Best Way to Cover Essential Expenses During ER

[Trooper]

Hi...looking for some advice here.

DW and are planning to retire in one year from now. I will be 57 and DW will be 56. Through an arrangement with my employer we are entitled to no-cost financial planning advice from Fidelity. Prior to the meeting I loaded all our financial info (expenses, assets, SS amounts, etc) into their RIP. In that process I indicated which expenses were essential and which were discretionary.

Overall the RIP says we are good until age 93. However, the model also compares essential expenses with fixed sources of income like pensions and SS. Because we are taking SS at aged 67, the model shows we have a gap between guaranteed income and essential expenses of about $4500 month until SS kicks in.

Fidelity's adviser suggests that we buy an 8-year period certain annuity for about $395K that would throw off the $4500 to cover our essential expenses. How do we evaluate whether that is the right thing to do, whether that is a fair quote for the annuity? DW is fairly risk averse. What other investment options are out there that will accomplish the same goal?

Thanks...

[LOL!]

8 years of 4% sustained withdrawal is simply 32% of a portfolio. So why not have 32% of the portfolio in fixed income mixed between short-term bond funds and intermediate-term bond funds? If you feel these bond funds might drop 10%, then add in an extra 10% contingency, so say rounded off to 35% fixed income for your portfolio.

Oh, wait, a 65:35 asset allocation is in the very typical range for early retirees. It seems you probably already have settled on a similar asset allocation and thus do not need to do anything special --- except don't buy an annuity while you are so young.

[Animorph]

If the annuity returns better value over the 8 years than an online savings bank or a bond fund or a CD ladder, then it may well be a nice place to put some of your fixed income allocation. Keeping in mind that it is returning mostly just your original principal.

I've been happy to go with the larger withdrawal rate from my normal portfolio to cover those pre-SS years. There is no need to convert assets into "income". Those 8 years will be very much like the next 30 years after that, it's just that your withdrawal rate will be a little higher. On the other hand, these are the critical years for the portfolio, so you may want to stay a little conservative.

In my case, I sell for cash whenever the portfolio reaches my start of year value for coming years. I currently have 2 to 3 years of expenses in cash, depending on how the unexpected expenses run. If the market drops and my cash runs out I'll start selling for cash month to month.

[Independent]

Give a similar situation, we put the money into laddered CDs and I-bonds.

I'd check prices on them (recognizing that the I-bonds are CPI-indexed) and compare.

I'm more comfortable with FICA-insured CDs and gov't issued bonds then insurance company annuities.

Some people here would say that you can cover the later years (e.g. 8, 9, and 10) with stocks. That is a little higher on the risk/reward spectrum.

[fosterscik]

A quick calculation shows they are offering you an effective annual interest rate on your initial investment of a little less than 3% and then spending down your principle. If you can set up a bond ladder with better terms then you should do that. If safety is paramount (and you trust the solvency of the annuity insurance company) then 3% guaranteed is not terrible in today's interest environment. Given the likely hood that rates will (eventually) rise you should wait as late as possible to commit the funds if you decide to go the annuity route.

[brewer12345]

You are talking about essentially a fixed income vehicle, not an insurance risk transfer vehicle. That being the case, I would nix the annuity in favor of a fixed income ladder. There is no need to deal with the inflexibility and carrier risk posed by an insurance company annuity for an 8 year stretch.

[Katsmeow]

You could just withdraw more from the portfolio to cover that period of time rather than buy an annuity...

We had a somewhat analogous situation. We needed/need to cover several years of high expenses due to kids in college. Our spending would go way down after they are out. My biggest concern was not wanting to have to sell equities if there was a downturn and I didn't want to have to do so to cover the increased spending.

So I figured out how much more than 4% withdrawal we would need to spend each of the next 3 years. I then set aside that money in a short-term bond fund apart of the regular asset allocation.

[Trooper]

Quote:

Originally Posted by brewer12345 You are talking about essentially a fixed income vehicle, not an insurance risk transfer vehicle. That being the case, I would nix the annuity in favor of a fixed income ladder. There is no need to deal with the inflexibility and carrier risk posed by an insurance company annuity for an 8 year stretch.

Thanks Brewer...and thanks to the other respondents as well.
Is your comment because I'm not looking to mitigate longevity risk, but instead principal stability risk?

[Options]

Starting 1/15, when I FIRE, I will be using Animorph's strategy as well. That is, taking higher withdrawals until delayed SS @70. As delayed SS is the equivalent of an annuity for me (paying, IIRC, the equivalent of 8%), I see no reason to take out another annuity to cover the gap years. The PF will handle that. For my tastes, I can't justify the high annuity fees, either.

[Trooper]

In my example the delta between guaranteed income and and essential spending was $4,500/month, or to keep it simple $50K/year.

How would I go about a CD ladder to provide $50K/year for 8 years? Here's my initial stab:

1) 1 year from now (at retirement), pull $200K from savings and purchase 4 $50K CDs, maturing in 1, 2, 3, 4 years from then.
2) At the same time purchase a $200K 5 year CD.
3) When each of the CDs in Step 1 matures, use for spending in that year.
4) When the 5 year CD matures, use $50K for spending in that year, and for the remainder repeat the ladder as in Step 1

Am I close?

[brewer12345]

Quote:

Originally Posted by Trooper Thanks Brewer...and thanks to the other respondents as well. Is your comment because I'm not looking to mitigate longevity risk, but instead principal stability risk?

You have it right. I think that a ladder of CDs, bonds or bullet bond funds will do the same thing without giving you one big exposure to a counterparty that you have no way to evaluate and does not have FDIC backing.

[brewer12345]

Quote:

Originally Posted by Trooper In my example the delta between guaranteed income and and essential spending was $4,500/month, or to keep it simple $50K/year. How would I go about a CD ladder to provide $50K/year for 8 years? Here's my initial stab: 1) 1 year from now (at retirement), pull $200K from savings and purchase 4 $50K CDs, maturing in 1, 2, 3, 4 years from then. 2) At the same time purchase a $200K 5 year CD. 3) When each of the CDs in Step 1 matures, use for spending in that year. 4) When the 5 year CD matures, use $50K for spending in that year, and for the remainder repeat the ladder as in Step 1 Am I close?

You got it. As an extra plus, if you pick CDs with modest early surrender penalties you can always trade them in for new ones if rates ever rise.

[RetireAge50]

I would keep it simple and go with something like Wellington and/or Wellesley. Would not bother with CD's or annuities.

[Trooper]

Quote:

Originally Posted by RetireAge50 I would keep it simple and go with something like Wellington and/or Wellesley. Would not bother with CD's or annuities.

Thanks Retire, but even Wellesley is still nearly 40% equities. In our opinion too high to be considered for funding essential expenses, but we're all different :-)

[pb4uski]

I don't see an annuity paying 2.3% interest rate as being a great solution for you (for your FA, perhaps, but not for you).

+1 with Ha. Unless the $395k or so needed to fund this gap period is all or a high percentage of your total retirement savings, I would just invest my retirement savings in a balanced portfolio and schedule automatic withdrawals for $4,500 a month to cover the gap. You saved the money for your retirement, now you are using it for your retirement. Nothing wrong with that.

If for some reason you decide that you have some assets whose cash flows match those gap amounts, you could use CDs, target maturity bond funds, or even zero coupon bonds.

[Cat-tirement]

When I retire next month, DW will continue working for a while. Her income would cover essential expenses, except we plan for her to continue making max contributions to her 401k. To cover the gap while she's working, and then after she retires, I plan to use a combination of:

• After tax savings
• Sell some well appreciated stock, taxed at the 0% LTCG rate
• Since we will both be retiring in the years we each turn 55, we can take 401k distributions even before 59.5
• Funds from selling our house to move to our waiting retirement house, which we can access earlier if needed through a recent HELOC
• I have a pension that starts at 60 and DW has one that starts at 65, each one will cover about a quarter of essential expenses

This will cover us until SS at 70.5 (unless future analysis shows us better off taking SS earlier). I see no need for an annuity in our case.

[Katsmeow]

Quote:

Originally Posted by Cat-tirement When I retire next month, DW will continue working for a while. Her income would cover essential expenses, except we plan for her to continue making max contributions to her 401k. To cover the gap while she's working, and then after she retires, I plan to use a combination of: After tax savings Sell some well appreciated stock, taxed at the 0% LTCG rate Since we will both be retiring in the years we each turn 55, we can take 401k distributions even before 59.5 Funds from selling our house to move to our waiting retirement house, which we can access earlier if needed through a recent HELOC I have a pension that starts at 60 and DW has one that starts at 65, each one will cover about a quarter of essential expenses This will cover us until SS at 70.5 (unless future analysis shows us better off taking SS earlier). I see no need for an annuity in our case.

Won't one of you take Spousal SS at FRA?

[gayl]

Quote:

Originally Posted by Katsmeow You could just withdraw more from the portfolio to cover that period of time rather than buy an annuity... We had a somewhat analogous situation. We needed/need to cover several years of high expenses due to kids in college. Our spending would go way down after they are out. My biggest concern was not wanting to have to sell equities if there was a downturn and I didn't want to have to do so to cover the increased spending. So I figured out how much more than 4% withdrawal we would need to spend each of the next 3 years. I then set aside that money in a short-term bond fund apart of the regular asset allocation.

Quote:

Originally Posted by Trooper Thanks Brewer...and thanks to the other respondents as well. Is your comment because I'm not looking to mitigate longevity risk, but instead principal stability risk?

Also if you don't go with the annuity the nice salesman won't get his commission


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[Trooper]

Quote:

Originally Posted by pb4uski I don't see an annuity paying 2.3% interest rate as being a great solution for you.

Can I ask how you arrived at the 2.3% interest figure? That's one of the things I don't like about SPIAs...it's hard to get a true ROR that doesn't include return of my own money.

[eta2020]

We are facing same issue first 10 years of retirement. That is we can not access 401ks, IRAs and SSs. Those 3 things slowly kick in one after another.

We will only have access to dividend yield of brokerage account. Now I am always fully in equities but now in final working years I will for first time invest in something else then equities.

That is create CD ladder that we will use up first 10 years of retirement to supplement dividend yield of brokerage account. This also allows me to keep all equity funds as they are right now which on long run is a better deal IMO.