early retirement in sight; what to do with AA?

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early retirement in sight; what to do with AA?

Postby feh » Thu Jul 25, 2013 12:35 pm

Hi folks.

After 20 years of accumulation, early retirement is becoming a very real option. Wife and I are both 47. Firecalc says we are in very good shape (100% chance of not running out of money).

My question is - how do I need to change my AA between now and retirement, and once retired, what AA do I want to have until we can start accessing IRA/401K monies?

I can provide specific details if necessary, but here's a snapshot of our current AA:
    75% equites (44% US TM, 22% ITM, 8% REIT)
    25% bonds (all of it intermediate term; FSITX and PTTRX)
    50% in taxable, 50% in IRAs/401K
    taxable account is 100% equities
    no pension
Traditional thinking is 100-age in equities (or 110 or 120, depending on your risk tolerance). However, I'm not comfortable with this, because we'd be selling equities for 10 years (50 to 60) to live on, and a severe market downturn could cause major damage. The thought of being most conservative at the start of retirement and then increasing equities over time makes sense to me, as has been discussed here:

http://www.bogleheads.org/forum/viewtopic.php?f=10&t=120344&p=1759313#p1759313

So, let's say I retire in 3 years, at age 50. What would you recommend I do between now and then to prepare? It seems I need to increase my fixed income, but I'm not thrilled with the prospect of buying intermediate term bonds right now. What other options are there? Just shorter term bonds? CDs?

I like the idea of establishing a floor that I can depend on, especially between 50 and 60. Does that imply an SPIA? Other options?

Any comments/ideas welcome. Thanks!
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Re: early retirement in sight; what to do with AA?

Postby dad2000 » Thu Jul 25, 2013 12:52 pm

Congratulations!

Here are some questions/comments:

Do either of you have the option of going back to work should things sour shortly after retirement?

Given your (relatively) young age, I think that it's a suboptimal time to consider an SPIA. If Firecalc gives you a 0% depletion probability, I'd think that you have at least 20 years before having to consider SPIA.

As far as fixed-income, perhaps consider laddering CDs, and I-bonds for inflation protection.
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Re: early retirement in sight; what to do with AA?

Postby feh » Thu Jul 25, 2013 1:03 pm

dad2000 wrote:Congratulations!

Here are some questions/comments:

Do either of you have the option of going back to work should things sour shortly after retirement?


Yes, this would be an option. However, I am unlikely to ever make the kind of money I'm making now once I quit. I'm a software developer; been with the same company a long time and am well compensated. Trying to catch on someplace else as a coder in his 50s might be difficult.

Given your (relatively) young age, I think that it's a suboptimal time to consider an SPIA. If Firecalc gives you a 0% depletion probability, I'd think that you have at least 20 years before having to consider SPIA.

As far as fixed-income, perhaps consider laddering CDs, and I-bonds for inflation protection.


Are you suggesting I do this with new contributions, or with proceeds from selling equities?

Thanks.
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Re: early retirement in sight; what to do with AA?

Postby siamond » Thu Jul 25, 2013 2:27 pm

feh wrote:My question is - how do I need to change my AA between now and retirement, and once retired, what AA do I want to have until we can start accessing IRA/401K monies?


I had a very similar question on another thread that got buried a bit. I'm very curious to see what will be the answers to your question!

Now if the experts here could comment beyond the usual stock/bonds split topic, and answer more broadly on possible changes to your AA at large, notably within the equity bucket, this would be great.

My own AA includes the categories listed below, with a given %. Any reason for which I'd rethink such AA as I early-retire in my early 50s as the OP?

US Total Market
US Large Value
US Small Caps
US Small Value
Int'l Market
Int'l Value
Emerging
REITs
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Re: early retirement in sight; what to do with AA?

Postby Peter Foley » Thu Jul 25, 2013 2:48 pm

I just offered this same opinion in another thread so I will repreat it here. If I understand the studies correctly, historically small cap value and emerging markets have provided a slightly better return in exchange for a little more risk. Over a lifetime of investing, an average increase of 1% return is a big deal. It is not signficant enough to be a lifestyle changer over a 10 year or 20 year period. Therefore if I were nearing retirement I would be satisfied with the return of a Total Market approach. This also is a simplier approach and may be advisable to those in retirement where only one spouse has an interest in finance.

I've been retired for about a year and hold nothing but Total Stock Market and Total International in those accounts where that option is available at a reasonable cost. The low cost options available in a couple deferred acounts happen to be S&P 500 and Midcap funds so I do hold positions there.

As to the OP's question: If I were retiring at age 50 instead of 60 I would be inclined to follow a 110-age in equities because I would be planning for a 3% withdrawal over a 40-50 year time frame. I also agree with dad2000 that I wouldn't consider a SPIA until at least age 65, perhaps 70. You would have a lot of years in retirement to "practice" a sustainable standard of living before having to entertain such an approach.
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Re: early retirement in sight; what to do with AA?

Postby feh » Thu Jul 25, 2013 2:53 pm

Peter Foley wrote:As to the OP's question: If I were retiring at age 50 instead of 60 I would be inclined to follow a 110-age in equities because I would be planning for a 3% withdrawal over a 40-50 year time frame. I also agree with dad2000 that I wouldn't consider a SPIA until at least age 65, perhaps 70. You would have a lot of years in retirement to "practice" a sustainable standard of living before having to entertain such an approach.


In other words, you support the traditional idea of reducing equities as one ages? And that nothing out of the ordinary needs to be done for the years before which tax-advantaged accounts can be accessed?
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Re: early retirement in sight; what to do with AA?

Postby Peter Foley » Thu Jul 25, 2013 3:08 pm

There are a couple things that should be done early in retirement for the sake of tax efficiency. 1) Stop reinvesting dividends and capital gains in taxable accounts so that all your equity positions are long term. 2) Take a look at your income sources in retirement and try to stay within the 15% tax bracket so that you can sell some taxable w/o any tax liability for long term capital gains. You should also look at Roth conversions during this time period if you think you will be in a higher tax bracket when you start to collect SS.

Second edit to address additional question: I would slowly reduce my equity position if I no longer needed to take risk. Given the 40+ retirement you are planning, I wouldn't let equities drop below 40% if you still and had a need to take risk, and not below 30% unless I were adding a SPIA.
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Re: early retirement in sight; what to do with AA?

Postby bertilak » Thu Jul 25, 2013 4:02 pm

Peter Foley wrote:There are a couple things that should be done early in retirement for the sake of tax efficiency. 1) Stop reinvesting dividends and capital gains in taxable accounts so that all your equity positions are long term. 2) Take a look at your income sources in retirement and try to stay within the 15% tax bracket so that you can sell some taxable w/o any tax liability for long term capital gains. You should also look at Roth conversions during this time period if you think you will be in a higher tax bracket when you start to collect SS.

I think MOST people will go to a higher tax bracket once the RMDs get rolling.

Second edit to address additional question: I would slowly reduce my equity position if I no longer needed to take risk. Given the 40+ retirement you are planning, I wouldn't let equities drop below 40% if you still and had a need to take risk, and not below 30% unless I were adding a SPIA.

Are you suggesting one would sell equities to buy SPIAs? I think the general idea is to replace *bonds* with SPIAs.

There are couple of recent threads discussing a study by Wade Pfau and Michael Kitces that suggests selling bonds first and letting the equity allocation move upward in the disbursement (post retirement) phase. That's instead of buying SPIAs -- just spend the bonds first. I don't remember if running out of (or low on) bonds was addressed. I didn't read the study, just the summaries on the Pfau and Kitces blogs.
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Re: early retirement in sight; what to do with AA?

Postby Peter Foley » Fri Jul 26, 2013 5:38 pm

bertilak,

No I'm not suggesting that one sell equities to buy a SPIA. While I'm not at all a fan of SPIAs, I do recognize that they are a viable option in some circumstances when retirement savings might not be sufficient to support a reasonable withdrawal rate for a remaining average lifespan. These folks are retiring very young and need to plan for at least a 40 year retirement period. A lot can go worng in terms of sequence of returns, unexpected expenses, etc. I view SPIAs as kind of a hail mary pass - a point at which you may commit most of your remaining resources and abandon your AA.

While I agree that RMDs are likely to push many people into a higher tax bracket, so too does SS income. If a couple were to retire at age 50 and use up their taxable savings before taking SS, they then would be withdrawing from tax deferred at ordinary income tax rates to add to their SS income. For someone retiring at age 50 I cannot believe their SS will be their principal income source. So a $40,000 + withdrawal from a deferred account would make their SS highly taxes. Moving some deferred to a Roth provides a non taxable source of income so that they can exercise some control over their tax rate.
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Re: early retirement in sight; what to do with AA?

Postby livesoft » Fri Jul 26, 2013 6:05 pm

I don't see where your asset allocation has to change at all. You should ALREADY have an AA that you have been using that let's you sleep at night.
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Re: early retirement in sight; what to do with AA?

Postby kramer » Fri Jul 26, 2013 6:57 pm

I am same age, single, retired, am at 63% equities, 37% bonds. But everyone's situation is different. I feel like I still have some need to take risk, and I am willing and able. In fact, I want to take more risk but my head and my research says no. When I first retired a few years ago, I dropped my equity allocation by 10%, from 75% to 65%, in the year before retirement.

If current tax laws stay the same, then your tax bill will probably be Zero throughout your 50s. You will be able to earn about $20,000 in interest and unqualified dividends tax-free with the standard deduction, and another $70,000 or so qualified dividends tax free.

I would think about having my taxable account allocated something like 85/15 in favor of equities for tax purposes (and adjusting your IRAs to maintain your overall desired asset allocation). But until you can freely access your IRAs, that 15% is a floor (so if the account drops in size, the percentage of bonds will go up). That is around 3 years living expenses in safe bonds in your taxable account.

You will also want to think about Obamacare health insurance and income levels for subsidies. This is an indirect marginal tax you will need to consider for your particular situation.

Also, give some thought to income floors. For instance, I have some long term I-bonds and TIPs that provide a floor under my old age income, in addition to my social security. I wish I had done more of this before I retired.

The problem with SPIAs is that they are most valuable to you, with respect to mortality credits, when the uncertainty of your life expectancy divided by your remaining average life expectancy is highest. This is probably in your 70s.
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