Bucket System Withdrawal Plan ??

[rkser]

I am trying to understand the three bucket system of withdrawal in the retirement.

Bucket 1 - Cash, Online savings & CDs for the initial 3 yrs of expenses

Bucket 2 - Bond Mutual Funds for 3 to 10 yrs of expenses

Bucket 3 - Stock Mtual Funds for 10 to 20 yrs.....

All my Bond Funds are in Tax deferred Retirement Funds & my stock funds are in the Taxable accounts.

I understood that the Taxable accounts are to be used before you touch the Tax Deferred Retirement Accounts, in order to take the advantage of the Tax Deferral.

How do you reconcile the contradiction ? How would you crack this situation ?
Would you withdraw the expenses from the stock funds from taxable before you go to tax deferred Funds or vice versa. ??

Thanks

 

[audreyh1]

If you don’t want to draw from your tax deferred accounts initially, you can swap investment locations buy selling mutual funds in your taxable accounts and buy them in your tax deferred accounts. Just be careful of wash sale issues - only an issue if you realize a loss, then you just have to wait to rebuy in tax deferred.

You need to review the tax implications. You may realize a substantial capital gain if you’ve held the mutual funds a long time. And what about shrinking your tax deferred accounts? That may be beneficial tax-wise long term to reduce RMDs. So don’t assume leaving tax deferred alone is necessarily the best approach. You really need to look at the whole picture including opportunities for Roth conversions before reaching RMD age.

 

[rkser]

Thanks Audrey, for pointing out the helpful pros for spending the Tax deferred Bond accounts before going to the Stock Funds.

But, the Asset Allocation will tilt towards having more stocks with the remaining taxable accounts. Yes, converting the IRA's to Roth will use some of the taxable money.

Unless you sell some of the long held stock funds, pay taxes & start buying Bonds in the Taxable accounts, which comes with its own perils of increasing taxes.

I still have 2 years to start the de accumulating phase but the mind often wanders in to the future.

There must be some reasonable ways to keep the Asset Allocation conservative, as one starts spending the Bonds.

 

[Jerry1]

There must be some reasonable ways to keep the Asset Allocation conservative, as one starts spending the Bonds.

FWIW, one strategy is to allow the portfolio to become less conservative over time. Let’s say you start retirement with 40% stock. As you spend other buckets, that percentage will increase. However, at the same time, you have less years to cover. So if you start out by planing 30 years and you’re at 60% or even 70% with 15 years left, that is okay because you’ve got beyond the sequence of returns risk. I’m not sure of the percentages I’ll let happen over time yet, but that’s the plan I’ll be using. Starting at 40% and letting it creep up as I get further into retirement and life.

 

[audreyh1]

But, the Asset Allocation will tilt towards having more stocks with the remaining taxable accounts. Yes, converting the IRA's to Roth will use some of the taxable money.

Unless you sell some of the long held stock funds, pay taxes & start buying Bonds in the Taxable accounts, which comes with its own perils of increasing taxes.

I still have 2 years to start the de accumulating phase but the mind often wanders in to the future.

There must be some reasonable ways to keep the Asset Allocation conservative, as one starts spending the Bonds.

The bucket system is kind of designed to do that, no? Sell from bucket 1 first. This implies a higher equity allocation.

The mystery is in the replenishing of bucket 1 and 2. I was never sure how that worked. Seemed like you would end up market timing guessing when it is a “good time” to do that. Or is there some % in each bucket that when exceeded means you need to sell some and put in the lower bucket?

BTW don’t reinvest your dividend or capital gains distributions in your taxable accounts. That will give you some ready cash right there. You have to pay the taxes anyway.

The way you are set up you can’t sell mutual funds in taxable accounts without having a taxable gain (unless they are underwater). You can’t draw from tax deferred funds holding bonds without having taxable income. If you want to have less equities, you need to sell some of your taxable mutual funds. Kind of no way around that.

You’ve been set up for minimal taxes during accumulation, but tax strategy for drawdown can be quite different.

90% of our investments are in taxable accounts and I do simple rebalancing, no bucket system.

 

[Gotadimple]

The bucket system assumes one brokerage account. But many of us have more than one account. So to manage according to the 'system' (which is just asset allocation), you may need to have cash or bonds in more than one account. And manage the buckets across accounts. The caveat is that in taxable you avoid anything paying interest to reduce your tax liability.


So you can have the bucket system but unless you have enough room in each account you may not be able to keep each account for a single type of investment. The disadvantage to having one type of investment in a single account is that market forces can increase/decrease your total allocation beyond your ability to re-balance. In a down year for bonds, you may not be able to add to a tax-deferred account to true up the allocation because you have already deposited the maximum for the year.

I maintain 3 accounts (taxable, tax-deferred, and Roth) and while I may focus bonds in the tax-deferred and stocks/equities in the Roth/taxable, in practice, both the tax-deferred and Roth have a little of each type to reduce volatility.


At re-balance time, I focus on what cash is needed for the upcoming year, and sell from the tax-deferred to fund that (or Roth or taxable, depending on the tax liability). At the same time, I re-allocate. So between cash sitting in accounts from interest and dividends, I make sales to generate the additional cash needed and to re-balance. I do this with a spreadsheet, as I track my allocation that way.

- Rita

 

[rkser]

Here is another informative article from Morningstar on Bucket System withdrawal in Retirement -

Retirement 'Bucket' Portfolios for Vanguard Investors
Christine Benz
24 Sep 2018

https://www.morningstar.com/article...phg&utm_medium=affiliate&utm_campaign=2019may

 

[audreyh1]

Christine Benz is the best source I know for using the bucket system.

 

[Souschef]

The bucket system is great for ER people. They can let their investments in the tax deferred accounts grow faster.
Once you hit 70, the RMD's take over. I have one bucket, my IRA. I use the RMD's to pay my taxes and give some to our children.

 

[pb4uski]

Assuming 4% WR:

Cash... 3 years * 4% = 12% cash... but if you have a pension or taxable account interest or dividends that could be scaled back. For example, for me my pension and taxable account interest and dividends would scale it back to 8.5% (I target 5% which equates to a little less than 2 years rather than 3 years).

Bonds... 3-10 years * 4% = 12-40% bonds.... I use 35% which is 8 3/4 years.

Stocks... 10-20 years * 4% = 40%-80%... I use 60% which is right in the middle.

I guess my point is that I see little difference between buckets and 60/35/5 and I find a static allocation rebalanced a lot easier to manage.... besides, I find the broad ranges of the bucket system useless.

If when you ER you are over 59 1/2 and in a low tax backet and once pensions and SS and/or RMDs start you expect to be in a high tax bracket, I think it is better to draw off of tax deferred or do Roth conversions rather than draw off of taxable accounts to take full advantage of those handful of years that you are in a low tax bracket and to reduce the tax torpedo.

 

[RunningBum]

I've never really used the bucket concept either, or at least not consciously. I have an AA plan, and try to hold to that in the most tax efficient way. I ran into some challenges with managing to the ACA subsidy. If I just can't qualify, I can accept that, but missing it by a small margin hurts. My strategy now for the next 8 years was to set up a CD ladder to give me predictable interest and a cash influx each year to supplement the dividends I get from my index funds in taxable. If I need a little more I'll see if I can take a little bit of cap gains and stay within the ACA limit, otherwise I'll dip into my HSA or Roth. Maybe that's a bucket. I don't know.

From 65-70 I'll probably sell off some appreciated stock funds in my taxable account, and try to convert the rest of my tIRA to Roth. Maybe it makes more sense to just spend from the tIRA instead of convert and not sell stock funds. I'll figure that out. But I don't have a designated bucket of bonds or whatever. I'll raise the cash in the most tax efficient manner, and rebalance if I need to.

After 70, I'll need less when I start getting SS. I'll probably tap my Roth rather than sell highly appreciated taxable shares, unless inheritance rules change.

You have to figure out your own situation and what works best for you with everything considered. Look at the overall tax effect. I don't really like interest at regular income tax rates in taxable, but I had a situation with tax inefficient mutual funds in my taxable account that were going to kick me out of the ACA subsidy. Taking $5000 less income to retain an $8000 subsidy seemed like a good thing, and I needed to rebalance to be less stock heavy anyway, so keeping the proceeds in cash worked for me.

 

[rkser]

I am 63 & DW is 58, I will start withdrawing from Retirement Savings at age 65. We have about 1/2 the portfolio in Bond Funds in Tax Deferred & remaining mostly Stock Funds & some Tax Exempt Bonds in Taxable. I will start drawing SS at age 70. The present Asset Allocation is 50/45/5

In my research I am reading conflicting withdrawal methods by various finance authors.
I am unable to wrap my mind around which way to go, either to liquidate the Taxable Stock Funds first or the Tax Deferred Bond Funds first as each has its pros & cons.

One Probable withdrawal sequence for me could be -

Bucket 1 - 65 to 68 - Cash/CDs

Bucket 2 - 69 to 78 - Bond Funds from Tax Deferred

Bucket 3 - 79 to 95 - Stock Funds from Taxable

The thoughts raised in the above posts make sense to soften the tax bill some starting age 70 due to mandatory distributions, by drawing from Tax deferred first & to leave the stock funds for better appreciation.

- Convert the IRAs to Roth starting now by using the Cash/Cds.

- Direct all dividends & interest income to the Bank Checking account for monthly expenses

- May have to add Tax Exempt Bonds in Taxable as Tax Deferred Bonds are being liquidated to maintain a conservative Asset Allocation.

- Hoping the appreciation of the longer held Stock Funds will be enough to compensate for decreased tax deferral by earlier Bond Fund liquidation & the inheritance will benefit from the increased stepped up basis.

I welcome any critiques & thoughts on the withdrawal strategies used by other forum members

 

[RunningBum]

- May have to add Tax Exempt Bonds in Taxable as Tax Deferred Bonds are being liquidated to maintain a conservative Asset Allocation.

Will you be in a high enough tax bracket to make tax exempt bonds worthwhile? See https://www.investopedia.com/terms/t/taxequivalentyield.asp Don't be short-sighted and try to reduce taxes to the extent where you lower total return.

- Hoping the appreciation of the longer held Stock Funds will be enough to compensate for decreased tax deferral by earlier Bond Fund liquidation & the inheritance will benefit from the increased stepped up basis.

The purpose of tax deferral is to defer income while you are in a high tax bracket until you can take the income in a lower tax bracket. Once your tax rate has leveled out there is no advantage I see to keeping funds in tax deferred. You have a higher pre-tax amount that is compounding, but those gains are taxed too. Lay it out in a spreadsheet and you'll see that it really doesn't matter. And btw those gains will be taxed as regular income when withdrawn; if the gains were in a taxable account, you could get a more favorable LTCG rate, which actually means it's better to take the gains in a taxable account than a tax deferred account. And as you say, it's better for inheritance.

So I wouldn't worry about having to compensate for decreased tax deferral, it isn't an issue. In fact I think now that I'm at a low tax rate, tax deferred is the worst place for my money, and I'm trying to convert that account to a Roth as fast as I can, without jumping my income into a higher tax bracket than I'll see in retirement (and keeping my ACA subsidy).

 

[RunningBum]

You may also find that taking some from each bucket levels out taxes better than emptying one bucket at a time. That's a case by case basis and not possible to use a general rule.

 

[pb4uski]

....Lay it out in a spreadsheet and you'll see that it really doesn't matter. ....

We've used the example for Roth conversions of a $10k tIRA and 15% in taxes and investments double in 10 years.

Convert today and your $10k tIRA becomes a $8.5k Roth and doubles to $17k in 10 years.

Continue deferral and your $10k tIRA today becomes a $20k tIRA in 10 years that is worth $17k after you withdraw and pay the tax of $3k ($20k *15%).

In both cases, after 10 years you have $17k of after-tax value that is available to be spent if desired so tax deferral offers no benefit.

If the tax rate in the future is the same as the current tax rate then deferral offers zero benefit.... if future tax rate is lower then deferral is a disadvantage... it is all just tax-rate arbitrage.

 

[rkser]

Thank you Runningbum & pb4uski,

You raise good points, of Tax Deferral does not have any advantage, that is contrary to what I thought. I always learn something new from your posts & the collective knowledge on the forum.

So I guess, I am better off withdrawing first from for expenses & for the Roth conversions from the Tax Deferred Accounts. I need to be aware not to exceed modified Taxable income for the Marginal Tax Bracket I will be in.

I will leave the Stock Funds for appreciation & inheritance in the Taxable Accounts.

I do not understand how Bucket 1 is funded on a ongoing basis ? or is it just withdraw 1 to 2 years expenses from Tax Deferred & deposit into the Bucket 1 at start of the year

 

[Gotadimple]

Thank you Runningbum & pb4uski,

I do not understand how Bucket 1 is funded on a ongoing basis ? or is it just withdraw 1 to 2 years expenses from Tax Deferred & deposit into the Bucket 1 at start of the year

Yes, just what you said!


- Rita

 

[pb4uski]

What you describe... withdrawing from tax-deferred to fill up the 0% capital gains bracket is what I am doing... for some people it might be to the top of the 22% tax bracket... and I'm leaving taxable equities alone to grow and get a stepped up basis so effectively tax-free gains.

For people who use buckets, I think that bucket 1/cash is replenished from bucket 2/bonds and bucket 2 is replenished from bucket 3/stocks. Bucket gets replenished annually and bucket 2 gets replenished when stocks have done well. If stocks have an off year (like in 2018) then bucket 1 gets replenished from bucket 2 but there is no replenishment of bucket 2.... so you're living off of bonds until stock recover sufficiently to replenish bucket 2.

I think you could accomplish the same thing with a conventional AA by just having a decision rule that stocks are rebalanced only where they exceed their target, but if they are under target no rebalancing is done. So if my equities target is 60% and I rebalance annually, if stocks are over 60% then rebalance... if stocks are less than 60% then stand pat.

 

[rkser]

Yes that is what I do too, if stocks exceed or lose over 3%, I re balance annually to maintain the AA of 50/45/5.

Thanks, I understand the funding of Bucket 1 now.

 

[Bir48die]

Was pitched the bucket system by my FP who I let go. System made some sense. However have a year's cash at any given time and change my AA to allow me to draw without tapping equities.

 

[HI Bill]

You may also find that taking some from each bucket levels out taxes better than emptying one bucket at a time. That's a case by case basis and not possible to use a general rule.

+1 I would only take from Bucket 1 if my portfolio value had fallen significantly from its starting value. Bucket 1 isn't for the first three years, it's for up to 3 years during a bad SOR. Otherwise, I would maximize tax-deferred withdrawals to at least the MFJ standard deduction of $24.4K (2019) to essetially take the $ tax free, especially after age 59.5 and before RMD age.

I never saw this as a sequential withdrawal plan, but a sequential risk plan.

 

[targatom2019]

what is the lowest amount you able to withdraw from a tax deferred acc. like TIRA or 401k before you have to pay taxes ?

If I only need to take out 10K per year after 59.5 yo then will my tax rate be lower then taking out 50k per year ?

 

[pb4uski]

^^^ It all depends on what other income you have before any withdrawls.

If you had NO other income then the most you could take out without paying any federal taxes would be an amount equal to the standard deduction.... in 2019 $12,200 for a single and $24,400 for MFJ.

But, there are two low tax brackets of 10% and 12%.

If you had NO other income and took withdrawals to the top of the 12% tax bracket you could withdraw $51,675 and pay $4,543 in tax... a very reasonable 8.8%. Amounts are double for MFJ.

 

[kaneohe]

..............................................

I do not understand how Bucket 1 is funded on a ongoing basis ? or is it just withdraw 1 to 2 years expenses from Tax Deferred & deposit into the Bucket 1 at start of the year

In the beginning even tho I had a relatively large cash bucket, I found it depleted quite rapidly esp. once RMDs started. Now I try to replenish it
from the RMD......e.g. if I think that 33% will go for fed/state taxes, then 33% of the equity RMD plus the amount that was in fixed income RMD go to cash/fixed income.

The amount that was in equities less the amount for taxes can be reinvested.
If a 10K RMD (5K equity/5K fixed income) is distributed, then 6.7K goes for cash/fixed income and 3.3K is reinvested. This is a mechanical system that helps me take the emotion out of when to sell to replenish cash.

The cash still depletes due to normal spending but at a slower rate due to replenishment of the tax component.

 

[rkser]

For me, the system of pb4uski seems simple enough to follow to replenish Bucket 1 & to make some sense of the 3 bucket system.

I have got 2 more years before I start withdrawing from the Portfolio .... I will keep learning & hopefully get it down by that time.