Bucket Question

[Seattle]

Great site! Alot of very smart people here. Thanks in advance for any wisdom.

I posted a long time ago in the "I am" section, but stayed at work for a few more years to build up the portfolio. Now I am getting closer to ER and things are getting real and not just hypothesis.

Me: 51 years old - $6M net worth: $4.4M in after tax Vanguard investments (50/50), $800K in Fidelity 401K and rest in my house that is paid off. No debt. No pensions or anything else coming down the road. I need $150K a year to live comfortably (I don't need to adjust for inflation for 5 years, can just cut spending alittle each year and I will be fine)

My question is with the "bucket" strategy. I have read several places that buckets is a good way to start on ER, and one strategy is to take out 5 years of living expenses and put it in safe place (laddered CDs) and that supposedly allows any market fluctuation to work itself out before you have to dip back into your portfolio. For me that is $750K in my bucket leaving $4.45M five years to re-build back.

Did any of you deploy this 5 year bucket system to get started and how did it work for you? I am just really nervous about starting ER and hitting a nasty recession right out of the gate. Double whammy. At least with this 5 year bucket set aside away from the risk, I can ride out 5 years and even go back to work if it gets really ugly.

The other question I have about the bucket is that it *appears* that for 5 years I will literally not pay any income taxes or SS except for dividend income that are reinvested. Correct? Kind of nice benefit from that...after paying $400K a year in taxes, hard to believe I will go 5 years without paying...

And it's kind of crazy to think that a guy with $6M would be getting breaks on ObamaCare because I would be showing such a small income for 5 years, or at least that is the way I understand how ObamaCare works.

Just wanted to check with you guys on the bucket system and the tax situation that comes from it because I am getting closer to pushing the button on FIRE. It is really interesting, I would love to be done, but I just cannot figure out the best way to get started.

Thoughts?

 

[W2R]

Hi Seattle, and I'm so glad to read that you are getting very close to ER these days!

I think that keeping 5 years in cash is a good idea. It is really helpful to have a lot of cash if/when the market crashes, as in 2008-2009. With plenty of cash to live on, one is not so tempted to sell low at times like that.

Also, yes, I was completely floored when I realized how low my taxes really were in retirement. I mean, I had read on the forum where other people had said their taxes were low after retiring, but I didn't exactly believe it until I experienced these lower taxes.

Sounds to me like you have a pretty good handle on what to do, and what to expect after ER.

 

[Whisper66]

"Did any of you deploy this 5 year bucket system.....?" -- I don't because it feels overly conservative to me. I keep a maximum of 3 yrs of expenses in cash / bonds. That plus income from stock dividends (rates of ~3-5%) means I could hold out for ~5 yrs without selling any stock. Holding 5 yrs of assets in CDs feels like too much money not earning anything for me.

".... it *appears* that for 5 years I will literally not pay any income taxes or SS except for dividend income that are reinvested. Correct? " -- yes, I think that is correct. One thing people often do is not realize how much their yearly expenses go down in retirement due to decreased taxes.

"And it's kind of crazy to think that a guy with $6M would be getting breaks on ObamaCare because I would be showing such a small income for 5 years, or at least that is the way I understand how ObamaCare works." -- Hey, it's our federal government programs, of course they are crazy.....

"Just wanted to check with you guys on the bucket system and the tax situation that comes from it because I am getting closer to pushing the button on FIRE. It is really interesting, I would love to be done, but I just cannot figure out the best way to get started." ---- You could walk out today and be perfectly fine. The hardest part is just really knowing you want to do it. Your financial situation isn't tight at all, you could invest your money in many ways and be fine.

Good luck.

 

[growing_older]

I would be very cautious about adopting a bucket strategy instead of a total return strategy. While a large cash position can be reassuring it needs to be replenished from time to time, and that effectively reduces the bucket strategy to the total return strategy with a big part of the assets sidelined to maintain the cash bucket.

https://www.bogleheads.org/wiki/Buckets_of_Money

 

[Cobra9777]

A cash bucket of $750K is nearly 15% of your investable assets. That strikes me as too high and will be an unnecessary drag on performance. With $4.4M in a 50/50 taxable account, you should generate about $95K/yr in dividends. Your additional cash need is only $55K/yr. So set aside $275K to cover 5 years. That's a 5% allocation to cash, which seems more reasonable to me.

 

[RenoJay]

Regarding the tax question, you'll also have taxes on interest from the CDs but it'll be pretty minor. I agree with the previous poster that you only need to account for the delta between your dividends/interest and your lifestyle needs with the CDs and that you could end the auto reinvestment of dividends and instead use them to cover living expenses.


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[Seattle]

Wow, all very insightful posts. Thank you for the feedback. Perhaps I am being too aggressive with the cash position.

You guys gave me alot to chew on - thank you. I am now leaning towards more like $275K in cash and focus more on total return and dividends as they relate to my overall position.

I am going to get with Vanguard advisers and chart out a path for this model, something that will be easy to re-balance each year and figure out the cash flow, etc.

But thanks again to all - very helpful. Once I FIRE I will post back here and keep everybody up to date.

 

[nun]

If you have after tax investments of $4.4M in Vanguard and lets say you get dividends of 3% that works out to $132K in taxable dividends. Sorry you won't qualify for an Obamacare subsidy and will continue to pay tax unless you put stuff into tax free things like municipal bonds.

I would put enough for one or two years of spending in something safe like a bank account and CDs and then invest the rest according to a total return asset allocation that you like. Also efficient tax planning is more important for you than most.

 

[pb4uski]

I also am skeptical that you won't be paying taxes, but an easy way to confirm or refute that would be to plug your last year's return into Taxcaster adjusted to strip out your earnings from work and any other appropriate adjustments. If your after tax investments are 50/50 and stocks pay 2% in dividends and bonds pay 2.5% in interest then you would be well into the 28% tax bracket if you are single and in the 25% tax bracket if you are married (assuming standard deductions). You would also be way beyond getting an Obamacare subsidy.

I don't believe in buckets, but I did goose up my cash allocation from 0% to 6% when I retired as a sleep at night measure. In my case, 6% was twice my ~3% withdrawal rate. But in reality that 6% cash could cover almost 3 years of spending since I take taxable account dividends in cash.

FWIW, I manage my portfolio to a 60/34/6 stocks/bonds/cash AA and that equates to roughly 72/22/6 in inflation protection/stable value/liquidity buckets.

 

[mathjak107]

a bucket system can produce slightly better results since dividends can be reinvested to grow longer while cash and bonds are spent down .

that is the good news .

the bad news is to make maximum use of growing the equity's you have to delay refilling as long as you can .

that means your allocations to equity's are actually gong higher and higher as you spend cash and bonds down.

you can be 85 and perhaps 80% equity's before refilling .
of course you can refill earlier but then you lose the advantage of the bucket system allowing equity's and reinvested dividends time to grow

 

[EastWest Gal]

That much cash seems too high to me too.

Another source of taxable income you will be reporting is realized long and short term capital gains. When you pull out $750K all at once, you may find about $250K in cap gains you need to report. If your total income for total income for the year puts you in the 39% tax bracket ($457K for married filing jointly) your LTCG rate jumps to 25%. And short term gains are taxed as regular income. With dividend income of $130K and LTCG of $250K you're at $380K gross income already, for the one year. If you work a partial year before retiring, you could find yourself paying more taxes than expected.

It probably makes more sense to build the cash reserve by not investing your last year's excess income but put it in cash and short term treasury bonds. Also, do not reinvest the dividends staring now, to build cash reserves. Then sell a smaller amount of assets to beef your cash reserve, and sell them over a few years to keep the income lower.

I'm doing significant changes to my portfolio over a 3 year period to cut down equity exposure in retirement, something my former CFP delayed due to their shortsightedness and due to the huge market gains the last few years. I want to complete it before 2018, since after 2017 who knows if cap gains taxes will remain low-new president, new Congress. That will also minimize my cap gains going forward, since most of my portfolio will be at a higher basis. My entire portfolio had over $600K in unrealized gains when I started this process. Yours might be double that.


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[mathjak107]

a bucket system is just the reverse of a convention systematic withdrawal .

you have more cash and bonds early on with buckets but equity's rise through retirement until you refill .

you actually have less tied up in bonds and cash then a conventional plan does until the refill point improving performance on the back end instead of the front end .

 

[Turn_the_Page]

For me, it will be ~3 years of WD in cash. However, this is cash in the bank, not whatever cash equivalents are in the investment accounts. Five years seems too high to me, especially if you have a moderate/balanced allocation. The bonds/cash equivalents in the investment accounts will moderate the equity 'swings'.

 

[mathjak107]

we just retired and went with 2 years withdrawals and a 50k emergency fund .

 

[jabbahop]

The income and tax issues in the short term depend a bit on your investments.

We have mostly bonds in our tax advantaged accounts so we don't need to account for those gains until RMD times.

We have a mix of vanguard index funds that pay out little in terms of capital gains and dividends so we only have to worry about cap gains and when we sell which is a bit more controllable.

We still have a lot of deductions so have a number of years we could pay very little in taxes. Agree with others that tax caster is a great tool to do what ifs.


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[MooreBonds]

Also, don't forget the new 3.8% expanded medicare tax on investment income for incomes exceeding $200k (single) or $250k (married).

So if at all possible, try to review your holdings to stay below $250k total taxable income to avoid an extra 3.8% hit.

 

[RockyMtn]

I also have 60/34/6 AA. After tax accounts throw off enough in yearly dividends to live on and pay taxes with. All after tax account bonds are in muni's for tax efficiency.


Once pensions, SS, and RMD's kick in I will live off those and probably lower the cash allocation position somewhat as the dividends will become my cash cushion. 6% is a bit higher than I care to have in cash but find it useful for emergency purchases (cars, roof, etc) and for equity buying opportunities.

 

[rayvt]

I would be very cautious about adopting a bucket strategy instead of a total return strategy. While a large cash position can be reassuring it needs to be replenished from time to time, and that effectively reduces the bucket strategy to the total return strategy with a big part of the assets sidelined to maintain the cash bucket.

+1

Take a look at this spreadsheet and plug in whatever numbers you like. https://www.dropbox.com/s/xf4ma5blug27aws/SPY_Withdraw_by_CashBucket_rules.xls


The reason that cash bucket doesn't work is that you have to refill the bucket after drawing from it in a bear market. I have not been able to find a successful method of refilling it. Every cash bucket scenario I've tried has turned out to be worse than simply keeping a balanced (stocks/bonds) portfolio and taking your annual withdrawals at the same time you do the rebalancing.

The articles that advocate a cash bucket haven't thought it all the way through. They play on the fear of having to sell stocks when they are down big in a bear market. Well, guess what --- in a big down market when you rebalance you sell BONDS and BUY stocks.

 

[pb4uski]

I also have 60/34/6 AA. After tax accounts throw off enough in yearly dividends to live on and pay taxes with. All after tax account bonds are in muni's for tax efficiency.....

Why munis? Or I guess really, why any bonds in taxable accounts?

I just keep domestic and international equities in my after-tax accounts to take advantage of preferential tax rates on qualified dividends and LTCGs and foreign tax credit and keep all my fixed income in tax-deferred/tax-free accounts. My sense is that this is more tax efficient than having munis in my taxable account.

I guess that I could see that if my tax-deferred/tax-free declined to be less than 34% of the total that I might use munis in taxable and perhaps that is your situation.

 

[RockyMtn]

Why munis? Or I guess really, why any bonds in taxable accounts?

I just keep domestic and international equities in my after-tax accounts to take advantage of preferential tax rates on qualified dividends and LTCGs and foreign tax credit and keep all my fixed income in tax-deferred/tax-free accounts. My sense is that this is more tax efficient than having munis in my taxable account.

I guess that I could see that if my tax-deferred/tax-free declined to be less than 34% of the total that I might use munis in taxable and perhaps that is your situation.

Why muni's? Because 100% of my tax deferred is already in bonds and in order to get to my preferred AA I have to have a % of my after tax in bonds. I prefer muni's to avoid the federal taxes and generate cash to live on. I am not drawing anything from tax deferred at this point (age 57) and have been unable to do Roth conversions because of some stock options that are still vesting from mega corp.

 

[pb4uski]

Got it... makes perfect sense. I'm a long way from having my tax-deferred be less than 34% of the total and having that issue.

 

[Animorph]

I started retirement with about 3 years in cash, though DW decided to keep working so it turned out to be unnecessary. However, that was 2007, so the cash eventually came in handy.

A relatively large amount of cash at the start won't hurt your gains too much as long as you spend it first and don't replenish it. However, I have my doubts as to its average usefulness.

At a 3% initial withdrawal ratio you should be relatively safe already for any historical portfolio disaster, even a recession just as you retire. FIRECalc doesn't show any failures at 3% IIRC. So if things turn bad the cash will be nice, but you should be OK anyway. If things go great the cash will be a drag and you'll be a little worse off than if you had stayed with your AA. The extra cash ends up being just kind of a market timing effort.

The 4% initial withdrawal rate does have a few historical failure scenarios. To my mind, what you want is to reach about a 3% actual withdrawal rate (100% safe historically) as soon as you can. This could be via a nice bull market at the start of retirement, a steadily rising market, or saving cash at the start of a market bear, buying in near the bottom, and riding it back up.

However, holding a lot of cash would slow the drop from 4% to 3% withdrawals in a bull or steadily rising market. Maybe the bear market comes just after your cash runs out, forcing you to sell low. So holding a bunch of cash at the start could hurt, depending on what the market does. Or it might help if the market tanks soon after retirement. So what do you think, will the market tank now, in five years, or more? Will there be a big rise first or will it be flat until it drops? That's what you need to know, and it's basically just market timing.

Nonetheless, it may be prudent to hold significant cash if you are really sure the market will crash soon and your withdrawal rate is high enough that portfolio failure is a concern. I think the down side is not too bad and the up side is avoiding portfolio failure. However, I'm not sure you remain protected if the market stays flat while you burn your cash and then collapses just when the cash is all spent. Still some risk there.

In my case I had a pretty good cash balance built up in early 2007 and watched the market continue to rise 10% more. I needed a 10% drop just to get back to break even. Combined with buying back into the market mostly well before the final bottom, I did pretty well but I don't think it had a big portfolio impact.

You won't raise your cash right at the market peak, you won't add it back in right at the market bottom, and you're only playing with a fraction of you entire portfolio (hopefully). That tends to mute the beneficial effects.

I haven't seen a study, or tried it myself, that shows a benefit or harm to holding extra cash at the start of retirement. The closest would be Dr. Pfau showing that rising equity allocations during retirement helps portfolio survival a little bit, for the conditions that he assumed.

 

[Animorph]

Forgot to add that you look like a prime candidate for Roth conversions while your income is low.

 

[nun]

Forgot to add that you look like a prime candidate for Roth conversions while your income is low.

With $4.4M in after tax accounts is the OPs taxable income going to be low? We need to know how the $4.4M is invested to get an idea of the OPs tax bracket.

 

[mickeyd]

I have studied and read a bit about buckets and decided that it is no more than a way to make my own plan more complicated. Messing with unloading and reloading fictitious buckets may give you a nice picture of your stash, but in reality it seems needlessly complex.