Too much risk in this retirement draw down plan?

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Topic Author
TXJeff
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Too much risk in this retirement draw down plan?

Post by TXJeff »

Hello!

57 year old, with a $2 million plus portfolio. Early retiree as of last year. I use the inflation adjusted constant dollar withdrawal method: $65K for 2018. No pension, but will have social security. Asset allocation is 60/40 with 1/4 of portolio in IRA, the rest in taxable--so I have significant bonds in taxable. Tiny Roth where I recently started conversions from the IRA.

Last year, after lots of Bogle reading, and deciding I wanted to use the constant dollar method, I made this draw down plan:
1. Delay RMD's and SS until 70.
2. Every fourth year to age 70, sell $130k-$145k from taxable. That, plus regular interest and dividends would cover my annual draw down for the next three years, plus pay any taxes.
3. In the following 3 years, manage income for ACA and do Roth conversions--or later, for IRMAA and Roth conversions.

On paper, this plan looks like the sweet spot. IRA is converted down to a maximum of $250k when I'm 70, so RMD plus SS are less than $34k, and taxed at only 50%. MY federal taxes to age 70 would be a max of $12k every three years--and that assumes I sell veryhighly appreciated equities. Taxes could be much lower. I'd also lose the ACA subsidy that year: worth @ $4k in 2018.

MY question: am I increasing the risk in my portfolio by concentrating sales every fourth year?

I executed this "big sell" strategy this year for the first time. I sold a very highly appreciated individual stock that had grown to a double digit portion of my portfolio. The sale rebalanced me to my AA. And I'll offset some of the gains with carry overlosses and some 2018 tax loss harvesting. So the strategy worked well here--reduced my portfolio risk and sopped up otherwise "wasted" losses and TLH.

But what about next time? Is this concentrated sales strategy adding risk? And if so, how would you assess the risk?
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PolarBearMarket
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Re: Too much risk in this retirement draw down plan?

Post by PolarBearMarket »

I must be missing something: how does bulking the selloffs from your taxable account provide a sweet spot for Roth conversions?

Sales of appreciated assets from a taxable account are subject to capital gains tax, not income tax. Roth conversions are subject to income tax. You can do both in the same year without them interfering with each other.

The 'big sell' creates a pool of money that isn't earning interest for three years and increases the risk that you'll be pulling more than necessary out during a downturn.
Last edited by PolarBearMarket on Thu Nov 01, 2018 12:54 pm, edited 1 time in total.
aristotelian
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Re: Too much risk in this retirement draw down plan?

Post by aristotelian »

Seems like the inverse of the question people have whether to invest a lump sum or dollar cost average. The reason the conventional wisdom is for lump sum is that with markets generally going up, probabilities favor staying fully invested. The same logic would seem to argue against the big withdrawal and instead withdrawing the smallest possible amount in order to stay fully invested.

Behaviorally, I would have a very hard time doing the big sell in the midst of a correction, so from that standpoint, I think a constant withdrawal method would be the only policy that would work for me through thick and thin.
MotoTrojan
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Re: Too much risk in this retirement draw down plan?

Post by MotoTrojan »

PolarBearMarket wrote: Thu Nov 01, 2018 12:51 pm I must be missing something: how does bulking the selloffs from your taxable account provide a sweet spot for Roth conversions?

Sales of appreciated assets from a taxable account are subject to capital gains tax, not income tax. Roth conversions are subject to income tax. You can do both in the same year without them interfering with each other.

The 'big sell' creates a pool of money that isn't earning interest for three years and increases the risk that you'll be pulling more than necessary out during a downturn.
Do cap-gains not impact your income and thus marginal tax rate on conversions?
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PolarBearMarket
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Re: Too much risk in this retirement draw down plan?

Post by PolarBearMarket »

MotoTrojan wrote: Thu Nov 01, 2018 12:58 pm
PolarBearMarket wrote: Thu Nov 01, 2018 12:51 pm I must be missing something: how does bulking the selloffs from your taxable account provide a sweet spot for Roth conversions?

Sales of appreciated assets from a taxable account are subject to capital gains tax, not income tax. Roth conversions are subject to income tax. You can do both in the same year without them interfering with each other.

The 'big sell' creates a pool of money that isn't earning interest for three years and increases the risk that you'll be pulling more than necessary out during a downturn.
Do cap-gains not impact your income and thus marginal tax rate on conversions?
Long-term capital gains do not count as income. Short-term capital gains are subject to income tax.

However, maybe I am thinking about this opposite of OP. The Roth conversions create income, which would increase the long-term capital gains tax. Is the goal of separating taxable selloffs from roth conversions to reduce the capital gains tax on the taxable selloffs?
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TXJeff
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Re: Too much risk in this retirement draw down plan?

Post by TXJeff »

PolarBearMarket wrote: Thu Nov 01, 2018 12:51 pm I must be missing something: how does bulking the selloffs from your taxable account provide a sweet spot for Roth conversions?

Sales of appreciated assets from a taxable account are subject to capital gains tax, not income tax. Roth conversions are subject to income tax. You can do both in the same year without them interfering with each other.
I see these as two separate tax saving strategies: emptyingthe Roth to $250k max results in low post-70s taxes. And bulking selloffs from taxable enables ACA subsidies plus free Roth conversions in 3 of 4 years to age 65. I thought the ACA income limit of $38k applied to all types of income, including capital gains. Is that wrong?
Topic Author
TXJeff
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Re: Too much risk in this retirement draw down plan?

Post by TXJeff »

Maybe some background about my thinking will help:

I found I couldn't use the popular retirement draw down tools, because they had baked in assumptions, unchangeable, that were so different from my situation.

So I started researching draw down methods, the different taxes that would apply, etc. I saw that efficient tax management could make a huge difference to how much money a retiree kept

After deciding on constant dollar withdrawals, I hit on this "bulking" strategy for tax efficiency both pre and post 70.. Since I have. Considerable bonds in my taxable, I thought I'd be OK in up or down markets.
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TXJeff
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Re: Too much risk in this retirement draw down plan?

Post by TXJeff »

aristotelian wrote: Thu Nov 01, 2018 12:54 pm Seems like the inverse of the question people have whether to invest a lump sum or dollar cost average. The reason the conventional wisdom is for lump sum is that with markets generally going up, probabilities favor staying fully invested. The same logic would seem to argue against the big withdrawal and instead withdrawing the smallest possible amount in order to stay fully invested.

Behaviorally, I would have a very hard time doing the big sell in the midst of a correction, so from that standpoint, I think a constant withdrawal method would be the only policy that would work for me through thick and thin.
This is very helpful to me thinking about added risk. I'm a nerves of steel type, so I don't worry about whether or not I'll carry out a planned sale.

But your lump sum analogy gives me a lot to think about.

My main hesitation to doing yearly conversions for living expenses is that I lose both ACA subsidy and free Roth conversions. When I modeled these, it just didn't pencil out. But are you saying that the larger risks outweigh these dollar savings?
aristotelian
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Re: Too much risk in this retirement draw down plan?

Post by aristotelian »

TXJeff wrote: Thu Nov 01, 2018 1:29 pm This is very helpful to me thinking about added risk. I'm a nerves of steel type, so I don't worry about whether or not I'll carry out a planned sale.

But your lump sum analogy gives me a lot to think about.

My main hesitation to doing yearly conversions for living expenses is that I lose both ACA subsidy and free Roth conversions. When I modeled these, it just didn't pencil out. But are you saying that the larger risks outweigh these dollar savings?
Perhaps I am mixing up the questions you are asking. One question is when do you sell stocks and convert to bonds/cash. A second question is when to do distributions from retirement accounts.

I am suggesting that you maintain your allocation except for withdrawals in small increments. You should certainly do your distributions and realized gains in whatever is the most tax efficient way.
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PolarBearMarket
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Re: Too much risk in this retirement draw down plan?

Post by PolarBearMarket »

TXJeff wrote: Thu Nov 01, 2018 1:10 pm
PolarBearMarket wrote: Thu Nov 01, 2018 12:51 pm I must be missing something: how does bulking the selloffs from your taxable account provide a sweet spot for Roth conversions?

Sales of appreciated assets from a taxable account are subject to capital gains tax, not income tax. Roth conversions are subject to income tax. You can do both in the same year without them interfering with each other.
I see these as two separate tax saving strategies: emptyingthe Roth to $250k max results in low post-70s taxes. And bulking selloffs from taxable enables ACA subsidies plus free Roth conversions in 3 of 4 years to age 65. I thought the ACA income limit of $38k applied to all types of income, including capital gains. Is that wrong?
But the Roth conversions would also eliminate your ACA subsidies, so which years are you getting the subsidy?
curmudgeon
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Re: Too much risk in this retirement draw down plan?

Post by curmudgeon »

It sounds reasonable to me, but it will work best if you are willing to allow for some variation in your AA. I might consider allowing for some variability in when to do the sell-off year; if the market is solid, then do it, but if not maybe draw down from bonds for another year or two.
megabad
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Re: Too much risk in this retirement draw down plan?

Post by megabad »

TXJeff wrote: Thu Nov 01, 2018 12:42 pm But what about next time? Is this concentrated sales strategy adding risk? And if so, how would you assess the risk?
I don't understand how this necessarily adds risk? You don't talk about your asset allocation. The act or realizing a gain or loss doesn't necessarily imply more "risk" to me. If I sell VG 500 Index and then buy VG Total Stock Mkt Index the next day, I would say that my "risk" is very minimal. If I sell VG 500 Index and then buy 100 truckloads of marshmallows than perhaps I have been more exposed to market/equity volatility.
BigJohn
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Re: Too much risk in this retirement draw down plan?

Post by BigJohn »

I think it makes conceptual sense to lump capital gains into a year when you aren't going to do Roth conversions. That will keep your income down and either reduce the margin tax rate on conversions or allow you to convert more. You will lose some time in the market which may or may not have some lost opportunity costs.

What's your AA going into retirement? If you're worried that you might be selling stocks during a downturn in the fourth year, you can always sell bonds if/when that happens.
"The greatest enemy of a good plan is the dream of a perfect plan" - Carl Von Clausewitz
Topic Author
TXJeff
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Re: Too much risk in this retirement draw down plan?

Post by TXJeff »

BigJohn wrote: Thu Nov 01, 2018 4:38 pm I think it makes conceptual sense to lump capital gains into a year when you aren't going to do Roth conversions. That will keep your income down and either reduce the margin tax rate on conversions or allow you to convert more. You will lose some time in the market which may or may not have some lost opportunity costs.

What's your AA going into retirement? If you're worried that you might be selling stocks during a downturn in the fourth year, you can always sell bonds if/when that happens.
Yes, this is a good summary of the strategy.

This year it worked well. I sold an individual stock. I put the $$ for 2019 into a money market fund, and the $$ for 2020 and 2021 into CD's. The net result was to rebalance my AA back to my preferred 60/40.

And yes, in future years of doing sales, it would always be to rebalance to my AA.
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TXJeff
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Re: Too much risk in this retirement draw down plan?

Post by TXJeff »

megabad wrote: Thu Nov 01, 2018 3:41 pm
TXJeff wrote: Thu Nov 01, 2018 12:42 pm But what about next time? Is this concentrated sales strategy adding risk? And if so, how would you assess the risk?
I don't understand how this necessarily adds risk? You don't talk about your asset allocation. The act or realizing a gain or loss doesn't necessarily imply more "risk" to me. If I sell VG 500 Index and then buy VG Total Stock Mkt Index the next day, I would say that my "risk" is very minimal. If I sell VG 500 Index and then buy 100 truckloads of marshmallows than perhaps I have been more exposed to market/equity volatility.
I'd be doing concentrated sales every fourth year back to my AA of 60/40. The money from the sale goes into money market fund and CD's for spending over the next 3 years. So I think I've bought the marshmallows?
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TXJeff
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Re: Too much risk in this retirement draw down plan?

Post by TXJeff »

aristotelian wrote: Thu Nov 01, 2018 1:44 pm I am suggesting that you maintain your allocation except for withdrawals in small increments. You should certainly do your distributions and realized gains in whatever is the most tax efficient way.
Thanks for this. It clarifies for me that sometimes "withdrawals in small increments" and "distributions and realized gains in whatever is the most tax efficient way" can be at odds with each other. They were for me this year. I was hoping for a set it and forget it plan, but I see now that I need to stay flexible.
GuyInFL
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Re: Too much risk in this retirement draw down plan?

Post by GuyInFL »

TxJeff sez
2. Every fourth year to age 70, sell $130k-$145k from taxable. That, plus regular interest and dividends would cover my annual draw down for the next three years, plus pay any taxes.
megabad sez
If I sell VG 500 Index and then buy VG Total Stock Mkt Index the next day, I would say that my "risk" is very minimal.
Year 1: Sell $140k from taxable; buy VG Total Stock Mkt Index [Taxable gains realized]; spend (140k)/4 = $35K; Buying back equities eliminates the risk of selling big during a downturn since you are selling and then buying back in.

Year 2: Maintain ACA Subsidies; Free Roth Conversions; sell / spend $35K VG Total Stock Mkt. Only the minimal gains in one year on 35K is taxable
Year 3: Maintain ACA Subsidies; Free Roth Conversions; sell / spend $35K VG Total Stock Mkt. Only the minimal gains in two years on 35K is taxable
Year 4: Maintain ACA Subsidies; Free Roth Conversions; sell / spend $35K VG Total Stock Mkt. Only the minimal gains in three year on 35K is taxable
Ping Pong
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Re: Too much risk in this retirement draw down plan?

Post by Ping Pong »

You don’t have to change your asset allocation when you realize capital gains every 4 years. You can buy back the same fund on the same day and stay invested the whole time. This is called tax gain harvesting. You could then withdraw from the funds slowly over the next 3 years selling shares that you have reset to the higher cost basis.
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BolderBoy
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Re: Too much risk in this retirement draw down plan?

Post by BolderBoy »

PolarBearMarket wrote: Thu Nov 01, 2018 1:08 pmLong-term capital gains do not count as income.
I'm trying to get my head around this. My understanding is that long-term capital gains do count as an income item for figuring one's AGI, but that the tax on the LTCG is figured beneficially and separately from the rest of the tax on the AGI (after subsequent deductions).

Am I wrong about this?
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BigJohn
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Re: Too much risk in this retirement draw down plan?

Post by BigJohn »

BolderBoy wrote: Thu Nov 01, 2018 9:34 pm
PolarBearMarket wrote: Thu Nov 01, 2018 1:08 pmLong-term capital gains do not count as income.
I'm trying to get my head around this. My understanding is that long-term capital gains do count as an income item for figuring one's AGI, but that the tax on the LTCG is figured beneficially and separately from the rest of the tax on the AGI (after subsequent deductions).

Am I wrong about this?
BolderBoy, you are correct. LTCG are in AGI but their tax rate is lower than the tax rate for ordinary income. The interaction with Roth conversions (which is ordinary income) is complicated as the tax rate for LTCG is dependent on taxable income. However, there is a very broad window where the LTCG rate is 15% (from ~$77K to $479K for MFJ in 2018) so it may not make a difference if all the gains fall in that range.
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marcopolo
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Re: Too much risk in this retirement draw down plan?

Post by marcopolo »

GuyInFL wrote: Thu Nov 01, 2018 9:00 pm
TxJeff sez
2. Every fourth year to age 70, sell $130k-$145k from taxable. That, plus regular interest and dividends would cover my annual draw down for the next three years, plus pay any taxes.
megabad sez
If I sell VG 500 Index and then buy VG Total Stock Mkt Index the next day, I would say that my "risk" is very minimal.
Year 1: Sell $140k from taxable; buy VG Total Stock Mkt Index [Taxable gains realized]; spend (140k)/4 = $35K; Buying back equities eliminates the risk of selling big during a downturn since you are selling and then buying back in.

Year 2: Maintain ACA Subsidies; Free Roth Conversions; sell / spend $35K VG Total Stock Mkt. Only the minimal gains in one year on 35K is taxable
Year 3: Maintain ACA Subsidies; Free Roth Conversions; sell / spend $35K VG Total Stock Mkt. Only the minimal gains in two years on 35K is taxable
Year 4: Maintain ACA Subsidies; Free Roth Conversions; sell / spend $35K VG Total Stock Mkt. Only the minimal gains in three year on 35K is taxable
Maybe I am missing something. Can you explain what you mean by "Free Roth Conversions". Those conversions are treated as ordinary income, subject to the marginal tax rate, additionally, since you also mention aca tax credits in the same years as the Roth conversions, then there is an additional 9.5% effective tax on those conversions due to loss of tax credits for those additional dollars of income.
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TXJeff
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Re: Too much risk in this retirement draw down plan?

Post by TXJeff »

marcopolo wrote: Fri Nov 02, 2018 6:49 am Maybe I am missing something. Can you explain what you mean by "Free Roth Conversions". Those conversions are treated as ordinary income, subject to the marginal tax rate, additionally, since you also mention aca tax credits in the same years as the Roth conversions, then there is an additional 9.5% effective tax on those conversions due to loss of tax credits for those additional dollars of income.

Sorry for the confusing language. Yes, of course Roth conversions are taxed as ordinary income. But in my case, the combination of carry over loss/tax loss harvesting, plus my other deductions and credits, wipes out the tax.

As for the "additional 9.5% effective tax on those conversions due to the loss of tax credits" for the ACA--you are right. But when I analyzed things, the value of the tax free Roth growth plus the reduction in taxable income at age 70 when i start RMD'S and SS was much, much greater. (Less IRA $$ to tax, and SS taxed at 50% not 85%.)

Also to clarify, because of what I hold in my taxable, my regular div. and interest are less than $15k. So I can do more than $20k in Roth conversions and stay below the approx $38k cut off for ACA and the 12% tax bracket.
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