Nearing retirement - need help with FI and withdrawals

[orre]

Hello everyone.

I’ve been reading this forum for a few years and it’s had a very positive influence on my outlook on investing and retirement.

I am close to retirement and need advice on how to position myself for retirement, especially on the fixed income side. I recently completed a rollover from a previous employer.

I would like to retire in the next couple of years and then spend time in academic research or teaching. I may have an income during retirement though that is not certain.

I will need to draw 2.5% - 3.0% from the portfolio. I plan to delay Social Security until I am 70. I also plan to convert my Traditional IRA to a Roth IRA after I retire. I expect to be in the 25% Federal bracket during retirement. I intend to sell my house and retire elsewhere; hopefully in a state with lower or 0% tax rates, which will facilitate the Roth conversion and retirement income. I plan to use the $350,000 in home equity to either rent for a few years depending on where I find a research or teaching position, or purchase a small house or apartment with no mortgage.

Thank you in advance. I really appreciate your time and insights.


Emergency funds: Six months of expenses – Ally Savings
Debt: $400,000 mortgage at 3.25% - House appraised at $700,000 - No other debt
Tax Filing Status: Single
Tax Rate: 28% Federal, 10.8% State
State of Residence: Oregon
Age: 59

Desired Asset allocation: 50% stocks - 50% bonds
Desired International allocation: 40% of stocks

Current total portfolio: Low seven-figures

Current retirement assets:

Taxable (72% of total)

12% Vanguard Prime Money Market Fund (VMMXX) (0.20%) (Cash for investing)
31% Vanguard Large-Cap Index Fund Admiral (VLCAX) (0.10%)
11% Vanguard FTSE All-World ex-US Index Fund Admiral (VFWAX) (0.18%)
9% Vanguard Total International Stock Index Fund Admiral (VTIAX) (0.18%)
9% Vanguard Limited-Term Tax-Exempt Fund Admiral (VMLUX) (0.12%)

401k (1% of total)

1% Vanguard Total Bond Market Index Fund Institutional Plus (VBMPX) (0.05%)

Traditional IRA at Vanguard (26% of total)

27% Vanguard Prime Money Market Fund (VMMXX) (0.20%) (Cash for investing – recent rollover)

Total of All Accounts: 100%.

Contributions:

New annual Contributions
$22,500 to 401k (plus $5,000 employer match)
$6,000 to IRA (nondeductible)
$50,000 taxable from income

Available funds:

Funds available in 401(k)

Vanguard Total International Stock Index Fund Institutional Plus (VTPSX) (0.10%)
Vanguard Institutional Index Fund Institutional Plus (VIIIX) (0.02%)
Vanguard Extended Market Index Fund Institutional Plus (VEMPX) (0.10%)
Various Vanguard Target Retirement Funds
Various PIMCO, Dodge & Cox, Neuberger Berman, Wells Fargo and Fidelity funds

Portfolio Questions:

1. Based on my tax rates I understand it does not make sense to invest new money in non-deductible IRAs. Would it be better to invest that money in taxable?

2. How should I organize my taxable fixed income to prepare for retirement? Should I have all taxable dividends directed to a money market account for living expenses, and then draw on the Limited-Term Tax-Exempt account for any additional monies. How much should I have in the Limited-Term Tax-Exempt account and how much should be invested in an intermediate term account? Or should I keep all the taxable fixed income in short term funds? I am aware that interest rates are likely to increase over the next few years and would not want to be drawing on a fund whose NAV has decreased significantly as a result.

3. It would appear that I have approximately 10 years of expenses in my taxable fixed income. How should I invest the IRA account in that case? Total Bond, PedFed CDs, short term investment grade, intermediate term investment grade? Or some combination of those funds?

4. As the taxable fixed income is drawn down what strategy should I use? Sell portions of the stock funds as needed to replenish the fixed income and rebalance in the IRA (Roth IRA at that point)?

[livesoft]

I think you have this all thought out and see no big problems nor do I see any small problems.

I agree with not contributing to a non-deductible tIRA unless you can convert it right away to a Roth, but that seems unlikely given your IRA.

Your portfolio is apparently large enough that you should be able to only spend the dividends and not have to sell anything except losers in taxable. I don't think you have to commit to just withdrawing from fixed income in taxable. Wouldn't you want to withdraw what would help with rebalancing and also give you the least amount of taxes? That may be fixed income most of the time, but I would not assume that. You sort of mentioned this already. Just remember if you withdraw only fixed income, then you will very likely need to sell equities to rebalance. So you might as well sell equities to start with and keep the fixed income around to meet your asset allocation.

[orre]

I agree with not contributing to a non-deductible tIRA unless you can convert it right away to a Roth, but that seems unlikely given your IRA.

I have looked into that and, as you point out, I don't believe I can do the immediate Roth conversion.

Your portfolio is apparently large enough that you should be able to only spend the dividends and not have to sell anything except losers in taxable. I don't think you have to commit to just withdrawing from fixed income in taxable. Wouldn't you want to withdraw what would help with rebalancing and also give you the least amount of taxes? That may be fixed income most of the time, but I would not assume that. You sort of mentioned this already. Just remember if you withdraw only fixed income, then you will very likely need to sell equities to rebalance. So you might as well sell equities to start with and keep the fixed income around to meet your asset allocation.

It would be nice if I could only spend dividends but unless I have made a mistake in my calculations the dividends from the taxable portion of the portfolio are about 1.5% (1.1% of the total). The distributions from Total International has gone down (taking into account the last distribution was for a 9 month period) and of course the yields from Limited Term Tax Exempt are low now.

I see what you mean about selling equities to help with rebalancing, as well as providing withdrawals. I should be looking at all the funds before deciding what to sell. I had not thought about that. Thanks.

That's why I am not sure what to do with the fixed income part of the portfolio for retirement. Some posters here structure the FI to meet liabilities and so would have perhaps 3 years of expenses in Limited Term Tax Exempt and the remainder in Intermediate Term Tax Exempt. They would then replenish the Limited Term Tax Exempt with dividends and the sale of equities and Intermediate Term Tax Exempt as necessary.

I am assuming that I should leave the FI in the IRA untouched until I convert the IRA to a Roth over the next 10 years. Am I thinking about this correctly?

I am looking for suggestions for what to do with FI in both the taxable and non-taxable parts of the portfolio, and how to take out annual living expenses and rebalance the FI.

[orre]

Anyone?

[grok87]

Portfolio Questions:

1. Based on my tax rates I understand it does not make sense to invest new money in non-deductible IRAs. Would it be better to invest that money in taxable?

2. How should I organize my taxable fixed income to prepare for retirement? Should I have all taxable dividends directed to a money market account for living expenses, and then draw on the Limited-Term Tax-Exempt account for any additional monies. How much should I have in the Limited-Term Tax-Exempt account and how much should be invested in an intermediate term account? Or should I keep all the taxable fixed income in short term funds? I am aware that interest rates are likely to increase over the next few years and would not want to be drawing on a fund whose NAV has decreased significantly as a result.

3. It would appear that I have approximately 10 years of expenses in my taxable fixed income. How should I invest the IRA account in that case? Total Bond, PedFed CDs, short term investment grade, intermediate term investment grade? Or some combination of those funds?

4. As the taxable fixed income is drawn down what strategy should I use? Sell portions of the stock funds as needed to replenish the fixed income and rebalance in the IRA (Roth IRA at that point)?

Hello orre and welcome to the forum,
Let's start with the fixed income side of your portfolio. You want to be 50/50 stocks/bonds and have taxable space =72% and tax advantaged = 28%. Personally I'm not a huge fan of Total Bond Market but follow Swensen in thinking that one should stick to treasuries/tips for ones bond allocation. I think it is ok to substitute FDIC insured CDs and savings accounts for treasuries.

If you read through some of my "tips" (particularly 8,9,10) you''ll get a sense of my views on bonds.
http://www.bogleheads.org/wiki/Grok's_tips

And since you can't put all your bonds in tax-advantaged, munis seem indicated as well. let's start with the building blocks:

FDIC insured savings accts
Ibonds
CDs
TIPs
muni bond funds

So what to do specifically? Part of the problem (nice problem to have!) is that you have a large portfolio. let's call it $2 M for the sake of argument, which makes your bonds $1M.

1) Ibonds- the limit is $10 k per year so buy $10k now and $10 in January. This would amount to 1% of your portofolio. Still worth doing. (Taxable)
2) FDIC insured savings accounts-find a good local credit union that is hopefully paying around 0.5% or so and buy the full $250 k worth, equal to 12.5% of your portfolio. (Taxable)
3) 30 year TIps. I'm less enthusiastic about these than i used to be now that the real rates are down around 0.3%. But I still think they are worth an allocation for those who need to plan for a retirement of 30+ possible years. I would put 10% of your portfolio toward this, perhaps legging in gradually and mostly waiting for the next february auction. (Tax-deferred)
4) CDs- I would buy your full $250k worth of the 7 year cds. That means you can only buy $217 k worth today as it will turn into $250k in 7 years. So that's another 11% of your portfolio. (Tax deferred)

so we're up to 43.5% of your portfolio. The rest (6.5%) I guess goes into munis- say the vanguard intermediate tax exempt fund.
hope this helps
cheers,

[livesoft]

...
I am assuming that I should leave the FI in the IRA untouched until I convert the IRA to a Roth over the next 10 years. Am I thinking about this correctly?

I am looking for suggestions for what to do with FI in both the taxable and non-taxable parts of the portfolio, and how to take out annual living expenses and rebalance the FI.

I think you are thinking about this too much and trying to make it more complicated than it is. I recommend treating your portfolio as a single whole portfolio and not split up as two portfolios one in taxable and one in tax-advantaged.

I would make withdrawals with an eye on paying no taxes, making big Roth conversions, and maintaing asset allocatoin. I would use the calculator at http://www.i-orp.com and TurboTax to help me out. I started a thread describing how to pay ZERO taxes in retirement: viewtopic.php?t=87471

Don't worry about the trees. See the forest.

[bdpb]

I am close to retirement and need advice on how to position myself for retirement, especially on the fixed income side.

I would like to retire in the next couple of years ...

I intend to sell my house ...

Emergency funds: Six months of expenses – Ally Savings
Debt: $400,000 mortgage at 3.25% - House appraised at $700,000 - No other debt

Taxable (72% of total)
12% Vanguard Prime Money Market Fund (VMMXX) (0.20%) (Cash for investing)
9% Vanguard Limited-Term Tax-Exempt Fund Admiral (VMLUX) (0.12%)

New annual Contributions
$22,500 to 401k (plus $5,000 employer match)
$50,000 taxable from income

Not sure why you need to have a separate EF.

Check your 401k for after-tax contributions and in-service withdrawal/rollover to Roth IRA/401k. You can shelter up to 50k (minus employer match) per year in tax preferred accounts this way.

Pay down your mortgage with the taxable cash, muni bonds and new taxable contributions. If you sell soon, you get the money right back just like a CD. Where else can you get a five year CD yielding 3.25%? You will be lowering your risk and increasing your yield.

If you pay down the mortgage, the result will change your current stock/bond ratio, but you will have the same dollars in stocks. You will have to redesign your plan around this.

[Laura]

orre,

I think your 401k and the TIRA should be filled with bonds. Either Total Bond Market, TIPS, or Treasuries of some sort. I agree with the others that you should look at all of your holdings together and invest everything as though it is one portfolio and not one taxable and one tax deferred. When withdrawing for retirement you can manage which funds you use in order to keep taxes down, maintain your asset allocation, and convert as much of the TIRA to a roth as you can each year.

I assume you have gains in your taxable stock holdings so we won't change those here. If you have loses, go ahead and harvest them this year. In particular I would try to get out of the large cap index and into Total Stock Market so you have large, medium, and small cap companies covering the market.

taxable
31% Vanguard Large-Cap Index Fund Admiral (VLCAX) (0.10%)
11% Vanguard FTSE All-World ex-US Index Fund Admiral (VFWAX) (0.18%)
9% Vanguard Total International Stock Index Fund Admiral (VTIAX) (0.18%)
21% Vanguard Limited-Term Tax-Exempt Fund Admiral (VMLUX) (0.12%)

401k
1% Total Bond Market

TIRA
26% Total Bond Market or split this 50/50 with TIPS

New investments:
taxable
$16.7k Total Intl Stock Market
$25.05 Total Stock Market
$14.25 Limited Term Tax Exempt

401k
$27.5 Total Bond Market

If you are about to retire and sell your house I don't think paying off the mortgage right now is a good idea. There is no guarantee that you will get that money back although it seems like you probably would. On the other hand, if you are going to be there several more years that could be an excellent idea. There is no way to get that kind of guaranteed rate of return in today's market.

Laura

[bdpb]

If you are about to retire and sell your house I don't think paying off the mortgage right now is a good idea. There is no guarantee that you will get that money back ...

Huh? What do you mean there is no guarantee the OP will get that money back?

[grok87]

If you are about to retire and sell your house I don't think paying off the mortgage right now is a good idea. There is no guarantee that you will get that money back ...

Huh? What do you mean there is no guarantee the OP will get that money back?

I think Laura's point is a very good one. The OP has a house supposedly worth $700k and a mortgage for $400k. Let's say he pays off the mortgage in full and then wants to move in a year. But then he finds he can only get $600 k for it. And he doesn't want only $600k, he wants the $700k that its supposed to be worth so he decides not to sell, but to wait. The $400 k that he paid down the mortgage with is now tied up- i.e. it can't be easily pulled out.
cheers,

[grok87]

21% Vanguard Limited-Term Tax-Exempt Fund Admiral (VMLUX) (0.12%)

I guess I would point out that VMLUX has a yield of 0.64% (after tax) and has both credit risk and interest rate risk.
Whereas FDIC insured savings accounts and CDs have no credit risk. The savings accounts have no interest rate risk and even the PenFed CDs have basically none since you can cash out at par and lose just one years interest (=2%).
And yet the after tax yield on the savings accounts/CDs is actually similar to or higher than VMLUX. For a 7 year Pen Fed CD @ 2% pre tax yield, that is 1.5% after-tax (OP has said he would be in the 25% federal bracket).
cheers,

[bdpb]

If you are about to retire and sell your house I don't think paying off the mortgage right now is a good idea. There is no guarantee that you will get that money back ...

Huh? What do you mean there is no guarantee the OP will get that money back?

I think Laura's point is a very good one. The OP has a house supposedly worth $700k and a mortgage for $400k. Let's say he pays off the mortgage in full and then wants to move in a year. But then he finds he can only get $600 k for it. And he doesn't want only $600k, he wants the $700k that its supposed to be worth so he decides not to sell, but to wait. The $400 k that he paid down the mortgage with is now tied up- i.e. it can't be easily pulled out.
cheers,

He doesn't have to pay down the whole loan. I only suggested the cash and munis.

The OP seems to have quite a bit of liquidity. If he needed this 400k very badly, then he should probably sell the house even if he can only get 600k for it. I would imagine he would have no problem borrowing against the house to get some of it back if needed. May be an issue for others, but I don't think it's a problem for the OP.

If I were in this position, I would take the idle cash and munis and pay down the mortgage to about 200k. Then I would refi with PenFed into a 5/5 ARM at around 2.75%. New taxable investing and dividends would pay down the new mortgage.

[grok87]

If you are about to retire and sell your house I don't think paying off the mortgage right now is a good idea. There is no guarantee that you will get that money back ...

Huh? What do you mean there is no guarantee the OP will get that money back?

I think Laura's point is a very good one. The OP has a house supposedly worth $700k and a mortgage for $400k. Let's say he pays off the mortgage in full and then wants to move in a year. But then he finds he can only get $600 k for it. And he doesn't want only $600k, he wants the $700k that its supposed to be worth so he decides not to sell, but to wait. The $400 k that he paid down the mortgage with is now tied up- i.e. it can't be easily pulled out.
cheers,

He doesn't have to pay down the whole loan. I only suggested the cash and munis.

The OP seems to have quite a bit of liquidity. If he needed this 400k very badly, then he should probably sell the house even if he can only get 600k for it. I would imagine he would have no problem borrowing against the house to get some of it back if needed. May be an issue for others, but I don't think it's a problem for the OP.

If I were in this position, I would take the idle cash and munis and pay down the mortgage to about 200k. Then I would refi with PenFed into a 5/5 ARM at around 2.75%. New taxable investing and dividends would pay down the new mortgage.

I think there is a lot of sense in what you say. But I guess again I would advise caution. The thing about making life changes (retiring and moving to a new state), is that they are often very unpredictable and you never know when you are going to need liquidity and in what amounts and for how long.

Let me give you an example- say he decides to move next year and finds his dream retirement house. Sometimes there's a real advantage to being a "cash buyer" vs. having to go through the mortgage process. You can close quicker, drive a harder bargain, etc. You can always take out a mortgage later, after you close if you want the tax deduction (within 90 days I think).
If he were planning to stay put, I think the suggestion to pay down the mortgage would make more sense.
cheers,

[orre]

Livesoft, bdpb, Grok and Laura,

I just wanted to take a moment and say thank you for your advice and thoughts. This is exactly the kind of help I was looking for. As you can see there are several life changes on the horizon and that makes for uncertainty.

I need a few days to absorb what you have said and I'll reply then on the fixed income side.

I'll reply to Laura's questions on the stock funds below.

Thanks again.

[orre]

orre,

I assume you have gains in your taxable stock holdings so we won't change those here. If you have loses, go ahead and harvest them this year. In particular I would try to get out of the large cap index and into Total Stock Market so you have large, medium, and small cap companies covering the market.

taxable
31% Vanguard Large-Cap Index Fund Admiral (VLCAX) (0.10%)
11% Vanguard FTSE All-World ex-US Index Fund Admiral (VFWAX) (0.18%)
9% Vanguard Total International Stock Index Fund Admiral (VTIAX) (0.18%)
21% Vanguard Limited-Term Tax-Exempt Fund Admiral (VMLUX) (0.12%)

Laura

Laura,

I do have gains in all the taxable stock funds, as a result of TLH in early 2009. I would like to get back into Total Stock Market and have concerns about being just in Large-Cap Index.

Would it be advisable to sell Large-Cap Index to the extent that capital losses allow? I could do something like:

26% Vanguard Large-Cap Index Fund Admiral (VLCAX) (0.10%)
5% Small-Cap Index Fund Admiral Shares (VSMAX) (0.16%)

This way I would be covering the market but with more complexity. I could also use the rest of the capital losses to move some of the FTSE All-World ex-US Index (less capital gains in this fund) to Total International.

I don't know whether it is more valuable to keep the capital losses for the future for when I need to sell some of the stock funds for withdrawals and/or rebalancing, or provide balance in the portfolio now.

orre

[johnep]

You seem to have thought your planning through pretty well. Have you fully considered the loss of human capital once you retiree. When working, people can be more aggressive in their investments because their human capital often offsets any major investment losses. People can often choose to work longer to recoup those losses or save more. Once you retire that option is no longer available, at least not to the same degree. You mentioned the possibility of some work during retirement which might help in this regard.

50/50 AA is not overly aggressive in your situation but perspectives often change after retirement. I know that mine did. Best wishes in your plans.

[orre]

...
I am assuming that I should leave the FI in the IRA untouched until I convert the IRA to a Roth over the next 10 years. Am I thinking about this correctly?

I am looking for suggestions for what to do with FI in both the taxable and non-taxable parts of the portfolio, and how to take out annual living expenses and rebalance the FI.

I think you are thinking about this too much and trying to make it more complicated than it is. I recommend treating your portfolio as a single whole portfolio and not split up as two portfolios one in taxable and one in tax-advantaged.

I would make withdrawals with an eye on paying no taxes, making big Roth conversions, and maintaing asset allocatoin. I would use the calculator at http://www.i-orp.com and TurboTax to help me out. I started a thread describing how to pay ZERO taxes in retirement: viewtopic.php?t=87471

Don't worry about the trees. See the forest.

I have been out of town for several weeks and just getting back to this. Thanks for pointing me to i-orp. I have also read some of the Vanguard white papers on Total Return and this is starting to make more sense. I have been using TurboTax for years and will use that as you suggest to see how the numbers come out.

[orre]

If you are about to retire and sell your house I don't think paying off the mortgage right now is a good idea. There is no guarantee that you will get that money back ...

Huh? What do you mean there is no guarantee the OP will get that money back?

I think Laura's point is a very good one. The OP has a house supposedly worth $700k and a mortgage for $400k. Let's say he pays off the mortgage in full and then wants to move in a year. But then he finds he can only get $600 k for it. And he doesn't want only $600k, he wants the $700k that its supposed to be worth so he decides not to sell, but to wait. The $400 k that he paid down the mortgage with is now tied up- i.e. it can't be easily pulled out.
cheers,

That's exactly the kind of problem that could occur. If I did pay off the 400K mortgage I would also have to sell some of the equity mutual funds in taxable to maintain 50:50. Since I have capital gains I don't think that's a good idea.

Since the original post I am in the process of refinancing the mortgage (2.75%, zero points, zero cost) and thinking about taking 100K and reducing the mortgage to 300K. The monthly payments would be easier if I happened to be laid off.

[grok87]

If you are about to retire and sell your house I don't think paying off the mortgage right now is a good idea. There is no guarantee that you will get that money back ...

Huh? What do you mean there is no guarantee the OP will get that money back?

I think Laura's point is a very good one. The OP has a house supposedly worth $700k and a mortgage for $400k. Let's say he pays off the mortgage in full and then wants to move in a year. But then he finds he can only get $600 k for it. And he doesn't want only $600k, he wants the $700k that its supposed to be worth so he decides not to sell, but to wait. The $400 k that he paid down the mortgage with is now tied up- i.e. it can't be easily pulled out.
cheers,

That's exactly the kind of problem that could occur. If I did pay off the 400K mortgage I would also have to sell some of the equity mutual funds in taxable to maintain 50:50. Since I have capital gains I don't think that's a good idea.

Since the original post I am in the process of refinancing the mortgage (2.75%, zero points, zero cost) and thinking about taking 100K and reducing the mortgage to 300K. The monthly payments would be easier if I happened to be laid off.

Yeah but that 100k in cash would go a long way to covering the "extra" mortgage payments associated with the "extra" 100k of mortgage debt.
I'd stay as liquid As possible until you decide whether you are moving or not...

[orre]

21% Vanguard Limited-Term Tax-Exempt Fund Admiral (VMLUX) (0.12%)

I guess I would point out that VMLUX has a yield of 0.64% (after tax) and has both credit risk and interest rate risk.
Whereas FDIC insured savings accounts and CDs have no credit risk. The savings accounts have no interest rate risk and even the PenFed CDs have basically none since you can cash out at par and lose just one years interest (=2%).
And yet the after tax yield on the savings accounts/CDs is actually similar to or higher than VMLUX. For a 7 year Pen Fed CD @ 2% pre tax yield, that is 1.5% after-tax (OP has said he would be in the 25% federal bracket).
cheers,

Grok. I have been reading your tips. They have been very helpful in my planning. The advantage of Limited-Term Tax-Exempt is that it is liquid and withdrawals for living expenses are straightforward. I am certainly interested in using FDIC insured savings accounts and CDs. The after tax yield on the 7 year Pen Fed CD is the same as the yield on Intermediate Term Tax Exempt (1.48%) and I was thinking of splitting between Limited Term and Intermediate Term Tax Exempt.

How would you structure the FDIC insured savings accounts and CDs to allow for withdrawals and rebalancing over the next 10 years say? Would you suggest having the interest from CDs put into the savings account? The dividends from the stock funds and the CD interest would have to be made up by selling periodically. Obviously I don't want to sell 7 year CDs. Should I be looking at a CD ladder or a combination of CD and Limited Term? Is there a different way of doing this?

Thanks for your help.

[orre]

If you are about to retire and sell your house I don't think paying off the mortgage right now is a good idea. There is no guarantee that you will get that money back ...

Huh? What do you mean there is no guarantee the OP will get that money back?

I think Laura's point is a very good one. The OP has a house supposedly worth $700k and a mortgage for $400k. Let's say he pays off the mortgage in full and then wants to move in a year. But then he finds he can only get $600 k for it. And he doesn't want only $600k, he wants the $700k that its supposed to be worth so he decides not to sell, but to wait. The $400 k that he paid down the mortgage with is now tied up- i.e. it can't be easily pulled out.
cheers,

He doesn't have to pay down the whole loan. I only suggested the cash and munis.

The OP seems to have quite a bit of liquidity. If he needed this 400k very badly, then he should probably sell the house even if he can only get 600k for it. I would imagine he would have no problem borrowing against the house to get some of it back if needed. May be an issue for others, but I don't think it's a problem for the OP.

If I were in this position, I would take the idle cash and munis and pay down the mortgage to about 200k. Then I would refi with PenFed into a 5/5 ARM at around 2.75%. New taxable investing and dividends would pay down the new mortgage.

Good idea to refi. That's exactly what I am doing. 2.75% zero cost, zero points.

The problem hopefully is not needing the 400K badly, it's the problem of selling stock funds now to keep the 50:50. I certainly don't wish to borrow against the house later on. I'm close to being debt free and want to be debt free at all costs (no pun intended). When I move the equity in the house will pay for a small house or condo elsewhere and then I will be completely debt free.

[orre]

I think there is a lot of sense in what you say. But I guess again I would advise caution. The thing about making life changes (retiring and moving to a new state), is that they are often very unpredictable and you never know when you are going to need liquidity and in what amounts and for how long.

Let me give you an example- say he decides to move next year and finds his dream retirement house. Sometimes there's a real advantage to being a "cash buyer" vs. having to go through the mortgage process. You can close quicker, drive a harder bargain, etc. You can always take out a mortgage later, after you close if you want the tax deduction (within 90 days I think).
If he were planning to stay put, I think the suggestion to pay down the mortgage would make more sense.
cheers,

I have moved quite a few times during my career and moves are always unpredictable and full of surprises. I think this is even more true of retiring and moving to another state. No more salary! On the other hand, I can and will take my time in deciding on which state and which town. I plan to visit and stay in a few places before making this decision. I will likely rent for a year and make sure that everything is working out well.

Some of the places I am looking at do have quite a few houses for sale and it seems that buyers are keen to sell. I am thinking about some locations in Washington state, for example. So being a cash buyer would be a real advantage as you suggest.

I did not know you can take out a mortgage later. I'll see if that would make sense versus taking the standard deduction.

Thanks Grok.

[orre]

You seem to have thought your planning through pretty well. Have you fully considered the loss of human capital once you retiree. When working, people can be more aggressive in their investments because their human capital often offsets any major investment losses. People can often choose to work longer to recoup those losses or save more. Once you retire that option is no longer available, at least not to the same degree. You mentioned the possibility of some work during retirement which might help in this regard.

50/50 AA is not overly aggressive in your situation but perspectives often change after retirement. I know that mine did. Best wishes in your plans.

I'm not sure I have fully considered the loss of human capital once I retire. You're certainly right that once you retire you can't offset any major investment losses. I plan to keep several years of spending in liquid accounts. My perspective may well change and if that happens I would slowly move to 40:60 rather than 50:50.

With low interest rates likely for the foreseeable future one reason for 50:50 is to make sure I keep ahead of inflation. I have no pension to factor into the equation.

Thanks for your thoughts johnep.

[orre]

I think Laura's point is a very good one. The OP has a house supposedly worth $700k and a mortgage for $400k. Let's say he pays off the mortgage in full and then wants to move in a year. But then he finds he can only get $600 k for it. And he doesn't want only $600k, he wants the $700k that its supposed to be worth so he decides not to sell, but to wait. The $400 k that he paid down the mortgage with is now tied up- i.e. it can't be easily pulled out.
cheers,

That's exactly the kind of problem that could occur. If I did pay off the 400K mortgage I would also have to sell some of the equity mutual funds in taxable to maintain 50:50. Since I have capital gains I don't think that's a good idea.

Since the original post I am in the process of refinancing the mortgage (2.75%, zero points, zero cost) and thinking about taking 100K and reducing the mortgage to 300K. The monthly payments would be easier if I happened to be laid off.

Yeah but that 100k in cash would go a long way to covering the "extra" mortgage payments associated with the "extra" 100k of mortgage debt.
I'd stay as liquid As possible until you decide whether you are moving or not...

Good point - it would go a long way to covering the "extra" mortgage payments. I will be moving as the house is larger than I need now, and a smaller and less expensive house/condo with no mortgage would allow me to be debt free. I value the simplicity and predictability.

I will stay liquid. I need advice on how to maintain liquidity while using FDIC savings accounts and CDs.

[Peter Foley]

With the information you have provided you seem well set for retirement in terms of net worth. With your anticipated withdrawal rate and delayed SS you have a good possibility of never coming close to exhausting your assets, and maybe not even tapping into your current principal except for a new house. This leads me to ask, what are you saving for in the future?

With such a long time horizon, and if you are comfortable with the risk, I would be tempted to bump my AA up to 55% equitites. That and some paydown of the mortgage would reduce your bond position in taxable. The way you are approaching your real estate holding is very bond like so I don't believe adding an additional 5% or so in equities adds much risk at all. Your 401k contributions can all go into bonds funds so you might slowly work your way back to your desired 50/50. (Unless of course the stock market does very well - but then your AA imbalance would be a nice problem to have. ) Increasing your AA to 55% equities would also allow you to purchase an index fund that would compliment your current holdings - something like Vanguard Extended market would help balance your Large Cap holding. I like the I bond suggestion as well in terms of a bond alternative.

Often when advice is given about asset allocation, Bogleheads tend to warn the OP if the desired AA is too aggressive or too conservative for one's risk tolerance and goals. In your case, where your AA is very appropriate, it is just the mix of taxable and non taxable that lead me to suggest a change.

P.S. It is nice to see laura back - you are fortunate to have received her input.

[grok87]

21% Vanguard Limited-Term Tax-Exempt Fund Admiral (VMLUX) (0.12%)

I guess I would point out that VMLUX has a yield of 0.64% (after tax) and has both credit risk and interest rate risk.
Whereas FDIC insured savings accounts and CDs have no credit risk. The savings accounts have no interest rate risk and even the PenFed CDs have basically none since you can cash out at par and lose just one years interest (=2%).
And yet the after tax yield on the savings accounts/CDs is actually similar to or higher than VMLUX. For a 7 year Pen Fed CD @ 2% pre tax yield, that is 1.5% after-tax (OP has said he would be in the 25% federal bracket).
cheers,

Grok. I have been reading your tips. They have been very helpful in my planning. The advantage of Limited-Term Tax-Exempt is that it is liquid and withdrawals for living expenses are straightforward. I am certainly interested in using FDIC insured savings accounts and CDs. The after tax yield on the 7 year Pen Fed CD is the same as the yield on Intermediate Term Tax Exempt (1.48%) and I was thinking of splitting between Limited Term and Intermediate Term Tax Exempt.

How would you structure the FDIC insured savings accounts and CDs to allow for withdrawals and rebalancing over the next 10 years say? Would you suggest having the interest from CDs put into the savings account? The dividends from the stock funds and the CD interest would have to be made up by selling periodically. Obviously I don't want to sell 7 year CDs. Should I be looking at a CD ladder or a combination of CD and Limited Term? Is there a different way of doing this?

Thanks for your help.

You're welcome.
Well see my tip #2 part b.
viewtopic.php?t=66328
Let's make things simple and assume you retire tomorrow, and as per your original post you need to draw 3% of your portfolio for the next 10 years. As per the Swensen approach I discuss you would set aside the following amounts now in cash or cash equivalents:

2013 money: 100% of 3%
2014 money: 100% of 3%
2015 money: 7/8 of 3%
2016 money: 6/8 of 3%
2017 money: 5/8 of 3%
2018. Money: 4/8 of 3%
2019 money: 3/8 of 3%
2020 money: 2/8 of 3%
2021 money: 1/8 of 3%
2022 money 0/8 of 3%

I.e you don't need to hold any of your 2022 spending needs in cash as it is more than 10 years off.

That adds up to 16.5% of your portfolio that should be in cash or cash-equivalents again asssuming you are retiring today.

So what are cash and or cash equivalents. I would say the following:
FDIC insured savings accounts
Credit union CDs with easy early withdrawal penalties
Ibonds (can't withdraw for one year)
Money market funds (but rates are unattractive) right now.

After you set aside these amounts in cash, I would then put the rest in your target 50/50 portfolio.
For the sake of argument let's work with a $1 million portfolio with $720 k in taxable and $280 k in an IRA.

So here's what I'd do:

Cash account 165 k (from taxable)
$20 k ibonds (10k this year, 10k next year)
$145 k FDIC insured savings account

Long term account 835 k
Taxable 555k
417.5 k equities
137.5 k limited term tax exempt

Ira
215k pen fed 7 year CDs @ 2% yield
65 k 30 year tips

Cheers,

[bdpb]

The problem hopefully is not needing the 400K badly, it's the problem of selling stock funds now to keep the 50:50. I certainly don't wish to borrow against the house later on. I'm close to being debt free and want to be debt free at all costs (no pun intended). When I move the equity in the house will pay for a small house or condo elsewhere and then I will be completely debt free.

Don't fall into the same fallacy that most everyone does. If you have a 50/50 portfolio with debt, it is not the same risk level as a 50/50 portfolio with no debt. The risk in a portfolio comes from how many absolute dollars you have in stocks, not what percentage of stock in your portfolio.

For example, you have 500k in stocks and 500k in bonds with a 400k debt. If the stock market goes down by 50%, you will lose 250k.

If you use 400k in bonds to pay down the debt, you can either rebalance back to 50/50 which would leave you with a 600k portfolio with 300k in stocks; or you can keep the stocks at 500k and bonds at 100k for a 83/17 AA.
Now if stocks go down by 50%, in the first case you've only lost 150k, in the second case you will lose 250k (the same as in your original portfolio).

Do you see my point about an AA with debt is not the same as the same AA without debt?

[orre]

The problem hopefully is not needing the 400K badly, it's the problem of selling stock funds now to keep the 50:50. I certainly don't wish to borrow against the house later on. I'm close to being debt free and want to be debt free at all costs (no pun intended). When I move the equity in the house will pay for a small house or condo elsewhere and then I will be completely debt free.

Don't fall into the same fallacy that most everyone does. If you have a 50/50 portfolio with debt, it is not the same risk level as a 50/50 portfolio with no debt. The risk in a portfolio comes from how many absolute dollars you have in stocks, not what percentage of stock in your portfolio.

For example, you have 500k in stocks and 500k in bonds with a 400k debt. If the stock market goes down by 50%, you will lose 250k.

If you use 400k in bonds to pay down the debt, you can either rebalance back to 50/50 which would leave you with a 600k portfolio with 300k in stocks; or you can keep the stocks at 500k and bonds at 100k for a 83/17 AA.
Now if stocks go down by 50%, in the first case you've only lost 150k, in the second case you will lose 250k (the same as in your original portfolio).

Do you see my point about an AA with debt is not the same as the same AA without debt?

Yes, you do have a point. The problem with the 83/17 AA is the huge loss in liquidity as well as increased risk. In the 50/50 AA approach that would be fine if this was all tax deferred but in a taxable account and with capital gains it is not feasible.

The approach I am going to take is refinance at 2.75%, sell the house and use the house equity to buy a house/condo. No more debt and I maintain liquidity until I am able to retire and move.

Thanks for your thoughts.

[orre]

You're welcome.
Well see my tip #2 part b.
viewtopic.php?t=66328
Let's make things simple and assume you retire tomorrow, and as per your original post you need to draw 3% of your portfolio for the next 10 years. As per the Swensen approach I discuss you would set aside the following amounts now in cash or cash equivalents:

2013 money: 100% of 3%
2014 money: 100% of 3%
2015 money: 7/8 of 3%
2016 money: 6/8 of 3%
2017 money: 5/8 of 3%
2018. Money: 4/8 of 3%
2019 money: 3/8 of 3%
2020 money: 2/8 of 3%
2021 money: 1/8 of 3%
2022 money 0/8 of 3%

I.e you don't need to hold any of your 2022 spending needs in cash as it is more than 10 years off.

That adds up to 16.5% of your portfolio that should be in cash or cash-equivalents again asssuming you are retiring today.

So what are cash and or cash equivalents. I would say the following:
FDIC insured savings accounts
Credit union CDs with easy early withdrawal penalties
Ibonds (can't withdraw for one year)
Money market funds (but rates are unattractive) right now.

After you set aside these amounts in cash, I would then put the rest in your target 50/50 portfolio.
For the sake of argument let's work with a $1 million portfolio with $720 k in taxable and $280 k in an IRA.

So here's what I'd do:

Cash account 165 k (from taxable)
$20 k ibonds (10k this year, 10k next year)
$145 k FDIC insured savings account

Long term account 835 k
Taxable 555k
417.5 k equities
137.5 k limited term tax exempt

Ira
215k pen fed 7 year CDs @ 2% yield
65 k 30 year tips

Cheers,

Hi Grok. I reread tip #2. Thanks for the example. Now I understand how this could all work. It might help others if you added this kind of example to your tips.

I have some follow up questions and comments.

1. In the first year of retirement (2013 in your example) one uses the 2013 money. At the end of 2013 is the idea to add 1/8 of 3% to the 2015 money? And likewise add 1/8 to the years out to 2022? This money would come from the 50/50 portfolio. In other words one always has 10 years of money set aside (the further out years are not fully funded of course)? I think this is similar to the ideas that Bernstein discusses in Life Cycle Investing.

2. You suggested putting all the cash reserve into a FDIC savings account. Is there any reason not to keep say 2013, 2014 and 2015 money in the savings account and use a set of CDs for the 2016 money and beyond? Clearly one would get increased rates for these longer term CDs.

3. The Limited Term Tax Exempt is liquid and could thus be used for rebalancing. Is that right? Hence one should not use Intermediate Term Tax Exempt given that rates may well rise.

4. I like the suggestion of a 7 year PenFed CD in the IRA. How would you deal with wanting to convert over the next 10 years as much of the IRA to a Roth? The reason I want to do this is to avoid as much as possible the need to take distributions from age 70 onwards as I may not need to do so. Hard to know how things will turn out over the next 10 years. So I'm attempting to answer my own question. Keep half of the 215K in say Short Term Investment Grade and use that to convert to Roth year by year and put the other half in the 7 year CD? Or create a CD ladder? Harder to do as PenFed does not have all the intermediate rungs for the CD.

5. If I get to that point can one convert 30 year TIPS to a Roth account? That is without selling?

6. The part B approach also has the effect of reducing risk as you describe in part A. Should one keep the cash reserve separate from the 50/50 portfolio or consider the cash as part of the overall AA?

Thanks again for your clear explanations. I am hoping this discussion will also help others.

[grok87]

You're welcome.
Well see my tip #2 part b.
viewtopic.php?t=66328
Let's make things simple and assume you retire tomorrow, and as per your original post you need to draw 3% of your portfolio for the next 10 years. As per the Swensen approach I discuss you would set aside the following amounts now in cash or cash equivalents:

2013 money: 100% of 3%
2014 money: 100% of 3%
2015 money: 7/8 of 3%
2016 money: 6/8 of 3%
2017 money: 5/8 of 3%
2018. Money: 4/8 of 3%
2019 money: 3/8 of 3%
2020 money: 2/8 of 3%
2021 money: 1/8 of 3%
2022 money 0/8 of 3%

I.e you don't need to hold any of your 2022 spending needs in cash as it is more than 10 years off.

That adds up to 16.5% of your portfolio that should be in cash or cash-equivalents again asssuming you are retiring today.

So what are cash and or cash equivalents. I would say the following:
FDIC insured savings accounts
Credit union CDs with easy early withdrawal penalties
Ibonds (can't withdraw for one year)
Money market funds (but rates are unattractive) right now.

After you set aside these amounts in cash, I would then put the rest in your target 50/50 portfolio.
For the sake of argument let's work with a $1 million portfolio with $720 k in taxable and $280 k in an IRA.

So here's what I'd do:

Cash account 165 k (from taxable)
$20 k ibonds (10k this year, 10k next year)
$145 k FDIC insured savings account

Long term account 835 k
Taxable 555k
417.5 k equities
137.5 k limited term tax exempt

Ira
215k pen fed 7 year CDs @ 2% yield
65 k 30 year tips

Cheers,

Hi Grok. I reread tip #2. Thanks for the example. Now I understand how this could all work. It might help others if you added this kind of example to your tips.

I have some follow up questions and comments.

1. In the first year of retirement (2013 in your example) one uses the 2013 money. At the end of 2013 is the idea to add 1/8 of 3% to the 2015 money? And likewise add 1/8 to the years out to 2022? This money would come from the 50/50 portfolio. In other words one always has 10 years of money set aside (the further out years are not fully funded of course)? I think this is similar to the ideas that Bernstein discusses in Life Cycle Investing.

2. You suggested putting all the cash reserve into a FDIC savings account. Is there any reason not to keep say 2013, 2014 and 2015 money in the savings account and use a set of CDs for the 2016 money and beyond? Clearly one would get increased rates for these longer term CDs.

3. The Limited Term Tax Exempt is liquid and could thus be used for rebalancing. Is that right? Hence one should not use Intermediate Term Tax Exempt given that rates may well rise.

4. I like the suggestion of a 7 year PenFed CD in the IRA. How would you deal with wanting to convert over the next 10 years as much of the IRA to a Roth? The reason I want to do this is to avoid as much as possible the need to take distributions from age 70 onwards as I may not need to do so. Hard to know how things will turn out over the next 10 years. So I'm attempting to answer my own question. Keep half of the 215K in say Short Term Investment Grade and use that to convert to Roth year by year and put the other half in the 7 year CD? Or create a CD ladder? Harder to do as PenFed does not have all the intermediate rungs for the CD.

5. If I get to that point can one convert 30 year TIPS to a Roth account? That is without selling?

6. The part B approach also has the effect of reducing risk as you describe in part A. Should one keep the cash reserve separate from the 50/50 portfolio or consider the cash as part of the overall AA?

Thanks again for your clear explanations. I am hoping this discussion will also help others.

Hi Orre,
Sure no problem.
Let's see:

1. Yes I think that's right.
2. Sounds reasonable to me.
3. Hmm. I think I went with "limited term tax-exempt" because that's what you had mentioned. Intermediate term tax exempt or long term tax exempt may be ok too for the "long term" portfolio once you have set aside the cash for your spending needs. Here's how the 3 funds compare right now:

limited term tax exempt: SEC yield 0.58%, duration 2.4 --> yield/duration ratio of 24%
intermediate term tax exempt: SEC yield 1.5%, duration 4.9 --> yield/duration ratio of 31%
long term tax exempt: SEC yield 2.04%, duration 5.9 --> yield/duration ratio of 35%

so based on the above, one might actually favor long term tax exempt. I think when you go to move money into cash in a year's time you would just sell/rebalance ALL of the funds in the long term account back to the target 50/50 target portfolio, i.e. you wouldn't just be drawing from the muni fund...I guess it could be a little tricky rebalancing the CDs though...

4. I don't know if you can convert a Pen Fed IRA from a regular IRA to a Roth IRA. I guess you could call and ask them...

5. I don't know but I would think a brokerage iRA could be converted from a regular IRA to a Roth without selling the holdings....

6. I guess I would tend to think of them as separate portfolios. I think its similar to say saving for a house. if one knows one is going to need say $100k to buy a house in 2 years, you wouldn't play the market with it right? In the same way spending needs that one is going to need in a year or two should be all in cash or cash equivalents and not thought of as part of a long term investment portfolio. I think most people would view this approach as common sense. Swensen's insight was:
1) To define the horizon for a long term portfolio as 10 years or longer'
2) To introduce the interpolation idea for years between 2 years and 10 years.

cheers,