Methodology for withdrawing for retirement

[surprising]

I'm struggling with how best to manage withdrawing to fund retirement. I am newly retired and have about $1M that needs to last until I can access 401k in about 9 years. Allocation is 48% dividend paying stocks/funds, 38% in equities (mostly high risk high growth stuff), and 14% cash. I also own rentals.

Budget is $10K/month for expenses, some months come in less, some more. My current methodology is pretty simple. I track all my expenses and then once the month is over, I calculate what I need to withdraw as:

Income = Dividends + Rents
Withdraw = Expenses - Income

If Withdraw is positive, I then need to sell stock to 'balance the books'. This is the part I struggle with. There are so many options here, I don't know what is the best, optimal way, to preserve my net worth. I could:

1. Sell a stock at a loss, which can offset other stock gains (not dividends though)
2. Sell a stock with long term gain, still have to pay taxes but more friendly long term cap gains
3. Sell a stock with short term gain, worst case scenario
4. Combination of 1-3 to keep overall gains to 0.
5. Sell some dividend stock, which will permanently reduce my dividends going forward
6. Use cash, but it will eat into emergency fund but could be best option during down markets

I have a spreadsheet that focuses on #5 that shows my dividend funds can last until 2035 if I withdraw the maximum for expenses every year. I never have to touch other equities so hopefully they can grow in the next 9+ years to offset.

BUT, there are even more variables to consider. What if I want to minimize income in order to quality for ACA subsidies? What if I want to do roth conversions? Am I overthinking all this and should just pick a SWR and be done with it?

 

[jebmke]

In taxable I always sell stocks that have unrealized gains whether I need the money or not. If I don't need the money, I invest the proceeds in some other equity fund that is similar to the one I just sold. So, if that covers your cash needs, that's what I'd do.

 

[Texas Proud]

You did not say what kind of accounts the investments are in... taxable, IRA or ROTH....

You did not say what your tax situation is... what is your marginal rate...

You did not say if you make enough that you do pay taxes on your cap gains...

I could not tell you what I think is best from what you posted...

OHH, are you on ACA? If so, is the credit big or small? Mine was big when I had 4 people on it... not as much anymore as I am now off and so is one kid...

 

[jazz4cash]

Selling stocks monthly to fund retirement sounds like a lot of work. Just keep 10% in a cash account and you avoid this monthly calculation and decision. You can then optimize your stock trades and refill the cash bucket before it is depleted

 

[N02L84ER]

When we sell, we sell the funds that were most off their desired percentage. In other words, we sell to keep our asset allocation in balance.

 

[surprising]

You did not say what kind of accounts the investments are in... taxable, IRA or ROTH....

All taxable, this is pre-401K bucket that's funding my retirement until I can touch 401K

You did not say what your tax situation is... what is your marginal rate...

No idea yet because I just retired and haven't a clue how much income I'll have. Hoping to be in 12% bracket though.

You did not say if you make enough that you do pay taxes on your cap gains...

Hoping to be at 0% long term cap gains -- I guess that's yet another variable to consider when making stock sales.

I could not tell you what I think is best from what you posted...

OHH, are you on ACA? If so, is the credit big or small? Mine was big when I had 4 people on it... not as much anymore as I am now off and so is one kid...

Not on ACA yet but within a couple years I will be.

 

[surprising]

When we sell, we sell the funds that were most off their desired percentage. In other words, we sell to keep our asset allocation in balance.

OK so for example if you are at 72 stock/28 bond and need to sell, you'd sell the stock first to bring you back to 70/30?

 

[HI Bill]

...I could:

1. Sell a stock at a loss, which can offset other stock gains (not dividends though)
2. Sell a stock with long term gain, still have to pay taxes but more friendly long term cap gains
3. Sell a stock with short term gain, worst case scenario
4. Combination of 1-3 to keep overall gains to 0.
5. Sell some dividend stock, which will permanently reduce my dividends going forward
6. Use cash, but it will eat into emergency fund but could be best option during down markets...

Look at what your tax rates would be with a given strategy, then consider what they'll likely be when you start 401(k) withdrawals. Regarding the ideas above:

1. I try never to do this, unless I'm unloading a position and rebalancing. You'll only regain a small percentage of the loss with the deduction.

2. I do this mostly. I look at the LTCGs percentage and try to balance income needs with keeping the LTCGs rate in the 0% bracket. At least that's what I did until my income eclipsed the 0% bracket.

3. No, don't do this. Too costly. Set stocks/funds to reinvest dividends in tax-deferred, but take dividends in taxable accounts for spending, as you're already paying taxes on them in the current year.

4. If you keep the gains to 0 now, you'll have huge tax bills later on as the gains grow. Also consider the future potential need to balance the sale of 100% taxable tax-deferred assets with some taxable assets that have LTCGs and the original investment isn't taxable upon withdrawal (basis).

5. Total return investor here. If you own dividend-paying funds, you'll likely sell at least some of them at some point. But look at total return on each of your investments, and keep the ones that give you the greatest total return.

6. Cash is last choice, only after selling losers. Save this option for market down years.

Suggest a spreadsheet and some modeling with your desired income and tax brackets, along with ACA and LTCG bracket considerations. Without an annual spend from your taxable accounts, no one can give you specific good recommendations.

 

[N02L84ER]

OK so for example if you are at 72 stock/28 bond and need to sell, you'd sell the stock first to bring you back to 70/30?

yes.

 

[Koolau]

Something I haven't seen in responses so far: Consider selling rentals and live off THOSE proceeids. There will likely be taxes involved, so do it "slowly" over time. Rentals CAN be a good income provider, but do you need that if you have the cash in hand from their sale? After all, you're just biding your time to get at your 401(k). I assume at that point, you'll have plenty of cash flow from the 401(k).

I'm sure by now you're comfortable managing your rentals, but will you be comfortable as you age? Given the opportunity to simplify your life, wouldn't you consider giving up the rentals - for cash? Just a thought.

Full disclosure: It's been my experience that those with rentals think they are the best possible investment - until they aren't so YMMV.

 

[surprising]

Something I haven't seen in responses so far: Consider selling rentals and live off THOSE proceeids. There will likely be taxes involved, so do it "slowly" over time. Rentals CAN be a good income provider, but do you need that if you have the cash in hand from their sale? After all, you're just biding your time to get at your 401(k). I assume at that point, you'll have plenty of cash flow from the 401(k).

I'm sure by now you're comfortable managing your rentals, but will you be comfortable as you age? Given the opportunity to simplify your life, wouldn't you consider giving up the rentals - for cash? Just a thought.

Full disclosure: It's been my experience that those with rentals think they are the best possible investment - until they aren't so YMMV.

Yep, the rentals gotta go someday. They have all appreciated a lot so I don't look forward to the taxes. We are toying with various ideas, like living in each one for a couple years to make it primary, then sell. Or do a 1031 exchange to buy a home where we want to live in the future, rent it out a couple years, then move into it.

 

[Flyfish1]

I assume you know about the Rule of 55? Meaning you can access the 401K at age 55 instead of 59 1/2 if you are not working.

 

[Al18]

Clarification - if you separate from service in the year you turn 55 or after, you can withdraw from your 401K without paying a penalty. If you leave your job the previous year, then you can’t access the 401K without penalty until you are 59 1/2.

 

[Al18]

Selling LTGC seems to be the best option to keep your taxes low. Checking your finances and deciding what to sell on a monthly basis seems exhausting. Consider selling 6 months to a year of stock, keep the proceeds in a Money Market account or an online saving account and setup automatic monthly transfers to your checking account. Repeat every six months to a year.

 

[surprising]

Selling LTGC seems to be the best option to keep your taxes low. Checking your finances and deciding what to sell on a monthly basis seems exhausting. Consider selling 6 months to a year of stock, keep the proceeds in a Money Market account or an online saving account and setup automatic monthly transfers to your checking account. Repeat every six months to a year.

I may eventually do that, but I actually like working with numbers and find it an interesting challenging problem.

 

[surprising]

Clarification - if you separate from service in the year you turn 55 or after, you can withdraw from your 401K without paying a penalty. If you leave your job the previous year, then you can’t access the 401K without penalty until you are 59 1/2.

Yep, doesn't apply to me. Been officially retired for 7 days now and a few years away from 55.

 

[LateToFIRE]

First, congrats on the early retirement. I also recently retired (but a few years older than you), with some similar issues/questions. So far, I've had enough cash not to worry about all this yet, but that road is coming to an end in a few months.

My plan is:

1) Sell rental properties - I know I don't want to be a landlord in retirement. The cap gains tax will be excruciating, but then I'll have a nice wad of after-tax funds enough to bridge me a few years without much touching anything else.

2) That move will then give me enough tax bracket flexibility to manage some Roth conversions and exit some concentrated stock positions with large unrealized cap gains.

3) Ultimately my goal is to generate sufficient income from dividends, small pension, and social security to fund regular expenses.

4) Once RMD's hit in a few years at age 75, that will present another set of tax problems - the conversions will only get me so far on that.

 

[audreyh1]

Clarification - if you separate from service in the year you turn 55 or after, you can withdraw from your 401K without paying a penalty. If you leave your job the previous year, then you can’t access the 401K without penalty until you are 59 1/2.

There is a caveat. The company 401K plan must allow this option.

 

[PointBreeze]

There is a caveat. The company 401K plan must allow this option.

Exactly! Mine did not

 

[Koolau]

Yep, the rentals gotta go someday. They have all appreciated a lot so I don't look forward to the taxes. We are toying with various ideas, like living in each one for a couple years to make it primary, then sell. Or do a 1031 exchange to buy a home where we want to live in the future, rent it out a couple years, then move into it.

Not a bad idea. We only had one rental but we did that. Lived there two years and then sold. Of course, that was always an option, though our original plan was to live out our days there. DW didn't like the "rain band" we were in, so we sold after two years.

One thing to be aware of: If you took depreciation on your rentals, you will be required to pay taxes on the "depreciation recapture" assuming you have a gain when you sell.

 

[TickTock]

Not on ACA yet but within a couple years I will be.

This is another consideration - BEFORE going on ACA, consider making moves which will increase your MAGI. Doing them later might result in reduced PTCs or falling off the cliff (if it's reinstated).

 

[surprising]

This is another consideration - BEFORE going on ACA, consider making moves which will increase your MAGI. Doing them later might result in reduced PTCs or falling off the cliff (if it's reinstated).

Yeah, it will be an interesting process to track things to ensure we stay under the limit for subsidies. I worry about one-time unforeseen expenses that could derail the whole strategy though.

 

[Al18]

One-time unforeseen expenses are easily funded by cashing in a CD or iBond.

 

[SecondCor521]

We are toying with various ideas, like living in each one for a couple years to make it primary, then sell. Or do a 1031 exchange to buy a home where we want to live in the future, rent it out a couple years, then move into it.

There have been changes in the tax regulations that now preclude this strategy. You can still do 1031 exchanges, but moving into rentals and then trying to use the $500K exclusion has been regulated away by the IRS. The regulations, as I understand them, now only allow you to count time that you lived in a house before you rented it towards the 2 of 5 year requirement; time lived in the house after it was a rental does not count, thus you can't claim the exclusion.

I don't have a cite for the above, but I've read discussions over at Bogleheads stating the above. I looked at the regulations when following along with that conversation and they seemed to track.

Were I in your shoes, I'd check with my tax preparer to clarify or confirm before trying to execute the strategy. It'd be a bummer if I thought it would work, spent two years living in a rental, and then found out it didn't work.

 

[surprising]

Can you find where this is stated? The only thing I've found so far is the following:

"The IRS realizes that a person’s circumstances may change; therefore, a property may change in character over time. For this reason, it is possible for an investment property to eventually become a primary residence. If a property has been acquired through a 1031 Exchange and is later converted into a primary residence, it is necessary to hold the property for no less than five years or the sale will be fully taxable."

So to me that seems to suggest I need to own the property as a primary residence for 5 years after converting, which seems doable.