March 21, 2022
Last year in Part 49 of the Safe Withdrawal Series, I wrote a post about using leverage in retirement, and in today’s post, I like to explore some additional issues.
A quick recap, the appeal of using leverage in retirement is that we would borrow against the portfolio instead of liquidating assets. Nice! That might help with Sequence Risk if we avoid liquidating assets at temporarily depressed prices. There could also be a tax advantage in that we keep deferring the realization of taxable capital gains, potentially until we bequeath our assets to our daughter who can then use the “step-up basis” for complete forgiveness of all of our accumulated capital gains. That’s the famous “buy, borrow, die” approach popular with high-net-worth folks.
The gist of the post last year: Not so fast! Leverage could potentially even exacerbate Sequence Risk if you are unlucky and retire right before a bad market event that’s deep enough (like the Great Depression) or long enough (like the 1965-1982 stagflation episode) to compromise the portfolio so badly that the margin loan becomes unsustainable relative to the underwater portfolio.
One solution proposed by several readers: instead of always borrowing against the portfolio, maybe we should carefully time when we use leverage. For example, borrow only when the stock market is down “far enough” and use withdrawals from the portfolio otherwise. And if the market is doing well again, potentially pay back the loan again! Sounds like a reasonable and intuitive plan. But I want to put that to the test with some real simulations. Let’s take a look at the details…
Continue reading “Timing Leverage in Retirement – SWR Series Part 52”
February 28, 2022
What a difference a year makes! In late 2020, only about 16 months ago, I felt the urge to comment on the then-fashionable discussion of how low inflation would impact retirees. See Part 41 – Can we raise our Safe Withdrawal Rate when inflation is low? of my SWR Series. Feels like a lifetime ago, doesn’t it?
The takeaway back then: don’t get distracted by high-frequency economic fluctuations. Low inflation doesn’t necessarily mean we can all raise our safe withdrawal rates. Certainly not one-for-one. There is neither empirical nor theoretical economic backing for materially changing your retirement strategy.
Only a little more than a year later the tide has turned. We’re now facing the highest inflation readings in about 40 years. 7.5% CPI and potentially 8% year-over-year once the BLS releases the February figure in mid-March. So, people asked me if my inflation views are symmetric, i.e., high inflation is also a non-event? As I signaled in my inflation post last month, I’m not too worried. Here’s why…
Continue reading “Retirement in a High-Inflation Environment – SWR Series Part 51”
January 3, 2022
Happy New Year, everybody. I hope you had a relaxing and healthy Christmas and a good start to the New Year!
Last month was the 5th anniversary of the Safe Withdrawal Rate Series! In December 2016, I published the first part of that series. I had material for maybe four or five parts but one thing led to another and with new ideas, most of them due to reader feedback, the series took off. It’s been running for 5 years and I obviously opened a bottle of bubbly last month to celebrate.
So, what’s the deal with the title then? Very simple: Blogging 101. You need a catchy title! I might have called the post “What I’ve learned in 5 years and 50 posts” or something along those lines. But to shake things up and get everybody’s attention, this is the title I went with. Think of this post as a natural extension of Part 26 “Ten things the “Makers” of the 4% Rule don’t want you to know” or the equally “tongue-in-cheek” posts “How to ‘Lie’ with Personal Finance” – Part 1 and Part 2.
So, after 5 years, 50 posts, what have I learned? What do I think others in the FIRE community are missing? What can you learn from my series that you may not have seen elsewhere? Let’s take a look…
Continue reading “Ten things the “Makers” of the FIRE movement don’t want you to know – SWR Series Part 50″
November 16, 2021
My Safe Withdrawal Series has grown to almost 50 parts. After nearly 5 years of researching this topic and writing and speaking about it, a comprehensive solution to Sequence Risk is still elusive. So today I like to write about another potential “fix” of Sequence Risk headache: Instead of selling assets in retirement, why not simply borrow against your portfolio? And pay back the loan when the market eventually recovers, 30 years down the road! You see, if Sequence Risk is the result of selling assets at depressed values during an extended bear market, then leverage could be the potential solution because you delay the liquidation of assets until you find a more opportune time. And since the market has always gone up over a long enough investing window (e.g., 30+ years), you might be able to avoid running out of money. Sweet!
Using margin loans to fund your cash flow needs certainly sounds scary, but it’s quite common among high-net-worth households. In July, the Wall Street Journal featured this widely-cited article: Buy, Borrow, Die: How Rich Americans Live Off Their Paper Wealth. It details how high-net-worth folks borrow against their highly appreciated assets. This approach has tax and estate-planning benefits; you defer capital gains taxes and potentially even eliminate them altogether by either deferring the tax event indefinitely or by using the step-up basis when your heirs inherit the assets. Sweet!
So, is leverage a panacea then? Using leverage cautiously and sparingly, you may indeed hedge a portion of your Sequence Risk and thus increase your safe withdrawal rate. But too much leverage might backfire and will even exacerbate Sequence Risk. Let’s take a look at the details…
Continue reading “Using Leverage in Retirement – SWR Series Part 49”
September 14, 2021
Welcome to a new installment of the Safe Withdrawal Rate Series, dealing with Bucket Strategies. This is one approach that’s often considered a viable solution to the dreaded Sequence Risk Problem. Simply keep buckets of assets with different risk characteristics designated to cover expenses during different time windows of your retirement. Specifically, keep one or more buckets with low-risk assets to hedge the first few years of retirement. And – poof – Sequence Risk evaporates, just like that! Sounds too good to be true, right? And it likely is. Long story short, while there are certain parts of the bucket strategy that can indeed partially alleviate the risk of retirement bust, bucket strategies are by no means a solution to Sequence Risk. Let’s take a look at the details…
Continue reading “Retirement Bucket Strategies: Cheap Gimmick or the Solution to Sequence Risk? – SWR Series Part 48”
August 18, 2021
In my post two weeks ago I outlined my approach to retirement planning: In light of significant uncertainty in retirement, I like to do a more careful, robust, and scientific analysis. Not because I could ever undo any of the existing uncertainties but because I don’t want to add even more uncertainties through “winging it” in retirement.
But how much detail is really required? I can already hear objections like “you can never know your future spending month-by-month, so why go through all this careful analysis with a monthly withdrawal frequency?” To which I like to answer: Well, maybe that’s the part where you can indeed use the “wing it” approach! So, today I want to go through a few case studies and learn how much of a difference it would make in my safe withdrawal strategy simulations if we a) carefully model the whole shebang in great detail, or b) just wing it and use a rough average estimate for the spending path. For example…
- Does the intra-year distribution of withdrawals matter? In other words, how much of a difference does the withdrawal frequency make: monthly vs. quarterly vs. annual?
- What if there are fluctuations in my annual withdrawals around the baseline average budget, due to home repairs, health expenses, etc.?
- What if those fluctuations have an upward bias?
- What if there is a slow (upward) creep in withdrawals?
- What about nursing home expenses later in retirement?
Where can I safely wing it? And which are the ones I should worry about? Let’s take a look…
Continue reading “When to Worry, When to Wing It: Withdrawal Rate Case Studies – SWR Series Part 47”
August 5, 2021
Welcome back to another post in the Safe Withdrawal Rate Series. For a quick intro and a summary of the series, please refer to the new landing page.
People in the FIRE and personal finance blogging community – readers and fellow bloggers alike – often tell me that while they enjoy my writings here, they wonder if I haven’t gone a little too far into the rabbit hole of quantitative analysis. Why measure safe withdrawal rates down to multiple significant digits? Why do all of this careful analysis if there’s so much uncertainty? Market uncertainty, policy uncertainty, personal uncertainty, model uncertainty! Why not just wing it? I always try to give a short reply to defend my quantitative approach and out of the many different mental and written notes I’ve taken over the years I created this post for your enjoyment and for my convenience to refer to if I get this question again next week.
Specifically, I want to propose at least three reasons for being diligent and precise not despite, but precisely because of retirement uncertainties. And, by the way, I will keep today’s post relatively lean in terms of simulations and calculations, and rather try to make this more of a philosophical exercise. So, if you’re one of the quant-skeptics I hope you keep reading because I can promise you that we don’t have to get too deep into the (quant) weeds. So, let’s take a look at my top three reasons to get the math right…
Continue reading “The Need for Precision in an Uncertain World – SWR Series Part 46”
April 28, 2021
Welcome back to another installment of the Safe Withdrawal Rate Series. In the previous installment, Part 44, I went through a number of general tax planning ideas, and I promised another post to introduce an Excel Sheet, I created to help me with my tax planning. There were numerous reader requests a long time ago when I ran the withdrawal strategy case studies (2017-2018) to publish not just the Safe Withdrawal Rate calculations but also the tax planning Excel Sheet. Well, I never published those Excel sheets because a) they were custom-tailored to those particular case studies, b) they potentially included personal information of the case study volunteers and c) they were created “for my eyes only” so I couldn’t really publish them without a massive effort to explain and document what exactly I’m doing there.
But now (with a three-year delay!) I’ve finally come around to creating something from scratch I feel comfortable publishing for a broader audience. It’s not a Google Sheet, but an MS Excel Sheet, more on that later. It’s probably still not a universally applicable tool. And most importantly, it’s a tool that still requires a lot of Excel Spreadsheet mastery. It will not spit out “the” optimal tax strategy, it will only help me (and maybe you) find that optimal tax strategy. A lot of handiwork is still necessary! Much more handiwork than with Safe Withdrawal Sheet (and even that is already a handful!).
So, I like to go through a simple case study to show how this sheet works and showcase how you can “hack” your withdrawal tax optimization strategy in that one specific case. Even aside from tax optimization, the sheet helps me gauge what’s the average effective tax rate throughout retirement, to help me figure out how much of a gross-up I have to apply to translate a net-of-tax retirement budget into a pre-tax withdrawal percentage.
I can’t foresee what exact tax challenges you might face, but with my tool, I would have been able to handle what came across my desk so far, both in my personal finances and the case studies I’ve done so far.
So, let’s take a look…
Continue reading “A Retirement Tax-Planning Case Study (and Excel Toolkit!) – SWR Series Part 45”
April 1, 2021
The readers have spoken and I listened! A lot of folks have been asking for an easier way to digest the Safe Withdrawal Rate research on my site. It has now grown to 44 parts and even with the new landing page, it must still seem like a daunting task to navigate all the different facets of retirement planning. So, I’ve thought long and hard about a more accessible method to convey the complicated subject matter of advanced retirement withdrawal strategies.
I can now announce that I’ve decided to – get ready for this – publish the entire Safe Withdrawal Rate Series on TikTok! I will split up the series, 44 posts and 100,000+ words so far into easy-to-digest bits and pieces. Each post in the Series will be made up of between 5 to 20 TikTok videos, each around 45 to 60 seconds long. I’ll kill two birds with one stone, 1) venture into new markets and meet new people in this exciting new medium, and 2) provide better access to my research for the folks with attention-span challenges. These days, who wants to read 5,000-word blog posts with charts and tables anymore, right?
If you thought this was a big announcement, wait for the even bigger news. Instead of going this major step all by myself, I’ve decided to partner up with one of the top-100 TikTok content creators! So, who is that new partner, you may ask? It’s … drumroll … Continue reading “The Entire Safe Withdrawal Rate Series: NOT to be published on TikTok! Happy April Fool’s Day!”
March 22, 2021
It’s tax season in the U.S. right now! Even though that deadline has just been pushed back to May 17, taxes are on everybody’s mind, so this is a good time to write about the topic in the context of the Safe Withdrawal Rate Series. Until now, I haven’t written all that much about taxes and the main reasons are:
- While I do have a combined 6 letters behind my name (Ph.D. & CFA), I’m missing the three letters “CPA” to write anything truly authoritative about the topic.
- My primary focus is on getting the Safe Withdrawal Rate right. It’s the first issue everyone should worry about. I did some case studies years ago for early retirees and some of them could actually raise their SWR to more than 5% if they do their accounting for future cash flows right. That’s 25% better than the naïve 4% Rule. If you start with a tax plan that’s already somewhat OK and close to optimal, I doubt that you can squeeze out another 25% in after-tax withdrawals through a truly “optimal” tax plan. Hence my approach: get your SWR right and factor in the tax optimization plan afterward to make sure you squeeze maybe another percent or two in the after-tax numbers! (And likewise, if you have a 60-year horizon and not much in the way of supplemental cash flows and you’re looking at a 3.25%, maybe a 3.5% withdrawal rate, you’re not going to “tax-hack” yourself to a 4% withdrawal rate either!)
- Taxes are very personal and it’s difficult to give any generalized advice. As much as I would like to create a spreadsheet like the Google Sheet to simulate safe withdrawal rates (See Part 28 for the details) where you plug in your numbers and the sheet spits out a detailed plan, it’s not so trivial. Very likely, the tax analysis would have to be more custom-tailored! And just to be sure, my Google SWR simulation sheet isn’t trivial either! 🙂
But of course, even if you first do your SWR analysis in before-tax terms, you will want to know how much of a haircut you need to apply to calculate your after-tax retirement budget. Some retirees can indeed make over $110,000 a year and don’t owe any federal tax as I showed in my post in 2019 (“How much can we earn in retirement without paying federal income taxes?“). And in the same post, I showed that to get to a 5% average tax you’ll likely need a $150k annual retirement budget. So, it’s a fair assumption that most of us in the FIRE community will likely get away paying less than 5% of our retirement budget in federal taxes. Add another 0-5% or so for most state tax formulas, and you will likely stay below 10% effective/average tax rate.
But I get the message: because we can’t completely ignore taxes, I wrote today’s post to talk about the general ideas and principles in retirement tax planning. In at least one additional future post (maybe two, maybe three) I will also do a few case studies to see the general principles in action. At that point, I will also include the Excel Sheet I use to perform the tax planning analysis because a lot of readers asked for that tool when I published the Case Studies 3+ years ago! And as I warned before: it’s not as simple as just putting your parameters and Excel automatically spits out your plan. It involves a bit more human input and analysis, stay tuned!
But before we even get to the messy parts, let’s take a look at some general principles…
Continue reading “Principles of Retirement Tax-Planning – SWR Series Part 44”