FIRE early - use bonds in tax-free or no?

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boringinvestor
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FIRE early - use bonds in tax-free or no?

Post by boringinvestor »

I am retiring early (late 30s). I have enough investments to sustain a 4% withdrawal safely.

I'm not sure what investment strategy to use in my IRAs (Roth and Traditional). On one hand, I could put a big chunk of taxable bonds in my IRAs since that would be tax efficient, and have more equities in taxable. On another hand, I'm very far from being able to utilize IRA money, so given the investment horizon perhaps stocks make sense.

In either case, the value of my taxable accounts very far outweigh my tax-advantaged, so I have a large chunk in muni bonds regardless. The question is how I should invest in my IRAs given my situation. IRAs comprise about 15% of overall NW.

Thank you!
Wanderingwheelz
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Re: FIRE early - use bonds in tax-free or no?

Post by Wanderingwheelz »

I came here to say that using a 4% withdrawal rate for a very long retirement that could easily stretch past 50 years isn’t safe. Far from it.

Depending on the amount of anssets and your expenses, owning any bonds at all might be a mistake regardless of where they’re places in your portfolio- especially muni bonds. Your age may require an aggressive allocation in order to have a high enough chance of succeeding. If I retired at age 39 I’d stay in all equites with maybe a year or two in cash, knowing that if things went wrong in the first 20 years I was still able bodied enough to rejoin the workforce to repair any damage that the bad SOR caused.
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steadyosmosis
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Re: FIRE early - use bonds in tax-free or no?

Post by steadyosmosis »

(post removed)
Last edited by steadyosmosis on Mon Apr 01, 2024 7:05 am, edited 2 times in total.
Age<59.5. Early-retired. AA ~55/45. Taxable account, Roth IRA, HSA...all are 100% equities. 100% of fixed income is in tIRA. I spend from taxable and rebalance in tIRA.
livesoft
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Re: FIRE early - use bonds in tax-free or no?

Post by livesoft »

boringinvestor wrote: Mon Apr 01, 2024 5:16 am I'm not sure what investment strategy to use in my IRAs (Roth and Traditional). On one hand, I could put a big chunk of taxable bonds in my IRAs since that would be tax efficient, and have more equities in taxable. On another hand, I'm very far from being able to utilize IRA money, so given the investment horizon perhaps stocks make sense.

In either case, the value of my taxable accounts very far outweigh my tax-advantaged, so I have a large chunk in muni bonds regardless. The question is how I should invest in my IRAs given my situation. IRAs comprise about 15% of overall NW.
Bonds in tax-deferred IRAs are not a problem to access penalty-free well before age 59.5 if one has a lots of equities in a taxable account because of this:

https://www.bogleheads.org/wiki/Placing ... ed_account

But presumably you will live off of return-of-capital (not taxed!) and thus be in the 0% tax bracket for quite some time. That means you will convert all your tax-deferred IRAs into Roth IRAs. Your Roth IRA will probably end up being a mix of equities snd bonds.

And you will have to rethink your muni bonds in taxable since your tax bracket will be so low they may not make sense for you.

But if your desired asset allocation is 85% equities and 15% bonds, then most of your bonds it seems would fit in your tax-deferred IRA and you wouldn't need muni bonds anyways.
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feh
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Re: FIRE early - use bonds in tax-free or no?

Post by feh »

Wanderingwheelz wrote: Mon Apr 01, 2024 5:32 am I came here to say that using a 4% withdrawal rate for a very long retirement that could easily stretch past 50 years isn’t safe. Far from it.
+1
fortunefavored
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Re: FIRE early - use bonds in tax-free or no?

Post by fortunefavored »

It probably doesn't matter.

But one consideration would be if you can/will do Roth conversions or not. If you can't/won't, then keeping low growth products (bonds) in your traditional IRA would be a good idea so it doesn't blow up to a huge amount in 50 years and you have to take RMDs.

Similarly, stick high growth and high dividend funds in your Roth (international if that's your thing.)

But since you say "the value of my taxable accounts very far outweigh my tax-advantaged" - it probably won't matter much.
YoungSisyphus
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Re: FIRE early - use bonds in tax-free or no?

Post by YoungSisyphus »

livesoft wrote: Mon Apr 01, 2024 7:00 am But presumably you will live off of return-of-capital (not taxed!) and thus be in the 0% tax bracket for quite some time. That means you will convert all your tax-deferred IRAs into Roth IRAs. Your Roth IRA will probably end up being a mix of equities snd bonds.
Livesoft, could you please expand on what you mean by this? Say one has 500K sitting in a traditional IRA (rollover from 401k/company), 250K in a Roth, and 250K in taxable.

What would the mechanic be that you are converting "tax-deferred IRAs into Roth IRAs"?
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22twain
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Re: FIRE early - use bonds in tax-free or no?

Post by 22twain »

boringinvestor wrote: Mon Apr 01, 2024 5:16 am I am retiring early (late 30s). I have enough investments to sustain a 4% withdrawal safely.
Are you aware that the "4% rule" applies to 30-year periods? You're likely to need your assets to last much longer than that. In the past, the odds of "success" have declined from 100% after 30 years. You might want to check this out using a tool like Firecalc.
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livesoft
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Re: FIRE early - use bonds in tax-free or no?

Post by livesoft »

YoungSisyphus wrote: Mon Apr 01, 2024 8:31 am Livesoft, could you please expand on what you mean by this? Say one has 500K sitting in a traditional IRA (rollover from 401k/company), 250K in a Roth, and 250K in taxable.

What would the mechanic be that you are converting "tax-deferred IRAs into Roth IRAs"?
Roth conversions are a constant topic at Bogleheads.org, so I'm not going to expand here, but just suggest you start by looking at:
https://www.bogleheads.org/wiki/Roth_conversion

Now if you want to see how to pay no Federal income taxes like more than 40% of families, then there is
viewtopic.php?t=87471
Last edited by livesoft on Mon Apr 01, 2024 8:48 am, edited 1 time in total.
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sailaway
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Re: FIRE early - use bonds in tax-free or no?

Post by sailaway »

livesoft wrote: Mon Apr 01, 2024 7:00 am
boringinvestor wrote: Mon Apr 01, 2024 5:16 am I'm not sure what investment strategy to use in my IRAs (Roth and Traditional). On one hand, I could put a big chunk of taxable bonds in my IRAs since that would be tax efficient, and have more equities in taxable. On another hand, I'm very far from being able to utilize IRA money, so given the investment horizon perhaps stocks make sense.

In either case, the value of my taxable accounts very far outweigh my tax-advantaged, so I have a large chunk in muni bonds regardless. The question is how I should invest in my IRAs given my situation. IRAs comprise about 15% of overall NW.
Bonds in tax-deferred IRAs are not a problem to access penalty-free well before age 59.5 if one has a lots of equities in a taxable account because of this:

https://www.bogleheads.org/wiki/Placing ... ed_account

I found a lot of comfort in embracing the fungibility of money and realizing how this works.

Also remember that you can access all your contributions to Roth at any time and conversions on a rolling basis. This doesn't necessarily help with bond placement, as conversions reduce the percentage you have in traditional accounts, but it is a reminder to consider long term taxes.

DH chose to downshift, rather than retire at your age, but we had always planned to use Roth conversions to optimize taxes, likely filling the lowest tax bracket. We expect to need the conversions to generate enough income for ACA subsidies. Our traditional accounts are nearly 100% bonds right now to maintain our 70/30 AA, so any conversions will mean starting to hold bonds in Roth accounts. The only bonds we have in taxable accounts are I bonds.
bonesly
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Re: FIRE early - use bonds in tax-free or no?

Post by bonesly »

boringinvestor wrote: Mon Apr 01, 2024 5:16 am I am retiring early (late 30s). I have enough investments to sustain a 4% withdrawal safely.
4% is for a 30-year withdrawal phase. If you're retiring late 30s but won't withdraw from your portfolio until age 65, then that's "safe" (90% chance of portfolio not running out of money before age 95).

If you're planning to start tapping your assets at age 40... that portfolio success rate drops to about 77%, which is much higher risk of running out early (and that's only to age 90). To get back to about 90% success rate, you need to reduce the initial withdrawal from 4% down to 3.3%.
- - - - -
Regarding taxable being 85% and tax-advantaged being 15%, with you being well below 59.5 for penalty-free Trad 401k/IRA withdrawals, you'd be living off the taxable account. Perhaps move some of your municipal bonds to a money market to support 1-3 years of expenses. If your tax rate is at the highest bracket possible a municipal money market fund (e.g., VMSXX) might even make sense.

Regarding the title question, I think you'd need to provide more info to evaluate If bonds in tax-free make sense or if your existing municipal bonds are the better long-term after-tax value. I don't think it's just an after-tax interest rate comparison as it would also involve a reduction in potential tax-free stock growth as part of the trade-off analysis.
Pepper11
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Re: FIRE early - use bonds in tax-free or no?

Post by Pepper11 »

feh wrote: Mon Apr 01, 2024 7:56 am
Wanderingwheelz wrote: Mon Apr 01, 2024 5:32 am I came here to say that using a 4% withdrawal rate for a very long retirement that could easily stretch past 50 years isn’t safe. Far from it.
+1
100% disagree.

The 4% rule is a worst case scenario preventor - nothing more. Something like 65% of simulated portfolios end up with more money than they started with using the 4% rule.

So why does no one ever consider that a very young retiree will likely have the best and most valuable emergency fund available -the ability to return to work if needed!

The probability of running out of assets using the 4% rule is greater with a 50 year runway compared with a 30 year runway, but it is still small. And the risk is still greatest due to poor sequence of returns, with a bear market crushing the portfolio early in retirement. If the catastrophic happens early in retirement, a 35 or 40 year old will likely be much more able to return to work than a 70/75 year old.

If instead both portfolios start with 10 years of standard returns, the most likely difference is that the 50 year runway will end with a far greater sum than the 30 year runway.
Last edited by Pepper11 on Mon Apr 01, 2024 2:56 pm, edited 1 time in total.
simplextableau
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Re: FIRE early - use bonds in tax-free or no?

Post by simplextableau »

Pepper11 wrote: Mon Apr 01, 2024 2:25 pm
feh wrote: Mon Apr 01, 2024 7:56 am
Wanderingwheelz wrote: Mon Apr 01, 2024 5:32 am I came here to say that using a 4% withdrawal rate for a very long retirement that could easily stretch past 50 years isn’t safe. Far from it.
+1
100% disagree.

The 4% rule is a worst case scenario preventor - nothing more. Something like 65% of simulated portfolios end up with more money than thathey started with using the 4% rule.

So why does no one ever consider that a very young retiree will likely have the best and most valuable emergency fund available -the ability to return to work if needed!

The probability of running out of assets using the 4% rule is greater with a 50 year runway compared with a 30 year runway, but it is still small. And the risk is still greatest due to poor sequence of returns, with a bear market crushing the portfolio early in retirement. If the catastrophic happens early in retirement, a 35 or 40 year old will likely be much more able to return to work than a 70/75 year old.

If instead both portfolios start with 10 years of standard returns, the most likely difference is that the 50 year runway will end with a far greater sum than the 30 year runway.
Completely agree.
FaustF86
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Re: FIRE early - use bonds in tax-free or no?

Post by FaustF86 »

I completely agree as well. There is a ~80% chance the portfolio will be fine. Those are good odds. The other ~20% happens if there is a giant downturn within 2-3 years of retiring. If that happens, an intelligent millionaire in their 30s-40s will have no problem finding a job to supplement their portfolio income for a few years.

I get a kick out of the fearmongerering surrounding ‘totally unsafe’ 4-5% withdrawal rates by people in their 30s and 40s.
MDivision
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Re: FIRE early - use bonds in tax-free or no?

Post by MDivision »

Some of you need to read up on Bill Bengen's latest research
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Meg77
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Re: FIRE early - use bonds in tax-free or no?

Post by Meg77 »

I'm in a similar situation - retiring at 40. I'm keeping my 401k/Roth IRAs in equities, as they've been allocated my whole career. If/when I get close to using up all my taxable funds and needing to tap retirement funds, I'll shift my allocation accordingly to add bonds to the retirement funds.

From a bucket mentality, I'll tap those funds last - and maybe never - so they should be in the highest growth /riskiest allocation. It makes no sense to prevent them growing much just to reduce future RMDs. I hope my RMDs are huge!! And I hope my income tax bill is enormous! That would mean I have a big pile of assets and a large income from them. People get way too focused on reducing taxes, even to the point of trying to reduce their actual resources just to pay less tax. :oops:

Yes I know you *can* access those accounts early, but it sounds like you won't need to. Besides from a cash flow perspective you want your cash and bonds accessible in your taxable accounts.

Rough order of operations:

1. Spend any earned income/gifts.

2. Spend interest and dividends as well as distributed capital gains from taxable mutual funds. I have all this set to not reinvest and hit the money market settlement fund.

3. Spend accumulated cash reserves (especially in bear markets); you can set up a "paycheck" from settlement fund to your checking account.

4. Now it gets more complicated. I want to have 1-3 years in cash at all times. So as I spend the cash down, I need to sell investments to replenish it. In a bull market, as hard as it is to take capital gains and sell while things look great, it's best to sell equities. But in an extended bear market - and just to keep your AA where you want it in volatile times - you'll want to have bonds to sell as well if you run low on cash to avoid selling stocks in a downturn.

Also traditionally (though not currently) bonds will yield more than cash, so maybe over time I'll lean more toward 1 year in cash and 2-5 in bonds or consider a bond ladder to fund some spending. I don't have enough cash to set one up now (most of my taxable investments are in equity funds with huge gains and rental property), but my mom hasn't had to touch her portfolio at all the first 8 years of her retirement because she inherited a muni bond ladder from her father that has just been slowly maturing. It's been really great and keeps decision fatigue to an absolute minimum.
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Pepper11
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Re: FIRE early - use bonds in tax-free or no?

Post by Pepper11 »

MDivision wrote: Mon Apr 01, 2024 3:26 pm Some of you need to read up on Bill Bengen's latest research
What is with the condesending tone?

Bill Bengen advocates adding microcaps in addition to small caps to "improve" withdrawal rate based on his updated reseach. No thanks- I'll stick with VTSAX. Why would he determine your asset allocation?
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Re: FIRE early - use bonds in tax-free or no?

Post by muffins14 »

Pepper11 wrote: Mon Apr 01, 2024 9:59 pm
MDivision wrote: Mon Apr 01, 2024 3:26 pm Some of you need to read up on Bill Bengen's latest research
What is with the condesending tone?

Bill Bengen advocates adding microcaps in addition to small caps to "improve" withdrawal rate based on his updated reseach. No thanks- I'll stick with VTSAX. Why would he determine your asset allocation?
Out of curiosity, do you prefer a smaller withdrawal rate than a higher one, or is there something particular about that research that you did not feel was adequately supported by the data?
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muffins14
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Re: FIRE early - use bonds in tax-free or no?

Post by muffins14 »

boringinvestor wrote: Mon Apr 01, 2024 5:16 am I am retiring early (late 30s). I have enough investments to sustain a 4% withdrawal safely.

I'm not sure what investment strategy to use in my IRAs (Roth and Traditional). On one hand, I could put a big chunk of taxable bonds in my IRAs since that would be tax efficient, and have more equities in taxable. On another hand, I'm very far from being able to utilize IRA money, so given the investment horizon perhaps stocks make sense.

Thank you!

You can always keep bonds in your traditional IRA and stocks in taxable, if it is more tax efficient that way due to taxes on dividends and long-term capital gains compared to your marginal tax rate in retirement.

When you need money to spend:
1) Sell stocks from taxable (either at a loss, (yay, tax-loss harvesting) or a long-term gain (yay, some return of principle and some LTCG))
2) Sell bonds and buy stocks in your IRA.

Now you've spent your money in a tax-efficient way while maintaining your asset allocation
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lakpr
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Re: FIRE early - use bonds in tax-free or no?

Post by lakpr »

Pepper11 wrote: Mon Apr 01, 2024 2:25 pm So why does no one ever consider that a very young retiree will likely have the best and most valuable emergency fund available -the ability to return to work if needed!
At least in my line of work, if one is out of workforce for a considerable amount of time (let's call it 2 years), then the person is almost untouchable with regards to getting a new job again. *IF* returning to work means taking up any menial job (Wal-Mart greeter, McJobs), I suppose you have a valid point -- but then again, would a person who felt confident to quit job based on FIRE assumptions, willing to take such jobs?
trees
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Re: FIRE early - use bonds in tax-free or no?

Post by trees »

I’m in a somewhat similar situation. What I ended up doing was while working and dumping lots into taxable, I put 401k in (mostly - some smaller cap to counterbalance risk) target retirement aimed at a somewhat early retirement (when I’d be 50), so it had some bonds (~15-20%) but wasn’t loaded down.

Now that I have enough saved in taxable that it’s significantly more than tax advantaged and I’m considering an early retirement or a greatly reduced income in a second career, I’ve switched it to be target retirement fund aimed at when I’m 70 (so right now <10% bonds), as I want larger growth to be in my Roth accounts and a bit more stability in taxable accounts anyway. I believe this will likely result in better growth overall given current delta between munis and taxable bonds anyway, but even if it doesn’t I’m ok with that tradeoff to better have my portfolio fit my likely risk comfort profile - which even if money is mostly fungible ISNT actually the same for both accounts.
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