Question on Variable Percentage Withdrawal (VPW) Method

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Brit
Posts: 48
Joined: Wed Oct 10, 2012 6:33 am

Question on Variable Percentage Withdrawal (VPW) Method

Post by Brit » Wed Dec 05, 2018 6:18 pm

I have a question on this statement:

"Missing payments, between retirement and the start of Social Security pension, can be provided by using a simple CD ladder or short-term bond fund. For the purposes of VPW calculations, the money set aside in this CD ladder or short-term bond fund should not be considered as part of the portfolio."

from this VPW posting:

https://www.bogleheads.org/wiki/Variabl ... withdrawal

My intrepreation of "missing payments" is the gap between the Suggested Withdrawal Rate (from the spreadsheet) and the my target annual income which will met by SS when I reach Full Retirement Age (FRA).

Example, for a

* target annual income of $80k
* Suggested Withdrawal Rate of $60k
* projected SS income of $20k at Full Retirement Age

the "missing payment" would be the $20k of projected SS income.

Am I understanding that correctly?

longinvest
Posts: 3109
Joined: Sat Aug 11, 2012 8:44 am

Re: Question on Variable Percentage Withdrawal (VPW) Method

Post by longinvest » Thu Dec 06, 2018 11:30 pm

Brit wrote:
Wed Dec 05, 2018 6:18 pm
I have a question on this statement:

"Missing payments, between retirement and the start of Social Security pension, can be provided by using a simple CD ladder or short-term bond fund. For the purposes of VPW calculations, the money set aside in this CD ladder or short-term bond fund should not be considered as part of the portfolio."

from this VPW posting:

https://www.bogleheads.org/wiki/Variabl ... withdrawal

My intrepreation of "missing payments" is the gap between the Suggested Withdrawal Rate (from the spreadsheet) and the my target annual income which will met by SS when I reach Full Retirement Age (FRA).

Example, for a

* target annual income of $80k
* Suggested Withdrawal Rate of $60k
* projected SS income of $20k at Full Retirement Age

the "missing payment" would be the $20k of projected SS income.

Am I understanding that correctly
I'll assume that FRA is 66 and the retiree's current age is 60. I'll also assume that the retiree's target allocation is 50/50 stocks/bonds.

Working backwards: The VPW Table tells us that the percentage at age 60 for a 50/50 stocks/bonds allocation is 4.5%, in other words, the portfolio's size must be ($60,000 / 4.5%) = $1,333,350 (rounded).

There's an additional (6 X $20,000) = $120,000 in a short-term bond fund to cover the missing $20,000 Social Security payments for 6 years from age 60 to age 65, inclusively.

This implies that the retiree has accumulated a total of ($1,333,350 + $120,000) = $1,453,350 before retiring at 60, from which $120,000 is put into a short-term bond fund and the rest is left in a stocks/bonds portfolio.

At 60, the retiree withdraws 1/6 of the short-term bond fund ($120,000 / 6) = $20,000. The retiree also withdraws 4.5% of the remaining portfolio ($1,333,350 X 4.5%) = $60,000 and rebalances the portfolio. The retiree now has ($20,000 + $60,000) = $80,000 for both paying taxes and spending (spending = $80,000 - taxes).

The VPW approach is dynamic; it adapts to market returns over time. Let's simulate this by assuming that during the next year, short-term bonds go up 1.5%, stocks go down 5%, and bonds go up 2%. This isn't a prediction! I just made up these numbers to illustrate how VPW and the Social Security bridge investment work. The remaining ($120,000 - $20,000) = $100,000 invested in the short-term bond fund grows to $101,500. Just after withdrawal and rebalancing, the residual portfolio was ($1,333,350 - $60,000) = $1,273,350. Half of it, $636,675 was in stocks and the other half in bonds. One year later, stocks have shrunk to $604,840 and bonds have grown to $649,410, for a total of $1,254,250.

There are now 5 remaining years until Social Security so 1/5 of the short-term bond fund is withdrawn ($101,500 / 5) = $20,300. The VPW Table tells us that the percentage at age 61 for a 50/50 stocks/bonds allocation is 4.6%, so ($1,254,250 X 4.6%) = $57,700 is withdrawn from the portfolio while rebalancing it. The retiree ends up with ($20,300 + $57,700) = $78,000 for both paying taxes and spending (spending = $78,000 - taxes) in the second year of retirement.

See how the amount has changed. It didn't remain at $80,000. It could have gone up or down. As the portfolio lost 1.5% (in my example, using totally made up returns), withdrawals got down a little and the total amount available for taxes and spending was reduced to $78,000. The next year, after that, the amount will change again.

In the 6th year of retirement, the short-term bond fund will be depleted. But, Social Security will take over in the 7th year for providing an inflation-adjusted $20,000 annual amount.

VPW calculations for taking portfolio withdrawals have to be repeated every year of retirement. (See the wiki page for details, including some suggestions for what to do at age 80 and later ages to dampen the financial risk of long life).

Good luck!
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic / international) stocks / domestic (nominal / inflation-indexed) long-term bonds | VCN/VXC/VLB/ZRR

Brit
Posts: 48
Joined: Wed Oct 10, 2012 6:33 am

Re: Question on Variable Percentage Withdrawal (VPW) Method

Post by Brit » Fri Dec 07, 2018 1:32 pm

Thank you, that totally confirms my understanding.

In my original post I assumed that the AWR would be flat but yes of course I understand its a variable percentage that's withdrawn and portfolio performance impacts that too. I can live with the variability as we will be able to dial things back to a certain degree and I'm an optimist so I like the idea of having more money in "good years", it will feel like a bonus :).

My mileage will of course vary but heck that's life

Again thanks for the detailed response!

Woodshark
Posts: 413
Joined: Fri Jan 07, 2011 4:09 pm

Re: Question on Variable Percentage Withdrawal (VPW) Method

Post by Woodshark » Sat Dec 08, 2018 7:57 am

Linginvest,

I've never taken the time to explore the VPW method before, thinking it was probably too complicated. Thank you for your detailed explanation. It is now something I will look further into.

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