Withdrawal Rate Mechanics

[davemartin88]

We're about 18 months away from needing to live off our retirement savings and trying to understand the best way to actually withdraw at a safe withdrawal rate. If we're looking to generate about $35-40K per year from a $1M savings, how would we want our assets to be invested. Let's assume about $350K is in retirement accounts and the rest in taxable accounts.

It's just not clear to me how you set up an actual stream of income? Do we look to keep a 60% bond/40% equity asset but also invest in dividend producing stocks? Buy an annuity, (just kidding!), seems like in years where we make a profit, relatively easy to harvest the income but in years where we have losses, do we still sell to produce the income while trying also to keep a reasonable asset allocation?

Anyone recommend a good book that actually talks to the mechanics of producing the income you need?

Tried some searches but got a lot of information about what is a safe withdrawal rate as opposed to how to actually structure the withdrawals. Maybe I didn't use the right search string?

 

[haha]

Tried some searches but got a lot of information about what is a safe withdrawal rate as opposed to how to actually structure the withdrawals. Maybe I didn't use the right search string?

I don't think this has been discussed very much around here. Some of us, including me, try to structure our portfolios so that the dividends and interest paid are adequate for our income needs. Others criticize this approach, saying among other things that it doesn't allow sufficient diversification.

I have thought about methods different from the income approach and to me its no wonder there hasn't been much discussion. It is full of tricky problems. Like you say, it was easy when you could just sell some index fund shares, pay a little tax, and watch your portfolio grow. But that can't have worked very well over the past 10 years at least, since there has been very little growth.

I hope you get some good answers, as it is a mystery to me.

ha

 

[W2R]

My taxable portfolio is 30% Wellesley, and the rest consists of very broad stock indices and fixed income.

I noticed that my dividends exceed the amount I intend to withdraw from my taxable account. So, I intend to take that, and then use the excess dividends and LTCG to rebalance.

My TSP (=401K) is all in fixed income - - "G Fund", a government bond fund that does not go down in value. Access to the G Fund is part of my job's benefit package. I plan to take regular monthly payments from that, increased by inflation each year.

My planned asset allocation overall, including all accounts, is 45:55 equities:fixed.

 

[Gearhead Jim]

Some people have suggested a "rebalancing" every year or 6 months, where the rebalanced money is placed in a short term account and used to pay living expenses for the next 12 or 6 months. The general concept seems sound but i haven't worked out any details.

 

[W2R]

Some people have suggested a "rebalancing" every year or 6 months, where the rebalanced money is placed in a short term account and used to pay living expenses for the next 12 or 6 months. The general concept seems sound but i haven't worked out any details.

Yes, I think that is like what I plan to do. I will let my dividends and LTCG go to money market in my taxable Vanguard account. During the first week each January I will withdraw my expenses from Vanguard to my bank. Then I will rebalance what is left in my taxable Vanguard account.

I won't be getting great interest on that year's withdrawal between the time it hits the bank and the time it is spent. But, I think this will be simpler for me at first and it will keep me from being tempted to dip into my nestegg. I will just move 1/12th of it from savings into checking accounts each month. Maybe later on I will set up a regular monthly withdrawal from my money market account at Vanguard.

 

[unclemick]

85% tax deferred Target Retirement 2015
15% taxable dividend stocks and stuff.

Target has their distribution at the end of Dec - by Feb the following year I look at the SEC yield and 5% of the end of the year amount, peer into the future, screw up my guts and deduct to my vanguard Prime MM acount.

The taxable dividends and any buys/sells/mergers/spin-offs get swept into Prime MM during the course of the previous year.

So jan/feb - there is 1-2 years of cash give or take in MM the first few months of the year.

Chickenheartness has me on full auto the last couple years(feb 2008, feb 2009) doing the SEC yield rather than spending the big bucks 5% variable.

Now for your amusement:

A 1 mil portfolio at 4% = 40k in say 2007 peak, 5% variable = 50k, 2.7 %SEC yield= 27k.

Toss in a yucky ducky 08,09 crash and partially bouce back:

800k at 4% = 32k, 5% variable= 40k, and now 4% SEC yield= 32k

Not wing flapping ecstatic but livable handgrenade wise.

heh heh heh - 16th year of ER - I seem to change method details every few years - but looking back seem to stay in the 3-5% of portfolio value(except one year post Katrina) ballpark. Others mileage may vary.

 

[Moemg]

On Jan.1 I write down what my withdrawal will be for that year then I access how much is already in my money market , how much I'll get in dividends ( so far I have been letting my dividends in my IRA be reinvested ) Then if I have enough in my Money market that year I do nothing .If it is a little short I look at my portfolio from a tax perspective of what to sell to make up the difference . Since I usually keep a few years of living expenses in the money market this does not happen often . Every month I have a set amount transferred from my MM to my checking account for my monthly expenses . The rest sits in the MM until I need it for emergency's or travel . I usually end up with an excess at the end of the year which is transferred to the next year . I'm sure some of the more knowledgeable posters have better ides but this works for me so far but I'm always open to better ideas .

 

[bbbamI]

We are living on a pension and will take the rest from our cash reserves each year until DH is 59 1/2. Then we will take distributions from two IRA's. One IRA has mostly stocks, the other has bond funds. We will take more from the IRA that is doing well. When DH is 62, he will begin ss and I will have an additional IRA in which I will begin to take withdrawals, then I'll start my ss at 62. We're on the conservative side, so it's 40/50/10.

We will keep track of our expenses and will adjust our withdrawal rate as needed.

 

[dex]

Dave,
Is the 35 - 40K incremental to any pensions and Social Security?

 

[davemartin88]

Dave,
Is the 35 - 40K incremental to any pensions and Social Security?

This was really an example to suggest that we were looking for about a 3.5-4% starting withdrawal rate, we actually have a bit more than this but wanted to keep it in round numbers. Our current actual plan has us looking for about $70K per year and we should have about $2M available to us by then.

We're hoping we won't use that much as we're starting to build a place in West Virginia that should have a much lower cost of living and if it goes right, no mortgage when we move there in 2 years. We'll also have to pay our own medical which is a big reason for the high number although we will be able to continue to participate in the group health plan from my wife's position after she "retires". We'll have to pay the entire amount but in today's dollars, this would be about $900 for our health, dental, and vision coverage.

We don't have any pensions (actually, DW may get $125 per month from her job but we'll believe it when we see it) and we're hoping that if SS is still around for us in 9 years or so when I'm eligible, we'll consider it gravy!

The thought of having a couple of years or so in a near cash account is a bit like what we're doing now- I'm effectively receiving some payments from my corporate job after being laid off/retiring last October- that money takes us through the next 18 months or so and gives us time to get our portfolio in to a retirement/income mode.

Thanks for the information so far, will have to read a few more times to fully digest!

 

[davemartin88]

85% tax deferred Target Retirement 2015
15% taxable dividend stocks and stuff.


heh heh heh - 16th year of ER - I seem to change method details every few years - but looking back seem to stay in the 3-5% of portfolio value(except one year post Katrina) ballpark. Others mileage may vary.

Thanks- why use 2015 as the target date and not, say, 2020? Is that how you keep the AA where you want it to be? Also sounds like you're taking 3-5% of your current portfolio each year rather than using a set rate as a starting point and varying from there based on inflation or other factors? Maybe that was one of your method changes along the way, lol.

BTW, I grew up in Raytown/Indepencence, Mo., still have family there but don't get back too often.

 

[Nords]

At the end of a profitable year we forecast our expenses, lowball our projected interest/dividend income, and figure out what we'd need to replenish our two-year cash stash. Then we cash in that amount while restoring our asset allocation.

Of course we didn't have to do any of that at the end of 2008... so hopefully at the end of this year we'll do it for at least 2010 and possibly 2011.

Our two-year cash stash sits in a money-market account and CDs. Luckily one of the CDs is maturing soon, although I'm sure gonna miss that 6.25% interest rate.

 

[Moemg]

Also sounds like you're taking 3-5% of your current portfolio each year rather than using a set rate as a starting point and varying from there based on inflation or other factors? /quote]


I retired Jan. 2007 so if I used that amount as my starting amount ( 4% & inflation adjustments forever )it would make me concerned so I've been using the 4% of the portfolio amount on Jan.1 so this year my spending is down . I'm not sure if I needed to make that adjustment but it helps me with the bag lady fears .

 

[clifp]

My approach is similar to Ha Ha, but the way I've seen the mechanic explained is similar to this.

Say your $1 Million at Jan 2008 is invested like this
Stocks 500K
Bonds 350K
5 Year CD ladder 100K
Money Market 50K

Let say at the end of 2008 your portfolio looks like this
Stocks 350K
Bonds 350K
5 year CD ladder 105K (5K interest)
Money Market 11K (1K interest less 40K living expenses)

It is now Jan 2009 and time to re balance and your portfolio is now $811K
Keeping the same AA.
Bonds (35%* 810) = $283,500 so you sell $66,500 of your bond fund
You use 55K to bring your stock portfolio up to $405K
The remaining $11,500 you stick into your money market.

One of the reasons to have a CD ladder is for exactly years like 2008. Normally you would roll over the CD and buy a new 5 year CD. This year the CD money goes into your money market (the good news CD rates are horrible) and you use it for living expenses.
At the end 2009 rebalancing your portfolio looks like this.
Stocks 405,000
Bonds 283,500
CDs $80,000
Money Market $42,500

What happens if 2009 looks like 2008, I think you use another CD, and if it still looks bad in 2010 reduce expenses?

If on the other hand the market rebounds you back fill your CD ladder (i.e. buy both a 4 and 5 year CD).


Now in practice, I doubt any retiree actually does it like this but the theory is reasonably sound.

 

[FANOFJESUS]

Should a person spend from taxable first up to about 10k-11k of taxable profit then the rest from the tax free items? This way you could avoid the tax man.

 

[FANOFJESUS]

85% tax deferred Target Retirement 2015
15% taxable dividend stocks and stuff.

Target has their distribution at the end of Dec - by Feb the following year I look at the SEC yield and 5% of the end of the year amount, peer into the future, screw up my guts and deduct to my vanguard Prime MM acount.

The taxable dividends and any buys/sells/mergers/spin-offs get swept into Prime MM during the course of the previous year.

So jan/feb - there is 1-2 years of cash give or take in MM the first few months of the year.

Chickenheartness has me on full auto the last couple years(feb 2008, feb 2009) doing the SEC yield rather than spending the big bucks 5% variable.

Now for your amusement:

A 1 mil portfolio at 4% = 40k in say 2007 peak, 5% variable = 50k, 2.7 %SEC yield= 27k.

Toss in a yucky ducky 08,09 crash and partially bouce back:

800k at 4% = 32k, 5% variable= 40k, and now 4% SEC yield= 32k

Not wing flapping ecstatic but livable handgrenade wise.

heh heh heh - 16th year of ER - I seem to change method details every few years - but looking back seem to stay in the 3-5% of portfolio value(except one year post Katrina) ballpark. Others mileage may vary.

Have you given up on the wellesley and gone with the 2015? Is 60% stocks a little steep in retirement?

 

[audreyh1]

You do not set up income producing investments to cover the withdrawal. You maintain a 50/50 or 60/40 or whatever portfolio AA (chosen based on portfolio survival over a given time period) and draw from it. You do this by selling assets as needed in Jan.

There might have been enough distributions generated the previous year to cover the withdrawal, there might not. It doesn't really matter. On Jan (or whenever your "start" is), you pull money out of the portfolio by selling some of whichever assets have performed the best and then rebalance it to the initial AA. If you keep a certain % in cash in your AA - you can withdraw that, but then you need to rebalance to the initial AA.

Some people let their dividends and distributions accumulate in cash, withdraw from that, sell any additional assets needed to cover their withdrawal and then rebalance.

All the portfolio survival studies are based on this model. They don't assume income producing investments but rather a set AA on stocks and bonds modeled on things like the S&P index (pretty low in dividend income) and some bond index. And annual rebalancing as part of the withdrawal. In other words, these models are based on the "total return" of the portfolio, not just the income produced by the portfolio.

Audrey

 

[utrecht]

Why do you have to do your entire "draw" for the year in Jan? Cant you do it monthly? Or do most people find that too much trouble?

 

[Gone4Good]

Income and dividends on a normally balanced portfolio stretch your initial cash balances more than you'd expect, particularly now that yields on risky assets have risen. As an example, take someone with a 60/40 mix of the S&P 500 and the Vanguard total bond market fund, a 4% withdrawal rate, 3% inflation, and 2 years of starting cash. That initial 2 year cash balance will last about eight years if dividends and income are deposited into it.

Considering that even periods of low returns are punctuated with peaks and valleys, an 8-10 year window of cash on hand should give some opportunity to rebalance and replenish.

 

[Gotadimple]

Why do you have to do your entire "draw" for the year in Jan? Cant you do it monthly? Or do most people find that too much trouble?

You could, but then you would be rebalancing monthly and transaction costs (if any) will eat up your earnings, AND, your frequent rebalancing will not achieve the effect you want with your asset allocation.

As others have said here:

Start with 2 years of cash (ideally one year in MMF, one year in CD's)
Compare what sits in your brokerage accounts cash to your annual budget
Rebalance to your asset allocation annually, if needed
After the rebalance draw the cash you need for your annual living expenses from the (1) cash in your brokerage accounts, and (2) result of sales/buys to rebalance.
Move the cash to your bank/money market fund. You can further divide the cash in to short term cd's that you draw on monthly or quarterly.

But what you probably don't want to do is to sell your high performing investments monthly to generate the cash you need to live on.

The two year cash cushion also provides you with the ability to NOT sell assets to live on if the market is performing poorly (like that hasn't happened recently )

Finally, make provision to pay your taxes as needed throughout the year to avoid penalties. See Audrey's thread on estimated taxes here

-- Rita

 

[unclemick]

Thanks- why use 2015 as the target date and not, say, 2020? Is that how you keep the AA where you want it to be? Also sounds like you're taking 3-5% of your current portfolio each year rather than using a set rate as a starting point and varying from there based on inflation or other factors? Maybe that was one of your method changes along the way, lol.

BTW, I grew up in Raytown/Indepencence, Mo., still have family there but don't get back too often.

Well - tongue in cheek - I fib about my age - 65. Vanguard suggests a more conservative 2010 or 2005 even. Or a conservative Target Income.

However my quirky lefhanded thinking goes as follows - now 65, if I take my SS plus non cola pension times 25 and call it a fixed phantom bond - my 65/35 stock/bond becomes 35/65 or age in bonds fitting one Boglehead guideline.

Two 4% SWR seems to fall in the range of my apples to oranges made up in my own head - SEC yield/ 5% variable(taken from Vanguard's website) bookends.

Offense is 5% variable in a really up market.

Defense is:
1. 4% of portfolio - perhaps not adjusted for inflation if I feel chicken.
2. SEC yield of portfolio - 3% or higher(I will adjust if yield drops too low).
4. Live off SS plus pension only - cut 60% of expenses in my super cheap mode - toss some Norwegian widow div.'s for lagniappe.

heh heh heh - instinctively first line of defense is to cut expenses. Up markets are bon temps rolliere.

 

[Moemg]

However my quirky lefhanded thinking goes as follows - now 65, if I take my SS plus non cola pension times 25 and call it a fixed phantom bond - my 65/35 stock/bond becomes 35/65 or age in bonds fitting one Boglehead guideline.

.

Good point ! I thought my 65% stock was too aggressive but considering my pension and SS it may be too conservative .

 

[audreyh1]

Why do you have to do your entire "draw" for the year in Jan? Cant you do it monthly? Or do most people find that too much trouble?

That's the scenario that is used by the studies.

Audrey

 

[samclem]

Some people let their dividends and distributions accumulate in cash, withdraw from that, sell any additional assets needed to cover their withdrawal and then rebalance.

Just to explain a little: One reason people do what Audrey describes here is to reduce their taxes. Since these dividends (and any interest) will be subject to tax anyway (unless they are in a tax-deferred account) it is usually best to use this money forst to support your withdrawals/spending before selling anything else (and incurring cap gains taxes).

 

[unclemick]

Just to explain a little: One reason people do what Audrey describes here is to reduce their taxes. Since these dividends (and any interest) will be subject to tax anyway (unless they are in a tax-deferred account) it is usually best to use this money forst to support your withdrawals/spending before selling anything else (and incurring cap gains taxes).

Yes.

heh heh heh -