Please critique my retirement plan

[JohnEyles]

Hello, I'm a newbie to the ER site and forums, and FIRECalc. I've been
lurking so far, and I'm impressed by the level of knowledge and the friendly
helpful attitude, so here goes ...

I am "provisionally" retired at 53yo, and I'd like to become "early" retired.

I'd like to aim for an income of $50K/yr. This is pre-tax; I don't think taxes
will hurt me TOO badly, since half of my portfolio is taxable accounts, and
those will be about half basis and half LT cap-gain - make sense ? I believe
a 37yr payout is reasonable - I doubt I'll live past 90yo - that's WELL past
my expectancy, and my people are NOT long-lived.

I have nest egg of about $1M, roughly half tax-advantaged & half taxable.

If I'm running the SS calculators properly, I'll start getting about $21K/yr
when I'm 66. I believe that is today's dollars. Yes, I'm allowing for the
fact I won't earn anything between now and age 66, but I maxed it
out for quite a while there.

I really like the "sleep at night" factor of immediate annuities and I plan to
invest 25%/$250K (certainly no more) into one. The Vanguard/AIG quote is
about $11K/yr with 3% inflation. (A simple spreadsheet computes that this
represents about 6% on this investment, if I live 'til 90; if I die sooner, I frankly
don't care that I didn't get such a great return !) I plan to use IRA money,
since the SPIA payout will be taxed as ordinary income, while so much of the
taxable money is cap-gains. I figure with the SPIA and SS, I have a guaranteed
minimal income that will promote sound sleep, while allowing me to invest
the remaining $750K more agressively.

So I tell FIRECalc that I need $39K/year (with CPI inflation and 37yr payout.
This is 5.2% WR on the $750K (that's left in my nest egg after I buy the
SPIA), but of course it includes the forecast SS, and it says I'm 100% safe,
invested at 60% S&P500, 20% small-cap value, and 20% T-Bills (0.4% ER).
Sounds good to me (except I'd like some foreign stock); I like to keep it simple !

So that's my basic plan. Right now I'm only about 50% in equities, so I plan
to move to the 60%+20% over the next few months.

I'd appreciate your comments !

Thanks, John

[Dawg52]

Sounds like a well thought out plan. Many will tell you to forget the annunity as you could probably do better with a ladder of t-bills or cd's. But if it makes you sleep better, go for it. Is health insurance covered? Married?

[TromboneAl]

Sounds like you've done your homework, John. I would read all you can about annuities before going that route, and also evaluate the pros/cons of taking SS earlier.

[JohnEyles]

Thanks for the replies folks. As I guessed, the main comment would be
regarding my proposal to sink 25% of my nest-egg in an immediate annuity.

I guess I don't see why SPIAs are such a bad deal. Here's my
reasoning ... I did a butt-simple spreadsheet where I simply put my
$250K (the amount I'm planning to fund the SPIA) into a hypothetical
account, grow it by X% each year, and subtract out the amount the
SPIA will pay each year (the initial amount grown at 3% per year).
I do a "goal seek" to make X so that the hypothetical acc't is depleted
at year 37 (recall I'm planning to live to 90yo, 37 yrs from now).

The value of X is 6.2% !! That seems like a pretty darned good rate
for a fixed-income investment to me; can you buy a long-term bond
which guarantees 6.2% ? (Not trying to pick a fight here - I am
admittedly a newbie to investing - but this is how it seems to me).
Now the rub is, of course, that if I want the account depleted at the
end of my predicted lifespan, about 25yrs from now, X is only about
4% - not such a good rate of return. BUT (and this is an argument
I haven't read before), if I die in 25yrs I'm gonna be doing just fine
with the 75% of my nest-egg which isn't in the SPIA, and I don't
really CARE that the SPIA didn't earn such a great rate - it's pretty
academic at that point. Put another way, seems like I want to aim
for the "worst" case scenario, where I live to 90yo, and for that the
ROR is darn good ! Of course there's the issue of the estate I leave,
but the non-SPIA money, not to mention my house, should take
care of that.

Regarding the other issue of when I take my SS, seems like I can
model that just by plugging various start dates and amounts into
FIRECalc, and see which gives the most optimistic result.

Thanks again, John

[modlair]

Quote:

So I tell FIRECalc that I need $39K/year (with CPI inflation and 37yr payout. This is 5.2% WR on the $750K (that's left in my nest egg after I buy the SPIA), but of course it includes the forecast SS, and it says I'm 100% safe, invested at 60% S&P500, 20% small-cap value, and 20% T-Bills (0.4% ER). Sounds good to me (except I'd like some foreign stock); I like to keep it simple !

FWIW, note that using the default firecalc at 80% equity and 20% 5 yr bonds says you're not at 100% success. It says 90.9%. Slice and dice type equity mixes have been shown to improve success, but it's not clear that such a thing is not data mining.

[SecondCor521]

John,

Just for kicks I plugged your numbers into Excel a slightly different way. What I did was take $250,000 as an initial payment, then figured one year from now you'd get $11,000, then the next year you'd get 1.03 * $11,000, etc. and that you'd receive 37 payments. This works out to a rate of return of 5.73% using the IRR function. However, according to the IRS (Pub 590 table 1), the life expectancy for a 53 year old is 31.4 years. Reducing the number of payments in Excel to 31 gives an IRR of 4.91%. According to http://www.kansascity.com/mld/kansas...s/15500747.htm, the 30 year Treasury rate is yielding 4.90%. Vanguard can probably create an asset allocation that pays better than that, so they come out ahead on average.

The big thing you're not thinking about is these rates are decent rates if you think of it like a CD or a long-term bond. However, the difference between a CD/bond and the annuity is that at the end of the period in a CD, you get your $250K back; in the annuity case you just made a $250K donation to Vanguard. The question to you then is, do you care if whomever is to receive your inheritance/estate gets $250K less if you go the annuity route?

2Cor521

[JohnEyles]

> note that using the default firecalc at 80% equity and 20% 5 yr bonds says you're
> not at 100% success.* It says 90.9%.* Slice and dice type equity mixes have been shown to
> improve success, but it's not clear that such a thing is not data mining.

I can't quite reproduce your numbers, but I agree that the "Total Market" portfolio
gives significantly less optimistic results than the "mixed portfolio" and I don't quite
understand why.* I'd like to know exactly what the default portfolio is.

I agree about data mining.* I think at success rates well above 90%, your failures
are all in that "perfect storm" period, so the results of tweaking the equity mix is
tailored to that scenario and probably not generally applicable.* *Given that, it
probably makes a LOT more sense to stick with the generic "total market" portfolio.

John

[JohnEyles]

Quote:

Originally Posted by SecondCor521 John, Just for kicks I plugged your numbers into Excel a slightly different way.* What I did was take $250,000 as an initial payment, then figured one year from now you'd get $11,000, then the next year you'd get 1.03 * $11,000, etc. and that you'd receive 37 payments.* This works out to a rate of return of 5.73% using the IRR function.* However, according to the IRS (Pub 590 table 1), the life expectancy for a 53 year old is 31.4 years.* Reducing the number of payments in Excel to 31 gives an IRR of 4.91%.* According to http://www.kansascity.com/mld/kansas...s/15500747.htm, the 30 year Treasury rate is yielding 4.90%.* Vanguard can probably create an asset allocation that pays better than that, so they come out ahead on average. The big thing you're not thinking about is these rates are decent rates if you think of it like a CD or a long-term bond.* However, the difference between a CD/bond and the annuity is that at the end of the period in a CD, you get your $250K back; in the annuity case you just made a $250K donation to Vanguard.* The question to you then is, do you care if whomever is to receive your inheritance/estate gets $250K less if you go the annuity route? 2Cor521

Now I AM confused.* *I'm not sure exactly what IRR is doing.* *But if I change
MY spreadsheet so that there's $250K left in the hypothetical account after the
37 payments (that began at $11465 and increased at 3% per year), then the
rate would have to be about 6.85%.* In other words, that's what Vanguard,
(or whoever) would have to earn on my premium to make those payments to
me and return my $250K.* (But of course* they're NOT returning the $250K).
Fascinatingly, that's less than a point more than the 6.2% the premium would
have to earn to make the graded payments but return nothing after 37yrs !* So
returning the principal doesn't represent that much add'l effective ROR, oddly.

The point is well-taken that the effective ROR is a lot less if I only live to 78yo
or 81yo or whatever.* *But, as I said, it makes sense for me to design the plan
to the most problematic reasonable scenario, the one where I live to the 90%
percentile of life expectancy (which is about 37 add'l years for a 53yo, according
to the table in Greaney's "How much can you safely withdraw" paper).

John

[TromboneAl]

Quote:

Regarding the other issue of when I take my SS, seems like I can model that just by plugging various start dates and amounts into FIRECalc, and see which gives the most optimistic result.

That's true. The two other considerations are:

1. If you have any concerns that SS benefits might be reduced, taxed differently, or means tested, you might want to take the money earlier.

2. You might die before the breakeven point.

[Dawg52]

Another approach in using annuities is to buy a fixed term. Let's say you bought a 10 year one that distributes $11,000/yr as in your example(no cola), you could buy this for $88,500. This would be payable to a beneficary if you were to die within the 10 year period. The return is roughly 4.48%. Still not as good as a 10 year t-bill or cd but at least you are not locking up 250k in an annuity. After 10 years, then you buy another one if you feel you need one.

I'm in a similar situation as you and I just can't talk myself into putting 25% in an annuity. A smaller one for a 7-10 year period, maybe.* * * Below is a good website in running some annuity numbers.

http://www.immediateannuities.com/

[SecondCor521]

Quote:

Originally Posted by JohnEyles Now I AM confused. I'm not sure exactly what IRR is doing. But if I change MY spreadsheet so that there's $250K left in the hypothetical account after the 37 payments (that began at $11465 and increased at 3% per year), then the rate would have to be about 6.85%. In other words, that's what Vanguard, (or whoever) would have to earn on my premium to make those payments to me and return my $250K. (But of course they're NOT returning the $250K). Fascinatingly, that's less than a point more than the 6.2% the premium would have to earn to make the graded payments but return nothing after 37yrs ! So returning the principal doesn't represent that much add'l effective ROR, oddly. The point is well-taken that the effective ROR is a lot less if I only live to 78yo or 81yo or whatever. But, as I said, it makes sense for me to design the plan to the most problematic reasonable scenario, the one where I live to the 90% percentile of life expectancy (which is about 37 add'l years for a 53yo, according to the table in Greaney's "How much can you safely withdraw" paper). John

IRR basically tells you, if you give it a series of cash flows, what is the interest rate one would have to earn in order to match that series of cash flows. So if you put in a $1,000 deposit in year 1 and a $1,100 year withdrawal in year two, the IRR would be 10%, because that is what you would have to earn in that case. (Alternatively, you can look at it as borrowing $1,000 in year 1 and paying back $1,100 a year later...you'd be paying 10% interest). Excel or a basic finance course can fill in more details.

The reason it doesn't make that much of a difference is that what you are in effect calculating is the rate of return Vanguard would have to earn if they took your $250K, made all those 37 payments to you at $11K and change, then paid you a bonus payment of $250K in year 37 or year 38 and still ended up with $250K in their pocket. The reason it's not that much different is that the extra 60-odd basis points of interest (I get 6.6291% versus 6.0017% if the bonus payment is in year 38) difference over 37 or 38 years on $250K actually adds up to that $250K extra. Compound interest -- the 8th wonder of the world. This is why all those little old ladies are moving their jumbo CD's around for a 1/4% interest rate change -- it makes a big difference over the long haul.

You are right in saying that your plan makes sense as long as you don't care that you don't get that extra $250K back. You're right in that you don't care, because you're dead, but do you have any heirs to worry about or provide for? Another way to look at this is that you could either take the $250K and buy the annuity or put it into a 30-year treasury bond and pull out the annuity payments you would have otherwise received. 30 years later, if you're still alive, you would be in the same spot with respect to your cash receipts, but in one hand you'd have an annuity that was now worth much less than $250K (based on your inflated payments and your reduced life expectancy as an 83 year old of only about 8-9 years). But it's an illiquid asset -- the only way to get your money out would be to sell your annuity stream, and you could get as little as $150K -- maybe, depending on your health and what rate of return the investor wants. In the other hand, you'd have $250K in cash.

I was going to attach my spreadsheet for you but it won't let me upload xls files. Here's the data, anyway. First column is the description, second column is if you got paid the bonus $250K, third column is without the $250K, and fourth column is the annuity that you might get at 83 years old:

Initial Amount $(250,000.00) $(250,000.00)
First payment $11,465.00 $11,465.00
3% increase $11,808.95 $11,808.95
… etc … $12,163.22 $12,163.22
Payment 4 $12,528.12 $12,528.12
5 $12,903.96 $12,903.96
6 $13,291.08 $13,291.08
7 $13,689.81 $13,689.81
8 $14,100.50 $14,100.50
9 $14,523.52 $14,523.52
10 $14,959.22 $14,959.22
11 $15,408.00 $15,408.00
12 $15,870.24 $15,870.24
13 $16,346.35 $16,346.35
14 $16,836.74 $16,836.74
15 $17,341.84 $17,341.84
16 $17,862.10 $17,862.10
17 $18,397.96 $18,397.96
18 $18,949.90 $18,949.90
19 $19,518.40 $19,518.40
20 $20,103.95 $20,103.95
21 $20,707.07 $20,707.07
22 $21,328.28 $21,328.28
23 $21,968.13 $21,968.13
24 $22,627.17 $22,627.17
25 $23,305.98 $23,305.98
26 $24,005.16 $24,005.16
27 $24,725.32 $24,725.32
28 $25,467.08 $25,467.08
29 $26,231.09 $26,231.09
30 $27,018.02 $27,018.02
31 $27,828.56 $27,828.56 $27,828.56
32 $28,663.42 $28,663.42 $28,663.42
33 $29,523.32 $29,523.32 $29,523.32
34 $30,409.02 $30,409.02 $30,409.02
35 $31,321.29 $31,321.29 $31,321.29
36 $32,260.93 $32,260.93 $32,260.93
37 $33,228.76 $33,228.76 $33,228.76
38 $250,000.00 $- $34,225.62
$35,252.39

6.6291% 6.0017% $145,891.72


2Cor521

[GolferAndy]

I'm with you on this John because you and I are the same age and I too plan on firing my employer this year. What I would question, however, is your planned 50k income stream. IMO a 5.2% withdrawal rate is simply too high with a possible 37 yr. time horizon, especially when you would be starting out with valuations as high as they currently are. In addition, a plan that counts on an income stream from a government entiltlement program that will almost surely be changed before you can collect a dime from it in 13 years time is also reason to be cautious. The generation(s) behind us baby-boomers will almost surely rebel at the future cost of providing us with full SS & Medicare benefits. I use the online SS calculator myself.. but I subtract 30% from what it says for my ER planning. Good luck.

[donheff]

Quote:

Originally Posted by SecondCor521 Another way to look at this is that you could either take the $250K and buy the annuity or put it into a 30-year treasury bond and pull out the annuity payments you would have otherwise received. 30 years later, if you're still alive, you would be in the same spot with respect to your cash receipts, but in one hand you'd have an annuity that was now worth much less than $250K

The numbers are numbing me. Azanon's test didn't cover ADD which keeps me from paying attention.

But on the above quote I am confused. I know little about bonds -- don't have any. But I was under the impression that if I buy a 30 year treasury I can't take anything back until I sell it -- preferably 30 years later. How do you "pull out the annuity payments?"

[SecondCor521]

I don't know about Treasury bonds much either, but apparently they (by they I mean the regular 30 year Treasury bond) pay interest every six months. A quick calculation says 4.9% of $250,000 is $12,250, so each six months would be about half that. If you wanted the inflation protection you would start out taking the ~$11k and leave the rest to compound. That doesn't work exactly, obviously, but it's close enough for the purposes of this analysis I think.

There's also all those I-bonds, TIPS, Series EE, etc. bonds that I don't know much about either.

2Cor521

[Spanky]

Quote:

Originally Posted by GolferAndy In addition, a plan that counts on an income stream from a government entiltlement program that will almost surely be changed before you can collect a dime from it in 13 years time is also reason to be cautious. The generation(s) behind us baby-boomers will almost surely rebel at the future cost of providing us with full SS & Medicare benefits.

With the execption of public pension plans despite possible rebellion.

[JohnEyles]

Quote:

Originally Posted by donheff The numbers are numbing me.* Azanon's test didn't cover ADD which keeps me from paying attention.* But on the above quote I am confused.* I know little about bonds -- don't have any.* But I was under the impression that if I buy a 30 year treasury I can't take anything back until I sell it -- preferably 30 years later.* How do you "pull out the annuity payments?"

The numbers are numbing me too.* But it looks to me kinda like 30yr T-Bond
DOES make more sense* than SPIA.* *But I can't tell for sure. Would some kind
and knowledgeable soul please have mercy, and explain to me, in very simple,
explicit, and jargon-free terms, exactly how a T-Bond works, please ?* *

My impression is, if I put my $250K in one, I'll get interest payments totalling
about 5% of that every year (is that right, given current auction results ?!?)
and this annual payment is flat over the 30 years. And then at the end of the
30yrs, I get my $250K back.* *(Never mind the possiblity of actually selling the
thing).* Also, since it's an auction (and that auction only occurs every 6 months),
is it true I won't know what rate I'm getting until I actually commit the money ?!?

Is this right ?

[JohnEyles]

Quote:

Originally Posted by GolferAndy I'm with you on this John because you and I are the same age and I too plan on firing my employer this year. What I would question, however, is your planned 50k income stream. IMO a 5.2% withdrawal rate is simply too high with a possible 37 yr. time horizon, especially when you would be starting out with valuations as high as they currently are. In addition, a plan that counts on an income stream from a government entiltlement program that will almost surely be changed before you can collect a dime from it in 13 years time is also reason to be cautious. The generation(s) behind us baby-boomers will almost surely rebel at the future cost of providing us with full SS & Medicare benefits. I use the online SS calculator myself.. but I subtract 30% from what it says for my ER planning. Good luck.

Congratulations on firing your employer !* I actually enjoy mine though, as long
as I'm only there a few months per year.* *Maybe if your employer is sad to see
you go, you can finagle some kind of occasional-work arrangement like me, and
significantly boost your retirement income picture ?

Yes, a 5.2% withdrawal rate seems way too high for 37 yrs.* Except it's only
5.2% for 9 to 13 yrs, until SS kicks in; then it's way lower.* *My impression,
correct me if I'm wrong, is that all the papers and conventional wisdom about
SWR is not taking SS into account.

Your point about the reliability of SS is a good one.* I've read somewhere
that SS is pretty safe, at least for OUR lifetimes, because of the massive
political strength of the segment of the population getting SS.* After all,
AARP is the strongest lobby they say, and this is only gonna get moreso.
Nonetheless, it seems like a good argument to begin at the earliest possible
age (62yo for me).* And* your 30% discounting of the SS calculator's result
seems only prudent; surprisingly, it only reduces my target overall annual
income of $50K by $2500 or so.*

[donheff]

Quote:

Originally Posted by SecondCor521 apparently they (by they I mean the regular 30 year Treasury bond) pay interest every six months. A quick calculation says 4.9% of $250,000 is $12,250, so each six months would be about half that. If you wanted the inflation protection you would start out taking the ~$11k and leave the rest to compound. That doesn't work exactly, obviously, but it's close enough for the purposes of this analysis I think.

That means you are taking out 90% of the interest per year. But you would need to leave about 3% of the interest to accumulate if the bond was to generate an additional 3% each year -- wouldn't you? If you take out essentially all of the interest, the bond principal never grows enough to generate interest sufficient to beat inflation. You can't dip into the principal so where does the cash flow come from? Am I mising something?

[astromeria]

Quote:

Originally Posted by JohnEyles Yes, a 5.2% withdrawal rate seems way too high for 37 yrs. Except it's only 5.2% for 9 to 13 yrs, until SS kicks in; then it's way lower.

I am planning on doing something similar--taking 5% until SS kicks in, although for us that's 5 years from now to age 62, and 2 years from when DH expects to fully retire from his semi-retirement job (in which he makes that same amount of money per year, $60k...25% of our peak income when we both worked in Silicon Valley! So much for needing 75-85% of income in retirement--we don't even need that in semi-retirement ).

[SecondCor521]

Quote:

Originally Posted by donheff That means you are taking out 90% of the interest per year. But you would need to leave about 3% of the interest to accumulate if the bond was to generate an additional 3% each year -- wouldn't you? If you take out essentially all of the interest, the bond principal never grows enough to generate interest sufficient to beat inflation. You can't dip into the principal so where does the cash flow come from? Am I mising something?

Everyone please note I was wrong in my earlier statements. Thanks to donheff for asking some questions that made me re-evaluate my math and discover my mistake.

It turns out that if one starts with $250K, earns 5.0389% on it, pulls out $11,465 in year 1 and increases the withdrawal amount by 3% per year, there will be exactly zero dollars left at the end of year 30, not $250K as I previously implied.

My brief career as a financial planner is now officially over. OP, please find someone who can do the math right (or do the math right yourself) before you make any big decisions with $0.25M. Also, please ignore my previous posts on this thread (or at least view any arguments I made with great suspicion).

2Cor521