Another AA question...

[mistermike40]

Hi, I have a question regarding AA (and there are a lot of really smart, investment-savvy people here!). My situation: I have a non-indexed pension that covers 100%+ of our living expenses/lifestyle (including all fixed costs, health care, food and drink, entertainment, clothes, short travel, etc). It decreases when I turn 62 (I just turned 59) but I'll probably take SS then, giving us even more "headroom". The 401k is for more expensive vacations, major house repairs, large purchases, etc... we won't be forced to draw from it (given our current expenses stay the same while increasing with inflation) until our late 80's.

My question: how would you set up a 401k AA for this situation? I want to keep it simple, just two or three index funds and bonds/cash. My current AA:


Passive Index Funds
50% Vanguard U.S. Large Cap Index Fund (tracks S&P 500)
20% Vanguard U.S. Small/Mid Cap Index Fund
10% BlackRock International All Cap Equity Index Fund

Bonds/Cash
20% BlackRock Bond Index Fund


I'm thinking (since I'm now retired and no longer contributing to the 401k) I should maybe shift from 80/20 to 70/30 or even 60/40. Or - since I can go for many years without drawing from it - maybe keeping it at 80/20 isn't being too aggressive? Also, given the fund choices listed (and assuming 80/20), would you stay at 50% SP500, 20% Small/Mid, and 10% International?

Thanks in advance for you thoughts/suggestions!

 

[sengsational]

Not everyone frames the AA decision the way I do, but I start with never having to sell low. So I want the cash/bond portion to last 7 years or something. Yes, the bonds can go down too, but short enough bonds should hold pretty good. So in your situation, not needing to draw on assets, you could go pedal to the metal. Then you run into 'sleep at night' issues, which tempers the ratio. And if you buy into the analytics, having at least some bonds gives you the rebalancing advantage. I'd go 80/20, as a gut response to your inquiry. Whatever you pick, it's more important to stick with it through all the gyrations than to worry about 5% one way or the other.

 

[RunningBum]

You look to be in a can't lose situation. Congrats. I view that pension and SS as being non-equity like, so I'd be aggressive with the rest and be able to leave more for heirs, charities, plus have fun with it. I was thinking 80/20, so what you have now sounds great. If you want to cut it back a bit I wouldn't find any fault with that. Some would say you've won the game so why risk any of it in equities, which is fine if you're of that mindset but I'd rather do 80/20 or 70/30. The main thing is to stay with it even if we do have a big drop, so that you gain it back in the eventual recovery.

 

[pb4uski]

There are two schools of thought on your situation where your pension and SS cover your expenses.

One extreme is that there is no need to take any risk with that money so just go with CDs. The other extreme is that since you don't "need" that money that you can take a lot of risk and volatility in exchange for higher returns. A complimentary view is that you are investing that money principally for heirs and charities since you don't "need" it so you should invest it like they would.

So no right answer... whatever is most comfortable for you and allows you to sleep at night.

On a different vein, between now at 59 and when you start SS and/or RMDs may be an ideal time to do withdrawals and/or Roth conversions at a lower tax rate than you will have once you have income of the pension, SS and RMDs (aka the tax torpedo). If it were me I would start draining the 401k once you have penalty free access to it if you can do so at a tax rate that is lower than your tax rate will likely be once pension, SS and RMDs are all going.

 

[Nature Lover]

My situation is similar in some respects to MisterMike's - pension income currently covers regular living expenses; investments are most likely to be reserved for additional discretionary expenses. Here's how I approach the AA question re: different parts of my overall portfolio:

For the 2 accounts that I am currently taking RMDs (inherited IRAs): I target ~50% equities. I like to be able to have a stable RMD amount, and this is a good balance IMO to participate in the markets while keeping the RMDs fairly stable.

For the account that I expect to be invested longer before any withdrawals (my primary IRA, so ~12 years to RMDs): I target ~65-70% equities.

I think I have a substantial enough safety net in the taxable portfolio to likely not make WDs from the tax deferred accounts other than for RMDs.

For reference, I target ~60% equities for my overall portfolio, including all accounts, (currently ~58%).

NL

 

[OldShooter]

I won't wade in to most of this but my thoughts on your equities were:

1) Why screw around with two funds that almost but probably don't quite capture the whole US market? Just buy one that does.

2) International content is lower than most recommend. There is a very recent thread here: http://www.early-retirement.org/forums/f44/international-stock-allocation-question-again-95597.html that you might find to be worthwhile reading.

 

[mistermike40]

Thanks, I appreciate everyone's input. I wanted to do my annual re-balance this week and thought this would be a good time to change AA (if desired)... I've decided to stay with 80/20.

I'm also going to look further into Roth conversions (I have penalty-free access to the 401k now), or possibly a CD ladder.

 

[pb4uski]

On the Roth conversions... look at your marginal tax rate with your pension and any taxable account income today.... and compare it with your marginal tax rate adding in 85% of SS and RMDs (~4% of your tax-deferred). The difference is potential tax savings.

In our case our marginal tax rate today is zero (taxable account investment income and my small pension are less than the standard deduction and our marginal tax rate with 85% of SS and RMDs is 22%... so I've been withdrawing or converting to the top of the 12% tax bracket and paying 11% on those distributions on average and saving 11%.

 

[sengsational]

Thanks, I appreciate everyone's input. I wanted to do my annual re-balance this week and thought this would be a good time to change AA (if desired)... I've decided to stay with 80/20.

I'm also going to look further into Roth conversions (I have penalty-free access to the 401k now), or possibly a CD ladder.

I always recommend i-orp as a data point for Roth conversion planners. It's typically aggressive in pushing through conversions, so many people are not taking the advice on face value, but you can enter both limited and unlimited conversions and see how much you're theoretically giving up.

 

[Sunset]

I would suggest OP delay taking SS and wait a few years, by using some of the 401K money to make up the shortfall at 62.

The amount in SS increases is substantial. It also makes it better for the surviving spouse, his pension amount for the surviving spouse is unknown, possibly 50% or zero ?

OP has not spoken as to his spouse retirement plans/income.

 

[DrRoy]

Every year you delay SS up to age 70 the payment rises 8%. I would temper the equity % just for peace of mind.

 

[VanWinkle]

I usually think about how long it would take to recover from a 50% down market. With an 80% equity Allocation, it would take over 65% to recover from a 40% loss to your portfolio. No problem when you're young and studly, but at 59 and retired, I would likely go in the 60/40 range just to reduce the chance of a large draw down. Not making big mistakes is more important than getting exact about AA.

VW

 

[marko]

Whatever you pick, it's more important to stick with it through all the gyrations than to worry about 5% one way or the other.

OP, Not to take anything from the other thoughtful posts here, but THIS is probably the best advice you'll get from this thread.

 

[mistermike40]

Thanks again for everyone's opinion, I really appreciate them. A few comments:

- I did stay the course at 80/20 (while employed) and didn't stress about market fluctuations. If I do decide to shift (maybe to 60/40) I would "set it and forget it" as before.

- OldShooter: my company's 401k plan has a limited number of funds to choose from. These seemed closest to how I would ideally invest, and they are very low-cost index funds.

- Sunset: my spouse would receive 65% of my pension if I pass away first. She was a stay-at-home mom for almost all of our marriage, she will receive a portion of my SS.

- I am considering delaying SS... I'm looking at 62, 65, 67 and 70. If I don't take it at 62 I can still get by with very minimal 401k withdrawals... I have a few years to decide.

 

[pb4uski]

....I am considering delaying SS... I'm looking at 62, 65, 67 and 70. If I don't take it at 62 I can still get by with very minimal 401k withdrawals... I have a few years to decide.

Another benefit of delaying SS and living on tax-deferred withdrawals is that in some situation it would allow you to reduce tax-deferred balances enough so RMDs don't push you into a higher tax bracket... IOW they mitigate the dreaded tax torpedo.

 

[OldShooter]

... OldShooter: my company's 401k plan has a limited number of funds to choose from. These seemed closest to how I would ideally invest, and they are very low-cost index funds. ...

No problem. They are fine funds and very reasonable to hold. I am just a KISS kind of guy. I still recommend, though, that you consider raising you international component to 30% of your equity total, or more.