Withdrawal strategy for 8 year bridge to SS?

[Jimonlimon]

I'm trying to break my issues into reasonable questions rather than put everything into one 10,000 word dissertation, so apologies if this doesn't paint the whole picture.

Planning to retire in a year at age 58-1/2 and start drawing my pension which is generous but won't cover all of our expenses. Currently targeting drawing SS just before FRA at 66-1/2 which means we would need to bridge the 8 year gap with withdrawals from our 401k's. While it's likely that my wife would draw earlier and I would draw later, for simplicity assume we both start at the same time. Our combined SS benefit estimate at 66-1/2 is $67,000/yr. We're both the same age (within two weeks!)

We will need at least $30,000 per year from the 401k to maintain our standard of living plus a few deferred costs. I would like to pull the same $67,000 that we will eventually get from SS per year as we plan to travel a lot and do other expensive things in our early years of retirement. (Actually it would take $73,000 fully taxable to match $67k SS after taxes)

Our combined 401k's total about $1.05 million as of now. I would like to preserve at least $400k (Inflation adjusted) at the end of this 8 year draw period, but ideally more like $500k.

The question: What's a good method to adjust our annual draws between the minimum $30k and wish of $67k?

One thought of a simple method is to just segregate about $400k now into an index fund and let it follow the market. With the remaining $650k +-, take the lesser of $67k or 1/8 the first year, 1/7 the next, etc. until starting SS. If it isn't providing enough we could increase the draws and start SS earlier; if it's doing better we could reduce the fractional draws and defer SS or just keep the excess invested.

This seems too ridiculously simple. If it shrinks our draws would be reduced and hopefully avoid a major problem in the out years. Even if it loses half the value to a crash in the first year we should have more than our $30k need. We could definitely get by on less. In fact we could get by on just the pension if it came to it.

Each of our 401k's are about 70% in stock funds and the rest in allegedly more stable bond/money/etc. funds. Mine will be available immediately upon my retirement via the "rule of 55".

 

[COcheesehead]

I am a big advocate of pre funding liabilities. I would build an eight year bond ladder - now is a good time to capture yield.

 

[Spock]

Since you mention age 58 and a half, check your 401K plan docs to make sure you can withdraw from the 401K before age 59 and a half without penalty ("rule of 55").

 

[Jimonlimon]

Since you mention age 58 and a half, check your 401K plan docs to make sure you can withdraw from the 401K before age 59 and a half without penalty ("rule of 55").

Thank you for the warning. I confirmed it both with the employer-side information and the provider (Nationwide). Very clear and simple. I don't have to change anything- just request an amount and from which funds.

 

[Jimonlimon]

I am a big advocate of pre funding liabilities. I would build an eight year bond ladder - now is a good time to capture yield.

I appreciate the suggestion. I haven't really looked into that yet. Since my pension will cover about 3/4 of our current spending I was thinking the extras from 401k could be in stock funds and wouldn't need the security (and presumably lower yield) of bond ladders.

Under my 401k account with Nationwide I don't have the ability to buy individual products, just bond funds, stock funds, index funds, etc. I can set up a Schwab Personal Choice Retirement Account which gives access to certain types of bonds. I will investigate this option.

 

[perez99]

I appreciate the suggestion. I haven't really looked into that yet. Since my pension will cover about 3/4 of our current spending I was thinking the extras from 401k could be in stock funds and wouldn't need the security (and presumably lower yield) of bond ladders.

I'm in the bond camp as well for the bridge money. The bridge is only good if you are certain it will be there. If you put it in equities and the market goes down (say a lot), you wont starve due to your pension, but wont be able to do the travel/etc that you want to do.
So first decide the risk you want to take with your bridge money. I will put the bridge money in a bond ladder or if not possible in a stable value in the 401k. The rest in the index fund.
Good luck in whatever you decide!

 

[FI_RElater]

... needs more planning

a couple of things

I know that, at least for my 401k, that ANY withdrawal that goes directly to me would result in 20% federal withholding... so another route is to transfer a significant amount to a self directed IRA (as IRA's in most, like Schwab or Fidelity, don't require that withholding but rather allow you to specify how much, if any, that is withheld). The amount could be beyond what you need in the immediate term-- the rest, especially after the early years once you know your expected burn, could be converted to Roth before you start SS (we converted earlier IRA to Roth before starting SS and will transfer my last 401k to IRA now that I've started SS.... if I have tax space at end of year I'll be able to easily do a small Roth conversion to take advantage)

Generally, money needed within five (to even ten) years shouldn't be subject to the vagaries of the market!. For us, we established a five year CD ladder (you could use treasuries, but at least with CD's there is a defined early withdrawal penalty whereas with treasuries if you needed the funds earlier than the maturity you are subject to the market); this allowed us to not be as subjected to SOR and spend within our expected needs (and also had reserves, so the actual funds lasted about seven years).

 

[GravitySucks]

I am a big advocate of pre funding liabilities. I would build an eight year bond ladder - now is a good time to capture yield.

Agree. Keep funds at least equal to your minimum required spending for anything less than five years in safe bonds. I felt better with an eight year ladder. Float back up to your preferred AA if that’s still where you want to be.

 

[COcheesehead]

I appreciate the suggestion. I haven't really looked into that yet. Since my pension will cover about 3/4 of our current spending I was thinking the extras from 401k could be in stock funds and wouldn't need the security (and presumably lower yield) of bond ladders.

Under my 401k account with Nationwide I don't have the ability to buy individual products, just bond funds, stock funds, index funds, etc. I can set up a Schwab Personal Choice Retirement Account which gives access to certain types of bonds. I will investigate this option.

Just plan for sequence of return risk if you are in equities and need the money. With bond yields today, they may return more than equities especially considering their return to par. The ultimate in capital preservation.

 

[G-Man]

Within a 401K plan, do you really have the ability to create a bond ladder?

In addition, I interested to hear more about the self-directed IRA if the original poster is using the "Rule of 55" to draw down on funds in his 401K. How would that work if he is not 59 1/2 years old yet?

 

[COcheesehead]

401’s can be rolled into an IRA which offers way more choices including individual bond purchases.

 

[Spock]

Within a 401K plan, do you really have the ability to create a bond ladder?

In addition, I interested to hear more about the self-directed IRA if the original poster is using the "Rule of 55" to draw down on funds in his 401K. How would that work if he is not 59 1/2 years old yet?

I think the term "self-directed" is being mis-used here. A self-directed IRA is for unconventional investments like direct real estate or bullion and it requires a special custodian.
In this case, in order to buy individual bonds, a standard rollover IRA is all that is needed.

 

[Out-to-Lunch]

Faced with a similar situation, I chose to create a bond ladder (using TIPS, but that was my preference) that would cover, along with a pension, the base spending. The rest was invested in a standard portfolio for discretionary draws.

 

[COcheesehead]

To the OP, my own experience was two bear markets within my first three years of retirement. I chose, five years out from retirement, to pursue Kitces’ bond tent strategy. You can Google it. Frankly it saved my butt. If in equities I would have taken a 20%-35% haircut - while taking six figures out of my portfolio for expenses. Instead, today I am above my retirement day portfolio balance by six figures plus even with three plus years of expenses removed.

 

[pb4uski]

Within a 401K plan, do you really have the ability to create a bond ladder?

In addition, I interested to hear more about the self-directed IRA if the original poster is using the "Rule of 55" to draw down on funds in his 401K. How would that work if he is not 59 1/2 years old yet?

Most 401ks don't offer the investment choices to create a bond ladder and if you qualify for penalty free withdrawals under the rule of 55 and move 401k money to a tIRA then you lose the ability to make penalty free withdrawals of that money until you turn 59-1/2.

However, there may be a way to have your cake and eat it too. When you retire, you could transfer a portion of your 401k to a tIRA and invest the proceeds in a bond ladder in the tIRA to create the bridge and leave the remaining money invested in equities in the 401k. Then from when you retire after age 55 until you are 59-1/2 as bonds in the bridge mature you sell equities in the 401k and withdraw that money for spending and reinvest the proceeds from the bond maturity in the tIRA into equities. Equities are unchanged... a sell for the 401k withdrawal and a corresponding buy in the tIRA from the proceeds of the bond rung maturity. But you get out the money needed for the SS bridge penalty free but get the security of the bond ladder.

Once you are 59-1/2 then you can directly withdraw from the tIRA penalty free and simplify your process.

Money is fungible.

 

[Jimonlimon]

… interested to hear more about the self-directed IRA if the original poster is using the "Rule of 55" to draw down on funds in his 401K. How would that work if he is not 59 1/2 years old yet?

In my case, it will only be one year until I’m 59 1/2. I could cover that first year with draws directly from my 401k

 

[Al18]

Your initial assumption of only having 500K at the end of 8 years is too conservative, in my opinion. If you stay invested in 60/40 stock/fixed income or 50/50, there’s a good chance you will still have about 1 million after 8 years.

Since you still have 1 more year of work, I would prioritize your savings outside of your 401K account, such as building up your savings in CD’s and/or investing in stocks or stock ETF in a brokerage account. This will allow you to live on smaller 401K withdrawals and CD’s and selling stocks. As mentioned above, 401K withdrawals require 20% Federal Tax withholding. In contrast, the long-term capital gains tax rate for MFJ is 0% up to $89,250 according to https://www.nerdwallet.com/article/taxes/capital-gains-tax-rates. You should reread that last sentence a few times - NO taxes on long-term stock sales up to $89,250!

Once you are 59 1/2, you should consider moving the 401K to an IRA at Fidelity, Schwab, etc where you have more investing options and can easily purchase CD in your IRA.

 

[Out of Steam]

Your initial assumption of only having 500K at the end of 8 years is too conservative, in my opinion. If you stay invested in 60/40 stock/fixed income or 50/50, there’s a good chance you will still have about 1 million after 8 years.

Since you still have 1 more year of work, I would prioritize your savings outside of your 401K account, such as building up your savings in CD’s and/or investing in stocks or stock ETF in a brokerage account.

Agree with this. We have been in a very similar bridging situation over the past 3 1/2 years, and our biggest pre-retirement error was not building enough savings outside retirement accounts. We plan to finally fix this over the next 18 months by keeping up a 4% withdrawal rate after taking one of our Social Security payments.

We'll be ending this bridging period with about as much in retirement savings as we started it with.

 

[Jimonlimon]

...
Since you still have 1 more year of work, I would prioritize your savings outside of your 401K account, such as building up your savings in CD’s and/or investing in stocks or stock ETF in a brokerage account. This will allow you to live on smaller 401K withdrawals and CD’s and selling stocks. ....

We have two kids in college and are running a slight negative monthly cash flow, so until I retire there's not a spare penny for additional investments, roth conversions, etc. I'm resigned to every penny of income being fully taxable. The good news is that our 401k deferrals were mostly in the 1990's and avoided 28% federal taxes, so paying 22% for withdrawals seems pretty good in comparison.

 

[Al18]

We have two kids in college and are running a slight negative monthly cash flow, so until I retire there's not a spare penny for additional investments, roth conversions, etc. I'm resigned to every penny of income being fully taxable. The good news is that our 401k deferrals were mostly in the 1990's and avoided 28% federal taxes, so paying 22% for withdrawals seems pretty good in comparison.

Your first sentence sounds unusual. You may want to read the Early Retirement FAQ’s on this forum before you retire.

 

[Jimonlimon]

Your first sentence sounds unusual. You may want to read the Early Retirement FAQ’s on this forum before you retire.

Please elaborate. I've read many of the FAQ's and am not sure which portion you refer to.

Thanks

 

[COcheesehead]

Your first sentence sounds unusual. You may want to read the Early Retirement FAQ’s on this forum before you retire.

And all those zero earning years prior to taking SS may mean a lower amount than expected.

 

[Al18]

… so until I retire there's not a spare penny for additional investments, roth conversions, etc.

Where does the spare money for additional investments come from once you stop working?

I retired early 4 years ago at age 56 and can tell you my tax situation and withdrawals changed drastically once I retired. My federal tax rate was cut in half once I retired and my state tax rate is less than 1% in NJ.

 

[Jimonlimon]

…
Where does the spare money for additional investments come from once you stop working?.

I'm not planning additional investments with new money- just utilizing funds from our combined 401k's which are about $1,050,000 right now.

And all those zero earning years prior to taking SS may mean a lower amount than expected.

Based on SSA.gov and SSA.TOOLS my SS benefit will only go up about $20/month if I work another year, $15 more for the following year, and even less for additional years. I already have more than 35 substantial earning years for SS so each additional year doesn't add much to my lifetime earnings calculation.

I was trying to make this thread fairly simple- so I didn't detail our main source of retirement income: my government pension that after taxes will initially replace 85% of our current net income. This includes healthcare coverage.

 

[COcheesehead]

I'm not planning additional investments with new money- just utilizing funds from our combined 401k's which are about $1,050,000 right now.



Based on SSA.gov and SSA.TOOLS my SS benefit will only go up about $20/month if I work another year, $15 more for the following year, and even less for additional years. I already have more than 35 substantial earning years for SS so each additional year doesn't add much to my lifetime earnings calculation.

I was trying to make this thread fairly simple- so I didn't detail our main source of retirement income: my government pension that after taxes will initially replace 85% of our current net income. This includes healthcare coverage.

Just as long as you understand that what SS reports as your benefit assumes you will work up to your date of taking SS and at your current income level.