Passive income and SRW

[starry night]

Help me. Since there are no stupid questions and I have acquired a great deal of regard and respect for many of you that I've been reading out there, help me out with this one. What we have done is split our pot into two nesteggs -- one is set aside as our nest egg "for later" consisting of our retirement accounts (IRA, 401K rollovers, etc. - all the tax deferreds) plus some stock holdings and the equity in our home. All of this is not needed for now - invested for growth and tax-advantages. Second nest-egg is "for sooner" - this is the after-tax savings that we are willing to live off now to pull the plug on employment (I've just put in my notice for 3/15/06, and husband will jump ship 7/1/06 after mid-year bonus). This fund should carry us well up to SS eligibility and beyond.

Anyway, this fund pays us $40K in dividends and distributions annually, so we expect to only have to withdraw about 2% from corpus, and plan to accomplish this when we rebalance portfolio annually - withdrawing from gainers or when allocation needs correction.

How does the receiving of distributions factor in to the calcuated Rate of Withdrawal?? Since reinvested earnings are part of the calculated rate of return, is this also considered as part of the rate of withdrawal? Or is withdrawal viewed as only the actual reduction of principal/corpus? What do I need to know?

 

[ESRBob]

Starry Night,
Your withdrawal rate counts everything you take out in a year, as a percent of your assets. It is not just the amount of 'principal' (I think you call it corpus) that you draw down.

Many people find a well-balanced portfolio generates 2 or 2.5% interest and dividends. That means that, for a 4% withdrawal, you are liquidating assets for the additional 1.5 to 2% you need to make up the additional amount. (Maybe more, since some of the interest and dividends may be earned in tax-advantaged accounts where you can't actually spend it yet)

The additional 1.5 or 2% might come to you conveniently through capital gains distributions in a stock fund, or you may find that when you do your annual rebalancing, you need to top up your cash/money market allocation for spending purposes. Unless every asset class is going down, you will likely be selling winners, or realizing some capital gains, in order to fund some of your annual spending. Is that "eating into the corpus or principal?" Since they are gains, I am not so sure, and thus have never really loved that terminology.

If you are just bridging a few years to Social Security, you may want to think about your SWR somewhat differently than those who are still a long way from SS. In other words, SWR matters over the long run -- it tries to tell you what amount you can safely withdraw over decades. If you just need to bridge some living expenses between now and 2009, for instance, after which point SS kicks in, then I would say your real issue is to look at how your withdrawals stack up as a percentage of the assets you'll have remaining post 2009. If that number is within a safe range, then I would say don't worry so much about the next few years when your withdrawal may be higher than a safe number.

Not sure if that is what you were asking, but it seems it would be relevant in your case.