preparing for ER: pretend you're my financial advisor

[mrfeh]

Hi folks.

I'm preparing for ER, and would like to know what steps I need to take between now and then. Here's the plan:

• wife and I both 47
• I plan on retiring in 3 years, at 50
• wife will retire in 5 years, at 52
• annual expenses: $40-45K
• tax bracket in retirement: 15%

My wife's salary doesn't quite cover our expenses, so we'll need to start partially living off of savings for a couple years. In five years, we'd be living completely off of our taxable account until we have access to IRAs, 8 years later.

Finances:

• overall AA: 70/30
• taxable account: $625K (100% equities)
• Roth IRAs: $115K (100% equities)
• 401K: $125K (100% equities)
• trad IRAs: $375K (100% fixed income)
• I-bonds: $20K
• no debt

If I need to provide more info, please let me know.

My primary concern is getting from 52 to 60. What would your advice be?

Thanks!

 

[LOL!]

One important thing in your retirement is that you will NOT be paying income taxes because your taxable income will be so low. In that case, be sure to map out how you will do conversions of your 401(k) and traditional IRAs to a Roth IRA while you are in that zero-percent tax bracket. See also Retirement Calculator - Parameter Form and TurboTax for help with that.

 

[mrfeh]

One important thing in your retirement is that you will NOT be paying income taxes because your taxable income will be so low. In that case, be sure to map out how you will do conversions of your 401(k) and traditional IRAs to a Roth IRA while you are in that zero-percent tax bracket. See also Retirement Calculator - Parameter Form and TurboTax for help with that.

Thanks for the reminder - yes, we will be able to convert when we're in our 50s.

Any recommendations on what I need to do over the next 3 years?

 

[Ready]

Hi there. Based on your ages, I think you should prepare for 40 years of retirement, rather than the traditional 30 years. Run your numbers through firecalc.com to see where you stand. If I were in your situation, I would want to withdraw no more than 3% per year from my savings to live on, so that I would feel comfortable that my portfolio would not be depleted before the 40 year time span.

Based on this, you should have at least $1.5M in savings. It looks like you are a few hundred thousand short. Can you put away another $300K or so in the next 3-5 years? Also, a couple living on $45K is relatively sparse. Are you budgeting for repair/replacement costs for auto, housing, major appliances, etc? And, are you including health care costs once you no longer have your employer to subsidize health care costs (assuming they do now)?

I think you're close to reaching FI, but not quite there yet, so it all comes down to how much you can save in your remaining years of work.

 

[mrfeh]

Hi there. Based on your ages, I think you should prepare for 40 years of retirement, rather than the traditional 30 years. Run your numbers through firecalc.com to see where you stand. If I were in your situation, I would want to withdraw no more than 3% per year from my savings to live on, so that I would feel comfortable that my portfolio would not be depleted before the 40 year time span.

Based on this, you should have at least $1.5M in savings. It looks like you are a few hundred thousand short. Can you put away another $300K or so in the next 3-5 years? Also, a couple living on $45K is relatively sparse. Are you budgeting for repair/replacement costs for auto, housing, major appliances, etc? And, are you including health care costs once you no longer have your employer to subsidize health care costs (assuming they do now)?

I think you're close to reaching FI, but not quite there yet, so it all comes down to how much you can save in your remaining years of work.

Yes, I've used firecalc, and I agree we're looking at a 3%/year withdrawal rate. And I know we haven't reached our number yet - which is why I'm not retiring tomorrow. If the market does poorly the next 3 years, I can always keep working.

I appreciate the comment, but I don't want this to become a conversation about whether we can retire. For now, let's just assume things will go according to plan; if it does, what financial moves do we need to take in preparation?

 

[Independent]

There seems to be some conventional wisdom that we should spend down taxable accounts first. (I can't claim that I've ever tested it.)

The biggest investment threat to retirement is the possibility that market prices fall immediately after I retire, forcing my to sell assets at depressed prices. That is, I have to sell "too many" shares.

Putting those two statements together, the 100% equity allocation in your taxable accounts looks significantly high. If the stock market goes down, you may find yourself paying a penalty or doing an awkward 72t just so you can get at the bonds.

I'd try to shift some money in the taxable accounts into things that I can sell without losing my shirt if the stock market happens to go down. Since P/E ratios seem high right now, it doesn't look like I'd take a hit doing this.

 

[mrfeh]

There seems to be some conventional wisdom that we should spend down taxable accounts first. (I can't claim that I've ever tested it.)

The biggest investment threat to retirement is the possibility that market prices fall immediately after I retire, forcing my to sell assets at depressed prices. That is, I have to sell "too many" shares.

Putting those two statements together, the 100% equity allocation in your taxable accounts looks significantly high. If the stock market goes down, you may find yourself paying a penalty or doing an awkward 72t just so you can get at the bonds.

I'd try to shift some money in the taxable accounts into things that I can sell without losing my shirt if the stock market happens to go down. Since P/E ratios seem high right now, it doesn't look like I'd take a hit doing this.

Yes, I often have this same thought/question. Should I have a less volatile asset in my taxable account for the 50-60 period? I have read elsewhere that this isn't really selling low, because after selling equities in taxable, you sell bonds in tax-advantaged to buy equities. This keeps your AA constant. Of course, this doesn't negate the fact that your taxable account can lose a large percentage of its value in a short period of time.

Thanks for the comment - this is the kind of issue I'd like to discuss. Hopefully others that have ER'd will chime in to let me know what they did in this scenario.

 

[clifp]

Good questions.

Step 1 cut back your 401K contributions to the minimum need to get the company match. Generally you'll have lower expenses in things like an index fund,and you'll want to have as much as possible in taxable accounts. The exception to this advice would be is if you are in a much higher tax bracket >25% and you are primary earning. In which case you can have your wife cut back her contribution after you retire.

Step 2 and the real important one is make sure you can live on 40-45k. You can't control the market but you can control your expenses. The missing piece of the info your provided is how much you are currently making. Not that I care it is just easier to believe someone is going to be be able to live on 40-45K if the wife is making 30K and you are making 50K and doing a good job saving, than if you are both making 60K. I'd literally starting in Jan put 6K in a checking account and than transfer 3K a month into the account and only spend money from that account. If you can do that for 2 years running than you can in fact live on 42K a year.

Your overall AA is good and you have the right assets in your taxable account and tax deferred account. However I agree with independent you do want to have some cash in your taxable account so in the event of a bear market right after you retire you don't have to sell stocks. I'd suggest while you are still working setting up a 4 to 5 year CD ladder with roughly 20 to 25K each. So if the market goes down than you have a roughly 6 months expense in cash, the dividends from your equity portfolio should produce roughly another 15K (assuming you save more in the next 3 years).

 

[LOL!]

Some folks say get all your major physicals and tests (colonoscopy) while on employer health insurance in case something bad is found.

Others say, don't try to find anything bad until you have secured private health insurance for retirement, so that you are still insurable and rates are not too high.

I don't know how ACA affects those sentiments.

 

[REWahoo]

This thread may have some useful tips: http://www.early-retirement.org/forums/f29/how-do-did-you-prepare-for-er-20952.html

 

[mrfeh]

Good questions.

Step 1 cut back your 401K contributions to the minimum need to get the company match. Generally you'll have lower expenses in things like an index fund,and you'll want to have as much as possible in taxable accounts. The exception to this advice would be is if you are in a much higher tax bracket >25% and you are primary earning. In which case you can have your wife cut back her contribution after you retire.

This thought occurred to me on my way home. I was wondering if I should starting throwing as much as I can at our taxable account for the next 3 years. We are in the 25% bracket.

Step 2 and the real important one is make sure you can live on 40-45k. You can't control the market but you can control your expenses. The missing piece of the info your provided is how much you are currently making. Not that I care it is just easier to believe someone is going to be be able to live on 40-45K if the wife is making 30K and you are making 50K and doing a good job saving, than if you are both making 60K. I'd literally starting in Jan put 6K in a checking account and than transfer 3K a month into the account and only spend money from that account. If you can do that for 2 years running than you can in fact live on 42K a year.

My wife just went back to work; we had been living on my income alone, which is about $120K. I'm quite sure our current expenses are $40K.

Your overall AA is good and you have the right assets in your taxable account and tax deferred account. However I agree with independent you do want to have some cash in your taxable account so in the event of a bear market right after you retire you don't have to sell stocks. I'd suggest while you are still working setting up a 4 to 5 year CD ladder with roughly 20 to 25K each. So if the market goes down than you have a roughly 6 months expense in cash, the dividends from your equity portfolio should produce roughly another 15K (assuming you save more in the next 3 years).

Thanks. I did some googling after posting my question and came across a couple ideas I need to think about some more: bucketing and creating an income ladder for the first 3-5 years of retirement. I need to spend some more time thinking about these concepts.

 

[growing_older]

If the stock market goes down, you may find yourself paying a penalty or doing an awkward 72t just so you can get at the bonds.

This may not be true. If you sell whatever amount of equities in taxable you want (take a loss even) then sell bonds in taxadvantaged but use the proceeds to buy similar (not exactly the same to avoid wash sale) you have in fact accessed the same amount of money as selling the bonds, but moved the equity position into the tax advantaged space.

 

[BTravlin]

I think your AA is good when looking at a 35-40 year retirement. A little more volatile than many would be comfortable with but also more likely to provide the returns you'll need for a comfortable retirement over the long haul.

Having zero debt is key so you're free to save aggressively over your last few years working. And I agree, bulk up on cash in your taxable account since cash provides you flexibility in funding options.

 

[mrfeh]

I think your AA is good when looking at a 35-40 year retirement. A little more volatile than many would be comfortable with but also more likely to provide the returns you'll need for a comfortable retirement over the long haul.

Having zero debt is key so you're free to save aggressively over your last few years working. And I agree, bulk up on cash in your taxable account since cash provides you flexibility in funding options.

Yes, I think I'm going to start "setting aside" money for living expenses that I'll need 3+ years from now. The question is, what type of investment to use for that purpose.

What are folks thoughts on the following: CDs, I-bonds, municipal bond funds?

 

[woodguy00]

clifp, you recommended cutting back the 401(k) contributions in favor of after tax savings.

If the OP is currently in the 25% tax bracket and expects to live the years between retirement and 59 1/2 off of the taxable account, thus little or no income tax, wouldn't it make sense to max out 401(k) deductions and then look to roll the 401(k) and taxable IRA to Roth over time once retired at lower tax rates? Am I missing something?

 

[Fermion]

Healthcare shouldn't be *too* bad. Even if you have zero basis in your taxable account and have $40,000 of unearned income in capital gains and dividends, you will still qualify for a subsidy.

From: Subsidy Calculator | The Henry J. Kaiser Family Foundation

For 2 adults age 52, non smokers with no children:
Max out of pocket for premium = $3,312 a year
Max out of pocket not including premium = $12,700 per year

So about $16,000 a year worst case for medical.

Now if you are able to pull income from already taxed money such that your unearned income from capital gains and dividends is $25,000 a year instead of $40,000, then from the calculator your out of pockets drop to:

$1,129 for the premium per year and $4,500 per year max out of pocket other than premium.

So about $5600 per year worst case for medical.

Quite hilarious huh? If you make $40,000 you take home $24,000 after worst case medical expenses and if you make $25,000 you take home $19,400 after worst case medical.

This is why I am setting us up with a good amount of cash, plus I will do a bit of capital loss harvesting each year to keep our investment income low.

 

[Independent]

Yes, I often have this same thought/question. Should I have a less volatile asset in my taxable account for the 50-60 period? I have read elsewhere that this isn't really selling low, because after selling equities in taxable, you sell bonds in tax-advantaged to buy equities. This keeps your AA constant. Of course, this doesn't negate the fact that your taxable account can lose a large percentage of its value in a short period of time.

Thanks for the comment - this is the kind of issue I'd like to discuss. Hopefully others that have ER'd will chime in to let me know what they did in this scenario.

Good point. Some people aren't that organized, obviously you are.

Interesting tax question. If you sell stocks in your taxable accounts when the market is depressed, you'll pay less cap gains tax then if you had sold them earlier when the market was higher. Of course, you have to sell more shares in total to hit the same income goal. Is there some overall tax advantage? (assuming, again, that you are simultaneously buying stocks in the qualified to maintain an AA)

 

[mrfeh]

Good point. Some people aren't that organized, obviously you are.

Interesting tax question. If you sell stocks in your taxable accounts when the market is depressed, you'll pay less cap gains tax then if you had sold them earlier when the market was higher. Of course, you have to sell more shares in total to hit the same income goal. Is there some overall tax advantage? (assuming, again, that you are simultaneously buying stocks in the qualified to maintain an AA)

The major tax advantage to selling equities in taxable is that the cap gains are taxed at 0% if you are in the 15% tax bracket. Folks that can implement this strategy live (federal) tax free.

 

[Midpack]

The major tax advantage to selling equities in taxable is that the cap gains are taxed at 0% if you are in the 15% tax bracket. Folks that can implement this strategy live (federal) tax free.

The 0% tax on LTCG (and qualified dividends) for the 15% and under tax brackets was just enacted for 2008-2012, and then extended for who knows how long. I wouldn't plan on 0% LTCG tax indefinitely. YMMV

One of several articles suggesting the various windfalls for most if not all brackets will end after 2014.

Tax breaks for capital gains and dividends are likely to end by 2015, as lawmakers look for ways to broaden the tax base, allowing income tax rates on individuals to be cut.

Read more at http://www.kiplinger.com/article/bu...tal-gains-tax-breaks.html#2tUIfX65Qx7RTMiZ.99

 

[jIMOh]

Hi folks.

I'm preparing for ER, and would like to know what steps I need to take between now and then. Here's the plan:

• wife and I both 47
• I plan on retiring in 3 years, at 50
• wife will retire in 5 years, at 52
• annual expenses: $40-45K
• tax bracket in retirement: 15%

My wife's salary doesn't quite cover our expenses, so we'll need to start partially living off of savings for a couple years. In five years, we'd be living completely off of our taxable account until we have access to IRAs, 8 years later.

Finances:

• overall AA: 70/30
• taxable account: $625K (100% equities)
• Roth IRAs: $115K (100% equities)
• 401K: $125K (100% equities)
• trad IRAs: $375K (100% fixed income)
• I-bonds: $20K
• no debt

If I need to provide more info, please let me know.

My primary concern is getting from 52 to 60. What would your advice be?

Thanks!

My summary is you are close, most of issues are asset location, not asset allocation. Meaning location of which assets are in which accounts.

These are questions I would ask you:

You have $625k in a taxable account in equities, what is the BASIS of these investments? What is the large cap/small cap foreign allocation of these?

You stated expenses, but did not state income or current tax situation. Most of my advice would center around tax planning for next 3 years, not an investment strategy. Most financial planners are tax illiterate, so my second bit of advice is to find a tax professional you trust.

What is the detailed allocation of the fixed income? Treausuries, short term bonds, long term bonds, junk bonds, foreign, domestic, cash etc...

What is the dollar amount (monthly and annual) of contributions to Roth, 401k, and taxable accounts?

Then I would advise to do the following:

1) Move fixed income investments out of long term bonds and into short term or corporate notes. I would also look for alternative income income investments you are comfortable with (long-short, convertibles, short selling).

2) I would allocate new money (amount depends on answers to preliminary questions) to fixed income in taxable accounts, with a bias towards short term bonds, inflation bonds and alternative income strategies.

3) I would consider taking a mortgage out on house and investing proceeds into short term cash reserves. Within 3 years you should be able to find CDs which yield higher than a 3% loan, and this is a good inflation hedge.

4) I would revisit budget for replacement costs- roof, car, HVAC, Healthcare, Dental care, vision etc...

 

[mrfeh]

My summary is you are close, most of issues are asset location, not asset allocation. Meaning location of which assets are in which accounts.

These are questions I would ask you:

You have $625k in a taxable account in equities, what is the BASIS of these investments? What is the large cap/small cap foreign allocation of these?


Cost basis is $574K.

total US market: 42%, 11% unrealized gains
total int'l market: 30%, 0% unrealized gains
US small value: 22%, 7% unrealized gains
int'l small cap: 6%, 10% unrealized gains

You stated expenses, but did not state income or current tax situation. Most of my advice would center around tax planning for next 3 years, not an investment strategy. Most financial planners are tax illiterate, so my second bit of advice is to find a tax professional you trust.

What is the detailed allocation of the fixed income? Treausuries, short term bonds, long term bonds, junk bonds, foreign, domestic, cash etc...

Fixed income is 83% intermediate US bonds, 17% bank loan fund.

What is the dollar amount (monthly and annual) of contributions to Roth, 401k, and taxable accounts?

Have been maxing 401K for a very long time. Have been maxing IRAs also, but may not be able to this year, due to income ceiling. Taxable contributions vary, depending on how much extra cash we have. In total, we can save roughly $40K/year, until I retire.

Then I would advise to do the following:

1) Move fixed income investments out of long term bonds and into short term or corporate notes. I would also look for alternative income income investments you are comfortable with (long-short, convertibles, short selling).

Can you explain why? Our bonds are in our IRAs and won't be touched for years.

2) I would allocate new money (amount depends on answers to preliminary questions) to fixed income in taxable accounts, with a bias towards short term bonds, inflation bonds and alternative income strategies.

Yes, I'm starting to think the same thing. My current thoughts are I-bonds and short-term munis.

3) I would consider taking a mortgage out on house and investing proceeds into short term cash reserves. Within 3 years you should be able to find CDs which yield higher than a 3% loan, and this is a good inflation hedge.

Ooh, this is unlikely. It may make financial sense, but we've been mortgage-free for 10 years, and I don't want to go back.

4) I would revisit budget for replacement costs- roof, car, HVAC, Healthcare, Dental care, vision etc...

Yes, will do.

Thanks!

 

[jIMOh]

Thanks!

What is the detailed allocation of the fixed income? Treausuries, short term bonds, long term bonds, junk bonds, foreign, domestic, cash etc..

Fixed income is 83% intermediate US bonds, 17% bank loan fund.

You want more cash, and want more than just government bonds

What is the dollar amount (monthly and annual) of contributions to Roth, 401k, and taxable accounts?

You did not answer this question, and my specific advice focuses on this variable more than the others.

Have been maxing 401K for a very long time. Have been maxing IRAs also, but may not be able to this year, due to income ceiling. Taxable contributions vary, depending on how much extra cash we have. In total, we can save roughly $40K/year, until I retire.

I would allocate new money in taxable accounts to munis, corporate bonds, convertibles and other income instruments.

Then I would advise to do the following:

1) Move fixed income investments out of long term bonds and into short term or corporate notes. I would also look for alternative income income investments you are comfortable with (long-short, convertibles, short selling).

Can you explain why? Our bonds are in our IRAs and won't be touched for years.

You suggested in 3 years you will be touching taxable accounts, and you have no fixed income in taxable accounts. Whatever tax problem is created will be minimal (because the balances will be low), and short in time (3 years) .

By adding this, you will add flexibility to the plan- its possible you could live off income from taxable investments (and not sell $625 equities at a loss) while doing Roth conversions and getting asset location set up properly.

 

[mrfeh]

You want more cash, and want more than just government bonds

Sorry, didn't mean to give the impression it was just government. They are intermediate US bond market, not just government. PTTRX and FSITX.

You did not answer this question, and my specific advice focuses on this variable more than the others.

I thought I did - maxing 401K (about $20K including employer match) and IRAs ($11K).

I would allocate new money in taxable accounts to munis, corporate bonds, convertibles and other income instruments.


You suggested in 3 years you will be touching taxable accounts, and you have no fixed income in taxable accounts. Whatever tax problem is created will be minimal (because the balances will be low), and short in time (3 years) .

I think the plan will be to place some fixed income assets in our taxable account over the next 3 years. Does that make sense?

By adding this, you will add flexibility to the plan- its possible you could live off income from taxable investments (and not sell $625 equities at a loss) while doing Roth conversions and getting asset location set up properly.

Could you provide more detail on your last point? I don't think our taxable account is large enough to live off just dividends.

Thanks again.

 

[mrfeh]

This is my initial shot at living off our taxable account for 10 years. Does it make sense? Would you take a completely different route?

Thanks.

 

[jIMOh]

Could you provide more detail on your last point? I don't think our taxable account is large enough to live off just dividends.

Thanks again.

My suggestion would be add about $30k to taxable accounts each of the next 3 years. This would increase bond exposure of portfolio from about 30% to 35-40% in same timeframe without selling or rebalancing rest of portfolio.

The 100k added could yield 4-6% and generate $6000 of the needed $45k in income without cashing any investment out. It would lower the risk of the portfolio as well.

If that same 100k was invested in dividend paying stocks, its possible you could shift strategies to live off dividends... (3% of $725k would generate half the income you need at possibly lower tax rates).

I would focus on your tax situation each of the next 5-6 years first, see what you can do then which might be not in your favor now (Roth conversions, dividend tax rates, capital gains rates) and build that into the whole decision making process.