lot leftover from that $40K/yr you didn't have to take. The plan obviously works, except for the huge flaw that you had to work a lot longer to bring your portfolio up to $2M, which is way more than you need.

But what if you calculate the NPV of that $50K for however long you get it. I don't know what that value is, but let's say it's $500K. You still want $80K at a 4% WR, so you'd better have $1.5M in your investments to total $2M. Then you can take $80K/yr, but for the first years half that is coming from the deferred comp. When that is over, you can still take 4% of that original total value, and the plan still works. Your actual withdrawals from the real portfolio (without the deferred comp) was $40K for the first half, then $80K.

For an early retiree, the order might be flipped. You might withdraw $80K from the portfolio until you start collecting a pension and SS, and then you take $40K from the portfolio, and get $40K from the other sources.

In another similar thread, it was mentioned to let Firecalc figure this out for you. I suspect under the covers Firecalc is doing the same NPV calculation on these sources. I prefer to verify numbers myself rather than use a tool like Firecalc as a black box. What if the tool has errors? What if it makes assumptions you don't agree with? What if it goes away? It's a tool, not a bible.

 

[pb4uski]

WR = distributions and withdrawals divided by retirement date portfolio balance

 

[RunningBum]

WR = distributions and withdrawals divided by retirement date portfolio balance

Yes, and the challenge is to determine how big that balance should be when your distributions are not constant--there some years, and not others.

 

[donheff]

But what if you calculate the NPV of that $50K for however long you get it. I don't know what that value is, but let's say it's $500K. You still want $80K at a 4% WR, so you'd better have $1.5M in your investments to total $2M. Then you can take $80K/yr, but for the first years half that is coming from the deferred comp. When that is over, you can still take 4% of that original total value, and the plan still works. Your actual withdrawals from the real portfolio (without the deferred comp) was $40K for the first half, then $80K.

That sounds like an easy way to track the annuity outflow. You are essentially converting it to a virtual guaranteed cash bucket that will be your source for withdrawing $40K for each of your first 7 years. You just need to remember to deduct the $40K from the virtual part of your portfolio each year.

 

[pb4uski]

Yes, and the challenge is to determine how big that balance should be when your distributions are not constant--there some years, and not others.

True, which is why I focus on an "ultimate" WR, spending less pension less SS divided by retirement date portfolio balance reduced by pension and SS not received while retired.

So for example, if one retires with $1.0 million 5 years before SS of $20k a year starts and spends $50k a year the your ultimate WR would be ($50k spending - $20k SS)/($1.0m nestegg - ($20k SS * 5 years)) = 3.33%

Also, I would only reduce the numerator by 1/2 the annual benefit of a fixed pension to provide for inflation.

 

[audreyh1]

WR = distributions and withdrawals divided by retirement date portfolio balance

Any distributions are included in the portfolio until withdrawn.

If you are withdrawing distributions for spending as they are received, then yes you need to take what that into account whenever you decide to withdraw more.

Personally I let the distributions build inside my retirement portfolio until the end of the year as I need my total portfolio value on Dec 31 to calculate my Jan 1 annual withdrawal. I do % of Dec 31 portfolio value each year.

 

[pb4uski]

I view a distributons and withdrawals as synonymous... if one has distributions that don't leave the portfolio like reinvested dividends then I agree... or to be clear, only count money leaving the portfolio whatever one calls it.

 

[audreyh1]

I view a distributons and withdrawals as synonymous... if one has distributions that don't leave the portfolio like reinvested dividends then I agree... or to be clear, only count money leaving the portfolio whatever one calls it.

Well, some years distributions exceed what I withdraw. So I don’t mix them up even though I don’t reinvest distributions immediately, but instead wait to rebalance after my annual withdrawal.

 

[pb4uski]

Then it sounds like a portion of some of your cash is earmarked as being part of the retirement portfolio... too much mental gymnastics for me.

 

[Bir48die]

All I’m trying to do is calculate an estimated WR for 2019. The way I see it, I can either include the deferred comp cash flow stream as part of my withdrawals and include the current value of the entire deferred comp account in my asset total, OR I can exclude both the income stream and the asset. I did the calculation both ways and it was 0.7 points different, which made me wonder how others would do the calculation.

Think of it as a 7 year pension. Based on another recent thread, it sounds like most advocate leaving the income stream out of withdrawals and the asset value out of assets. This is the way I’ve handled pension and SS in our NW calculations, but I have always included the value of the deferred comp account in our assets.

This has some relevance to me. I am three years into a ten year DC payout. When I initially met with my previous FA he told me not to include DC in my withdrawal rate calculations. To him it was just another form of job compensation that is taxable. When I do figure my WR using my DC it puts me on the high side of what is comfortable to me. However, as I pull it out it all makes more sense.

So, what did I come up with? I have three different calculations on WR's:

1) With DC
2) Without
3) One that pulls out my inherited IRA (just for viewing purposes)

I am not steadfast in lumping things into one big category. Because we have all different forms of compensation (pension, SS, DC, taxable, IRA) I just make sure I have my yearly budget and manage these pieces to get me to the right spot.

 

[Scuba]

Thanks for the responses. I think what led to my uncertainty about how to treat this is that unlike a pension or SS, I received a statement each quarter for my deferred comp account showing a balance equivalent to contributions plus earnings, just like any other investment account. Therefore, I included this asset in my total of investable assets.

Now that I will for the first time start distributions from this account (not as a guaranteed annuity, but a fixed amount per month that I selected which based on the current balance will last about 7 years), I wasn’t sure whether the value of this asset should stay in the “investable assets” category or not. And if not, then I wouldn’t consider the distributions as a withdrawal either.

It’s somewhat academic as our plan works either way according to Firecalc, Fidelity RIP, i-Orp, and a customized model in Excel, but if I exclude both the distribution and the asset (as I’m doing with my pension and SS, neither of which I’m taking yet), our WR is 3.6%; if I include the distribution and the asset then we’re at 4.3%. Either way, our required withdrawals will decrease once I choose to start my pension and once SS for each of us kicks in.

I didn’t even calculate a WR for our first year of ER, but with all the discussion about it on this forum and the volatility in the market recently, I decided to calculate it for 2018 and estimate it for 2019. Since 2019 is my first year of deferred comp distributions, the question occurred to me.

 

[audreyh1]

Then it sounds like a portion of some of your cash is earmarked as being part of the retirement portfolio... too much mental gymnastics for me.

No, there is no earmarking involved. Besides, I always have some cash in my retirement fund. It’s part of my asset allocation.

I’m sure it helps greatly that my retirement portfolio is in a separate brokerage account from my annual spending money. So no mental gymnastics are involved at all. It’s quite clean with a once a year transfer from the retirement account to the spending accounts.