How to decide if you can live off investments or need to draw them down

[pb4uski]

... I am curious about how people decide if they have enough resources to live off of their investments and thus keeping the principal or use a spend down strategy and use up their investments, hopefully on their last day. ...

I think it is excessively foolish to insist that you only live off of income and never invade principal. Why? Did you save that money for your retirement or to hoard it?

I just look at spending in relation to assets and whether the withdrawal rate is prudent... it doesn't matter whether withdrawals are interest or principal as long as you have a prudent success rate.

If people worked until they could live on income and not invade principal then very few people would retire.

 

[Koolau]

I pay little attention to investment "results" like dividends or interest, etc. I take what I need from my stash as part of my rebalancing.

 

[EastWest Gal]

We've been living off of our portfolio for almost 5 years. About half of what we need comes from dividends, and the other half from selling from the portfolio as needed. Selling and living off the capital gains is a great way to go-as you have about 50% more cash than what you need to report as income, and qualified dividends and long term capital gains are taxed at much lower rates.

Since I retired in 2019, our portfolio has increased by 25%. We're not living cheaply,but we're not going hog wild. It feels weird selling equities, but after a couple of years of paying low federal income tax, it will feel just fine.

After a few years of retirement, your wife may decide to delay SS until at least full retirement age. She leaves quite a bit of money on the table taking SS early. If your portfolio is doing well at that time, there is no need to take SS at 62.

 

[mathjak107]

keep in mind dividends are quite tax inefficient…one pays taxes on the entire dividend .

the same income coming from appreciation only gets taxed on the gain portion.

also as little as a 2% dividend over the long term being taxed can wipe out any pluses from lower capital gains rates over time

 

[OldShooter]

... How do you know if you need to draw down your portfolio or if you can live off of the income it could throw off? ...

A simple-sounding but complex question. As has been pointed out, dividends are not free money.

The other question is inflation. To maintain your principal you can take and spend only income in excess of inflation. For example, assume a 5% inflation rate and 10% income from bond interest. You can only take and spend half of the 10%. The rest must be retained in "principal" to preserve the principal balance's buying power.

 

[GenXguy]

keep in mind dividends are quite tax inefficient…one pays taxes on the entire dividend .

the same income coming from appreciation only gets taxed on the gain portion.

Appreciation "is" the gain portion. When selling, you get taxed on the the whole gain just as you would the whole dividend.

also as little as a 2% dividend over the long term being taxed can wipe out any pluses from lower capital gains rates over time

Qualified dividends are taxed the same as capital gains.

 

[mathjak107]

Appreciation "is" the gain portion. When selling, you get taxed on the the whole gain just as you would the whole dividend.


Qualified dividends are taxed the same as capital gains.

yes , but you are taxed on the whole dividend, not just the gain.

tax on the gain is once , tax on the dividends repeats each time eventually wiping out the tax advantage if it goes on long enough

 

[pb4uski]

keep in mind dividends are quite tax inefficient…one pays taxes on the entire dividend .

the same income coming from appreciation only gets taxed on the gain portion.

also as little as a 2% dividend over the long term being taxed can wipe out any pluses from lower capital gains rates over time

Fair point but it depends on other income sources.... interesting fact is that in 2024 a married couple under 65 filing jointly could have $123,250 of qualified dividends and LTCG and pay no federal income taxes at all!

 

[mathjak107]

that situation is even better for tax gain harvesting . tax free gain harvesting is one of the best things one can do.

tax loss harvesting usually just amounts to kicking the tax can down the road like a 1031 exchange on real estate does .

but tax gain harvesting is all good

 

[GenXguy]

yes , but you are taxed on the whole dividend, not just the gain.

You pay taxes on a dividend when you earn it. You pay tax on the gain when you realize the gain. If you aren't selling, there is no gain, so you will just have the dividend. You won't be paying on a gain.

tax on the gain is once , tax on the dividends repeats each time eventually wiping out the tax advantage if it goes on long enough

I'm not sure why you are saying that. You aren't double, triple, and more taxed on the same dividend income. Each dividend is new income. I'll provide an example.

Two scenarios. Assume 15% capital gains tax bracket.

1) Over 5 years, you have a $100,000 capital gain from selling a fund. It paid no dividends.

2) Over 5 years you have a $50,000 capital gain from selling a fund that also paid $10,000 per year in qualified dividends.

In both cases, you have $100,000 of income that is taxed as long term capital gains, which in this example is 15%. So, in both case, you would pay $15,000. There was no loss in taxes due to receiving dividends vs. a greater capital gain.

 

[skyking1]

I think it is excessively foolish to insist that you only live off of income and never invade principal. Why? Did you save that money for your retirement or to hoard it?

I just look at spending in relation to assets and whether the withdrawal rate is prudent... it doesn't matter whether withdrawals are interest or principal as long as you have a prudent success rate.

If people worked until they could live on income and not invade principal then very few people would retire.

Agreed. We will spend well above a sustainable rate for the first several years, and deplete some of the principal in the process. That has always been the plan.
Based on age and health and health histories, we won't run out of money before we run out of time.

 

[mathjak107]

You pay taxes on a dividend when you earn it. You pay tax on the gain when you realize the gain. If you aren't selling, there is no gain, so you will just have the dividend. You won't be paying on a gain.

I'm not sure why you are saying that. You aren't double, triple, and more taxed on the same dividend income. Each dividend is new income. I'll provide an example.

Two scenarios. Assume 15% capital gains tax bracket.

1) Over 5 years, you have a $100,000 capital gain from selling a fund. It paid no dividends.

2) Over 5 years you have a $50,000 capital gain from selling a fund that also paid $10,000 per year in qualified dividends.

In both cases, you have $100,000 of income that is taxed as long term capital gains, which in this example is 15%. So, in both case, you would pay $15,000. There was no loss in taxes due to receiving dividends vs. a greater capital gain.

here is a much more detailed analysis by kitces

“ having even just a little bit of equity turnover and a modest level of ongoing dividends already erodes much of the value of the tax deferral normally associated with buy-and-hold strategies.

A mere 2.5% ongoing dividend can eliminate as much as 1/3rd of the benefits of tax- deferral, and just having equities turn over once per decade erases another 1/3rd of the benefits of tax- deferral over the span of 30 years.”

https://www.kitces.com/blog/asset-l...e-account-versus-ira-depends-on-time-horizon/


https://www.kitces.com/wp-content/u...-Exploring-The-Benefits-Of-Asset-Location.pdf

 

[CardsFan]

I think it is excessively foolish to insist that you only live off of income and never invade principal. Why? Did you save that money for your retirement or to hoard it?

I just look at spending in relation to assets and whether the withdrawal rate is prudent... it doesn't matter whether withdrawals are interest or principal as long as you have a prudent success rate.

If people worked until they could live on income and not invade principal then very few people would retire.

I fully agree. But, sometimes when starting the withdrawal process, it can be difficult. That's why I suggested looking at the overall income, and realizing that the "spend down" is only a a fraction of what you think it is.

No doubt, it is a mind game.

 

[skyking1]

It helps me play that mind game by having buckets. Knowing that the bucket of Roths is not to be disturbed for x number of years makes it easier to dip into the others.
That it is growing tax free while I leave it alone helps with the mind games.

 

[GenXguy]

here is a much more detailed analysis by kitces

“ having even just a little bit of equity turnover and a modest level of ongoing dividends already erodes much of the value of the tax deferral normally associated with buy-and-hold strategies.

A mere 2.5% ongoing dividend can eliminate as much as 1/3rd of the benefits of tax- deferral, and just having equities turn over once per decade erases another 1/3rd of the benefits of tax- deferral over the span of 30 years.”

https://www.kitces.com/blog/asset-l...e-account-versus-ira-depends-on-time-horizon/


https://www.kitces.com/wp-content/u...-Exploring-The-Benefits-Of-Asset-Location.pdf

Ok thanks. I reviewed. They didn't show the math or a yearly chart over those 30 years, which would have been interesting to see.

But, I made my own chart assuming a 15% tax on dividends and capital gains to simulate what they were showing, but over a shorter time frame. The problem isn't that the dividend is being double taxed, but when the taxes are subtracted from the dividends before reinvestment, it cuts down growth more over time than the higher taxes you would pay on a gain alone in the long run, assuming same 15% tax rate. Fortunately, this doesn't change anything for me or what I would have done. I should be in the 0% capital gains tax bracket beginning this year.

 

[mathjak107]

Ok thanks. I reviewed. They didn't show the math or a yearly chart over those 30 years, which would have been interesting to see.

But, I made my own chart assuming a 15% tax on dividends and capital gains to simulate what they were showing, but over a shorter time frame. The problem isn't that the dividend is being double taxed, but when the taxes are subtracted from the dividends before reinvestment, it cuts down growth more over time than the higher taxes you would pay on a gain alone in the long run, assuming same 15% tax rate. Fortunately, this doesn't change anything for me or what I would have done. I should be in the 0% capital gains tax bracket beginning this year.

yes the dividend isn’t double taxed , but the cumulative effect is what takes its toll tax wise.

i hold berkshire in my taxable account

 

[Koolau]

Agreed. We will spend well above a sustainable rate for the first several years, and deplete some of the principal in the process. That has always been the plan.
Based on age and health and health histories, we won't run out of money before we run out of time.

That's the way we did it. It wasn't quite planned that way, however. We ended up doing two moves and two rehabs in two years. That's expensive. We burned through ALL of our cash which we had planned on lasting us 10 years. IOW, we changed our minds on what was important to us. THE place to live exactly WHERE we wanted it was more important to us than following the financial plan. We called that being "flexible." It still w*rked out well for us and no regrets. BUT it confirms that the 4% rule or FIRECalc , etc., are for insuring you have enough money in FIRE before you FIRE. They are not designed to "dictate" how you take the money in FIRE. Flexibility is key IMHO.

 

[RobLJ]

Agreed. We will spend well above a sustainable rate for the first several years, and deplete some of the principal in the process. That has always been the plan.
Based on age and health and health histories, we won't run out of money before we run out of time.

That's our approach. Since we stopped working entirely (I was working online halftime from 2015-early 2020), our withdrawals peaked at almost 6%; for 2024 it was down to 5.1%. Next Jan I will hit FRA, take SS and the WR will be down to 3.4% and then down to 1.8% when DW takes her SS, sometime from 2029 or after. This assumes the portfolio will remain roughly constant; it's up about 25% since we came to Reno in 2015 and semi-retired.
So I wasn't too worried about the "high" withdrawal rate, assuming it would moderate once SS kicked in and drop below 4%.

With SS in sight, I've stopped worrying as much about the portfolio, as of a year or two ago. It was more of a worry from 2015-2020.

 

[sakowitzm]

Maybe this was posted but I didn't see it. I particularly like Retiree Portfolio Model. Just google that and you'll see that you can go to Bogleheads and download the spreadsheet. There's an awful lot in there, and it will likely take at least a couple of hours to poke around and see all that it's taking into account. But once you do that, you can "play with" doing TIRA to Roth conversions; bleeding out your TIRA in the early years (to reduce RMDs and thus taxes); look at drawing down relatively equally from taxable, TIRA, and Roth over time; etc, etc.

 

[LateToFIRE]

Maybe this was posted but I didn't see it. I particularly like Retiree Portfolio Model. Just google that and you'll see that you can go to Bogleheads and download the spreadsheet. There's an awful lot in there, and it will likely take at least a couple of hours to poke around and see all that it's taking into account. But once you do that, you can "play with" doing TIRA to Roth conversions; bleeding out your TIRA in the early years (to reduce RMDs and thus taxes); look at drawing down relatively equally from taxable, TIRA, and Roth over time; etc, etc.

+1, I have spent days at a time messing with RPM. Big learning curve, but worth it if you're an Excel junkie, and very educational because all the guts of it are right there for you to see how its coming up with the results. Not a Monte Carlo simulation or even a historic simulation, but still a great tool. You can still stress test your results manually, by haircutting your starting assets or inflation or market return assumptions.

 

[HI Bill]

My investments don't throw off 4-6% in dividends. I spend taxed dividends first (not reinvesting), then sell other ETF shares to make up my WR. Yes, I'm selling equities, but those remaining are still growing. In my early ER years (55-59.5), I'm trying to balance using the full 0% MFJ tax bracket for LTCGs with the need to reduce my inherited IRA and "Rule of 55" 401(k) by taking taxable withdrawals with no penalties.

Either way, you're living off your investments. (If you spend all dividends and the markets are flat, you'll see your investments values decline).

 

[2retireearly]

I retired at 56. I had a bunch of cash. So I lived off of that,plus took 20k a year from my 401k. Since I retired after 55, I could take it with no penalty. I kept my taxes low. for 2 year I used ACA, so I was happy to keep income as low as I needed it to be to cover a fairly rich lifestyle. The goal is to take out only as much as you need..keep the taxes low, and keep your health prems low (i ended up taking my companies health plan which was only $200 a month), but for 2 years my ACA was only $95 a year. it was fun to play with the numbers. But stock up on cash, now, for when you are retired.

 

[ERhoosier]

There are 2 financial aspects to the "can I live off my investments" question- income & expenses. Lots of good thoughts on investment income. I'm also a big fan of firecalc, especially its 'what if' graphs illustrating how sequence of returns can make or break things even at the same average rate of return. But the other key component is the expense side. The longer the retirement the wider the cone of financial uncertainty. IMHO any long term plan of predicted expenses should include alternative plans should major unexpected expenses rear their ugly head(s).
The 'can I live off my investments' question can be a difficult one, especially for those whose well-paid career is difficult to re-enter should they experience a future financial need to do so.

 

[Echard]

A financial planner today told me that if you hold three years of cash living expenses you virtually eliminate SoRR. I know this is wrong. I’d like to send him one or more studies that will show him he’s wrong. I don’t think the guy is very bright. He’s also trying to get all his retirement clients on cash value life insurance, arguing that’s the best investment approach, which is also ridiculous.

 

[disneysteve]

A financial planner today told me that if you hold three years of cash living expenses you virtually eliminate SoRR. I know this is wrong. I’d like to send him one or more studies that will show him he’s wrong. I don’t think the guy is very bright. He’s also trying to get all his retirement clients on cash value life insurance, arguing that’s the best investment approach, which is also ridiculous.

Don’t waste your time trying to correct him. He’s a salesman. He’s not interested in truth. He’s only interested in suckering as many people as possible. The commissions on whole life are incredibly high. He’s not stupid. He knows he’ll make a bundle from every poor sap he can convince to take out a policy.