Should retirees build a reserve for RMDs?

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D Paul
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Should retirees build a reserve for RMDs?

Post by D Paul » Sat Feb 04, 2017 11:48 pm

We are both retired and hold most of our equities in taxable accounts, and hold bonds in IRAs. My traditional IRA is all bonds, split equally between VG Total Bond and VG Intermediate Corp Bond, with no cash. I will start RMDs in 2020, and we will use that money for living expenses. With so many factors that can negatively impact bond prices in the future, would it be wise to build a cash reserve for paying RMDs? I'm contemplating two different strategies to build a reserve: 1. I could sell some bond shares now and hold a cushion of say, 2 or 3 years (sounds like market timing) or 2. I could direct bond dividends into a MM in the IRA to build a reserve for RMDs. Your views?

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willthrill81
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Re: Should retirees build a reserve for RMDs?

Post by willthrill81 » Sat Feb 04, 2017 11:54 pm

I very much doubt that we're going to see a streak of significant interest rate increases. If they continue, they seem almost certain to increase quite slowly. As such, I really doubt that you're going to suddenly see a net loss holding those bond funds. But who knows?

If you're really unsure about it, just take the amount you would have put into cash into VISPX or directly into TIPS. At least then your cash won't be losing 1-3% each year while you're waiting for RMDs.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Phineas J. Whoopee
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Re: Should retirees build a reserve for RMDs?

Post by Phineas J. Whoopee » Sun Feb 05, 2017 12:53 am

Hi D Paul,

There are two things:

1) Over a long retirement period, as hoped for anyhow, the fluctuations will work themselves out, except in the event of a bad sequence in which early returns are significantly negative, which would be driven by stocks. Investment-grade intermediate-term bonds simply don't pose very much of a risk. Their long-term returns are driven by the interest on the underlying holdings, not their market values, and one doesn't need to spend all of one's resources on the very first day of retirement.

2) That said, a little cash isn't much worse than a few bonds in terms of portfolio construction. If you want to take part of your fixed income allocation and put it into short-term bonds or cash, like in a savings account (although you might try to go for a high-ish yield, as such things stand today), it doesn't make all that much difference. Allow me to elaborate.

Let's imagine, for no reason other than it's so common a recommendation, that Vanguard's Total Bond Market Index Fund, VBMFX, with its average duration, looked up just now, of 6.0 years, would be suitable for a moderate allocation of 60/40, and that one had enough to sustain a 4% withdrawal rate calculated from the first year and adjusted for inflation. It is not a withdrawal plan, just a guideline for analysis. That would mean one had about 10 years worth of expenses in the bond fund.

Now, what if you decided to put three years worth of your fixed income allocation into cash, a cushion as you term it, with an average duration of zero years (cash can be modeled as zero-duration fixed income)? The math is simple. You would have a portfolio average fixed income duration of 0.7 x 6.0 = 4.2 years. It's not outside the range of reasonable choices at all.

To put it another way, it probably won't make much difference, so why not do it if it helps you feel better? Your portfolio's returns and volatility will be driven by your equity allocation either way.

Does that make sense?

PJW

sport
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Re: Should retirees build a reserve for RMDs?

Post by sport » Sun Feb 05, 2017 1:14 am

Instead of cash, you might want to use Vanguard's Ultra Short Term Bond Fund. The risk due to rising interest rates is very small and you will get a better yield than cash. Alternatively, a short term bond fund will give a little more yield with a little more risk.

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Phineas J. Whoopee
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Re: Should retirees build a reserve for RMDs?

Post by Phineas J. Whoopee » Sun Feb 05, 2017 1:37 am

willthrill81 wrote:...
If you're really unsure about it, just take the amount you would have put into cash into VISPX or directly into TIPS. At least then your cash won't be losing 1-3% each year while you're waiting for RMDs.
It is not at all clear that Vanguard's Inflation-Protected Securities Fund, VIPSX, with its average real duration, looked up just now, of 7.9 years, is an appropriate choice to preserve value over the next three (2017 to 2020) to six (three years beyond that) years.

The fund is protected against inflation, but should not be expected to return anything closely resembling CPI-U each and every year.

Over the past 52 weeks alone its fluctuation has been 7.05%. It is in no way suitable as a short-term investment.

An equivalent portfolio of directly-held TIPS would perform the same.

PJW

Erwin
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Re: Should retirees build a reserve for RMDs?

Post by Erwin » Sun Feb 05, 2017 1:50 am

Phineas J. Whoopee wrote:
willthrill81 wrote:...
If you're really unsure about it, just take the amount you would have put into cash into VISPX or directly into TIPS. At least then your cash won't be losing 1-3% each year while you're waiting for RMDs.
It is not at all clear that Vanguard's Inflation-Protected Securities Fund, VIPSX, with its average real duration, looked up just now, of 7.9 years, is an appropriate choice to preserve value over the next three (2017 to 2020) to six (three years beyond that) years.

The fund is protected against inflation, but should not be expected to return anything closely resembling CPI-U each and every year.

Over the past 52 weeks alone its fluctuation has been 7.05%. It is in no way suitable as a short-term investment.

An equivalent portfolio of directly-held TIPS would perform the same.

PJW
Why a TIPS ladder with positive real yields will not do it? It is the most common LDI strategy tool.
Erwin

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Phineas J. Whoopee
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Re: Should retirees build a reserve for RMDs?

Post by Phineas J. Whoopee » Sun Feb 05, 2017 2:07 am

Erwin wrote:...
Why a TIPS ladder with positive real yields will not do it? It is the most common LDI strategy tool.
A TIPS ladder, that is a portfolio of TIPS with different maturities, will have its market value fluctuate just the same as if it were held through a financial intermediary like a fund.

If you're talking about a non-rolling ladder, that is one with a systematically and deliberately decreasing duration, those behave differently than rolling ladders, which are what most funds are, but still the portfolio's value fluctuates every day, and if its owner is to manage it well the underlying holdings need to be marked to market periodically.

The OP's question was about setting money aside, now or over time, before starting to take distributions in three years, and the largest amount OP referred to was three years worth of expenses, hence my calculations of three to six years and comparison of them to the fund's looked-up-just-now average real duration of 7.9 years.

willthrill81, to whose post I was responding, drew no portfolio distinction between Vanguard's Inflation-Protected Securities Fund, VIPSX, and putting cash "directly into TIPS," so interpreted h/er/is meaning to be what s/he wrote. It didn't occur me to interpret it any other way.

In other words, market values fluctuate whether or not one chooses to ignore them. To hide a thing does not cause it to cease to exist.

PJW

Erwin
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Re: Should retirees build a reserve for RMDs?

Post by Erwin » Sun Feb 05, 2017 3:33 am

Phineas J. Whoopee wrote:
Erwin wrote:...
Why a TIPS ladder with positive real yields will not do it? It is the most common LDI strategy tool.
A TIPS ladder, that is a portfolio of TIPS with different maturities, will have its market value fluctuate just the same as if it were held through a financial intermediary like a fund.

If you're talking about a non-rolling ladder, that is one with a systematically and deliberately decreasing duration, those behave differently than rolling ladders, which are what most funds are, but still the portfolio's value fluctuates every day, and if its owner is to manage it well the underlying holdings need to be marked to market periodically.

The OP's question was about setting money aside, now or over time, before starting to take distributions in three years, and the largest amount OP referred to was three years worth of expenses, hence my calculations of three to six years and comparison of them to the fund's looked-up-just-now average real duration of 7.9 years.

willthrill81, to whose post I was responding, drew no portfolio distinction between Vanguard's Inflation-Protected Securities Fund, VIPSX, and putting cash "directly into TIPS," so interpreted h/er/is meaning to be what s/he wrote. It didn't occur me to interpret it any other way.

In other words, market values fluctuate whether or not one chooses to ignore them. To hide a thing does not cause it to cease to exist.

PJW
Agree. The OP could set up a ladder of TIPS (assuming that each has positive real yield) for the amount of the RMD maturing each year when the RMD is required.
Erwin

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House Blend
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Re: Should retirees build a reserve for RMDs?

Post by House Blend » Sun Feb 05, 2017 9:45 am

D Paul wrote:I will start RMDs in 2020, and we will use that money for living expenses. With so many factors that can negatively impact bond prices in the future, would it be wise to build a cash reserve for paying RMDs?
IMO, no.

Unless you already have an allocation to cash, there's not much point in adding cash or cash-like assets in tax-deferred. Market-time when you take your RMDs if you insist, but once you take them, you should re-invest or spend them as appropriate. And don't let asset locations dictate your asset allocation. If you are 50% taxable and your AA calls for 60% fixed income, then you will be holding fixed income assets in taxable whether you like it or not.

If you *do* have an allocation to cash, then you could make an argument for temporarily moving it into tax-advantaged while reducing cash in taxable. But it's not always a strong argument, as cash-like holdings can be among the most tax-efficient for those in higher tax brackets. (Unless/until we revisit the days when savings accounts paid 5%/yr.)

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midareff
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Re: Should retirees build a reserve for RMDs?

Post by midareff » Sun Feb 05, 2017 9:52 am

D Paul wrote:We are both retired and hold most of our equities in taxable accounts, and hold bonds in IRAs. My traditional IRA is all bonds, split equally between VG Total Bond and VG Intermediate Corp Bond, with no cash. I will start RMDs in 2020, and we will use that money for living expenses. With so many factors that can negatively impact bond prices in the future, would it be wise to build a cash reserve for paying RMDs? I'm contemplating two different strategies to build a reserve: 1. I could sell some bond shares now and hold a cushion of say, 2 or 3 years (sounds like market timing) or 2. I could direct bond dividends into a MM in the IRA to build a reserve for RMDs. Your views?

Both our taxable and IRA accounts are roughly 40/60 and I intend to keep them that way, re-balancing when and as needed. RMD starts next year for me and I plan on directing all dividends from within the IRA to the ST Corp Index and then having it auto transfer 1/12 th of the amount needed annually direct to our bank monthly. I'll be 70 this year so I try not to overthink or plan a detailed withdrawal strategy for anything more than 25 years away. Maybe in ten years I'll see it differently but for now that will do.

dbr
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Re: Should retirees build a reserve for RMDs?

Post by dbr » Sun Feb 05, 2017 10:53 am

D Paul wrote:We are both retired and hold most of our equities in taxable accounts, and hold bonds in IRAs. My traditional IRA is all bonds, split equally between VG Total Bond and VG Intermediate Corp Bond, with no cash. I will start RMDs in 2020, and we will use that money for living expenses. With so many factors that can negatively impact bond prices in the future, would it be wise to build a cash reserve for paying RMDs? I'm contemplating two different strategies to build a reserve: 1. I could sell some bond shares now and hold a cushion of say, 2 or 3 years (sounds like market timing) or 2. I could direct bond dividends into a MM in the IRA to build a reserve for RMDs. Your views?
Considering that the annual RMD is about 4% of the total holding in the IRA it would be completely unnecessary to worry about this. If it makes you feel better you can hold CDs rather than bonds and not have potential volatility but actually losing return by holding cash in a MM offsets any marginal advantage to reducing volatility. For the time span involved in taking RMDs intermediate bonds are a good balance between risk and return.

D Paul
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Re: Should retirees build a reserve for RMDs?

Post by D Paul » Mon Feb 06, 2017 12:09 am

Thanks everyone for your input! I now plan to simply hold the existing bond funds and take RMDs out of them when the time comes, starting in 2020.

D Paul

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Aptenodytes
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Re: Should retirees build a reserve for RMDs?

Post by Aptenodytes » Mon Feb 06, 2017 10:44 am

Just to be clear, it is spending that creates the concern, not RMDs. RMDs can be deposited in the asset category they came from. Spending can be lower or higher than RMDs.

FinancialDave
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Re: Should retirees build a reserve for RMDs?

Post by FinancialDave » Mon Feb 06, 2017 2:10 pm

D Paul wrote:We are both retired and hold most of our equities in taxable accounts, and hold bonds in IRAs. My traditional IRA is all bonds, split equally between VG Total Bond and VG Intermediate Corp Bond, with no cash. I will start RMDs in 2020, and we will use that money for living expenses. With so many factors that can negatively impact bond prices in the future, would it be wise to build a cash reserve for paying RMDs? I'm contemplating two different strategies to build a reserve: 1. I could sell some bond shares now and hold a cushion of say, 2 or 3 years (sounds like market timing) or 2. I could direct bond dividends into a MM in the IRA to build a reserve for RMDs. Your views?
When I first read this I thought 2020 that sounds like a long way off, but then I realized this is less than 3 years. What you don't say is whether you turn 70.5 in 2019 or 2020. If you wait to pay your first RMD until April of the year following 70.5 then it puts 2 RMDs in the same year. In any event there is no reason to sell bond funds now, but I do feel there is at least a reason to switch the reinvested dividends to pay them to the money market at least 2 years prior to your first RMD pay date. This does give you at least some cash in the account from which to make a decision. The fact that the first RMD can be 3.77% (RMD @71) if your birthdate is in the second half of the year or 3.65% if your birthdate is in the first half of the year (RMD @70) gives you some chance that depending on bond prices you would be able to pull from mostly cash. What you are likely to give up by turning off the reinvested dividends can be either plus or minus, which frankly is a risk of zero!

(Note: above based on using IRS table III from IRS pub 590b, which does not apply for all range of married taxpayers)

Dave
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hoops777
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Re: Should retirees build a reserve for RMDs?

Post by hoops777 » Mon Feb 06, 2017 4:39 pm

You can buy 3,4,5 year cds to cover the first 3 RMDs
K.I.S.S........so easy to say so difficult to do.

FinancialDave
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Re: Should retirees build a reserve for RMDs?

Post by FinancialDave » Mon Feb 06, 2017 7:43 pm

hoops777 wrote:You can buy 3,4,5 year cds to cover the first 3 RMDs
Are you talking about inside the IRA, or just from the taxable account. I have not looked into buying a CD inside an IRA?



fd
I love simulated data. It turns the impossible into the possible!

hoops777
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Re: Should retirees build a reserve for RMDs?

Post by hoops777 » Mon Feb 06, 2017 9:37 pm

I have multiple brokered CDs in my IRA.
K.I.S.S........so easy to say so difficult to do.

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