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”
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”
March 2, 2021
A while ago I wrote about the challenge of designing pre-retirement equity/bond glidepaths (“What’s wrong with Target Date Funds?“). In a nutshell, the main weakness of Target Date Funds (TDFs) for folks planning an early retirement is that if you have a short horizon and a large savings rate then the “industry standard” TDF is probably useless. 10 years before retirement, the TDF has likely shifted too far out of equities, likely below 70%!
The problem is that the traditional glidepaths are calibrated to the traditional retiree (who would have guessed???) with a sizable nest egg ten years away from retirement. In that case, you want to hedge against the possibility of a bear market so close to retirement from which you might have trouble recovering due to the relatively small contributions of “only” 10-15% of your income. But people planning early retirement with a small initial net worth and a massive 50+% savings rates should clearly take more risk to get their portfolio off the ground.
In any case, back then I mentioned that I had some additional material about glidepaths toward retirement for the FIRE community, to be published at a later date, which is today!
Why is this post part of the Safe Withdrawal Rate Series? First, today’s post is a natural extension of the FIRE glidepath posts (Part 19, Part 20) in this series. Moreover, the majority of readers of the series are not necessarily retired yet. Many seek guidance during the last few years before retirement. In fact, one of the most frequent questions I have been getting is that people who are almost retired and still holding 100% equities wonder how they are supposed to transition to a less aggressive allocation, say 75% stocks and 25% bonds at the start of retirement. Should you do a gradual transition? Or keep the allocation at 100% equities and then rapidly (cold-turkey?) shift to a more cautious allocation upon retirement?
My usual response: It depends on your parameters and constraints. You can certainly maintain your 100% equity allocation much longer than the traditional TDFs would make you believe. If you are “flexible” with your retirement date you can even keep the equity weight at 100% until you retire. If you are really set on a specific date and want to hedge the downside risk, you probably want to gradually shift there over the last few years. So, let’s take a look at my findings…
Continue reading “Pre-Retirement Glidepaths: How crazy is it to hold 100% equities until retirement? – SWR Series Part 43”
January 13, 2021
Happy New Year, everyone! And welcome to a new installment of the Safe Withdrawal Rate Series. Today I like to write about the One More Year Syndrome (OMYS) – the fear of retirement and the decision to just work another year. What I find intriguing about OMYS is that procrastination normally works the other way around. You opt for the fun and easy stuff and promise yourself to do the hard work tomorrow. Only to repeat that charade again tomorrow and postpone the unpleasant tasks to the day after tomorrow. And so on.
But why procrastinate a fun-filled early retirement and keep working? Physician on FIRE and Fritz at The Retirement Manifesto have written about their rationales. The number one reason is that you grow your nest egg and put your retirement finances on a better footing. That was certainly my main rationale, too. I could have retired comfortably in 2017, probably even in 2016 but I delayed that decision until 2018.
So, qualitatively it’s obvious. But can we quantify by how much the OMYS improves your retirement security? Is it worth the additional year in the workforce? How can we incorporate OMYS in the Big ERN Google Safe Withdrawal Simulation Sheet? Is it possible that OMYS will boost your retirement health so substantially that it’s not as irrational as it’s sometimes made? Let’s take a look…
Continue reading “The Effect of “One More Year” – SWR Series Part 42″
October 29, 2020
Today’s GDP release for the third quarter came in at 33.1%. Not a typo. After the disastrous second-quarter number of -31.4%, the worst quarterly number on record we now got the best quarterly reading on record. What’s going on here? What do I make of that number? Are we out of the woods now? I’m putting on my economist’s hat for today and share my thoughts in a short post. Let’s take a look…
Continue reading “What to make of that Q3 U.S. GDP number?”
October 26, 2020
A few weeks ago I wrote the post “Do we really have to lower our Safe Withdrawal Rate to 0.5% now?” about the pretty ridiculous claim that the Safe Withdrawal Rate should go all the way down to just 0.5%, in light of today’s ultra-low interest rates. The claim was transparently false and it was great fun to debunk it. But recently I came across another proclamation of the type “We have to rethink the Safe Withdrawal Rate” – this time proposing to raise it all the way up to 5% and even 5.5%! Well, count me a skeptic on this one, too. Though I’d have to tread a bit more cautiously here because the 5.5% SWR claim doesn’t come from some random internet troll but from the “Father of the 4% Rule” himself, Bill Bengen. He’s been doing the rounds recently advocating for a 5% and even 5.5% Safe Withdrawal Rate:
- In September in a piece he wrote for FA-mag with a recommendation to raise the SWR to 5%.
- On October 1, the same article, reprinted almost verbatim under a different title in the same magazine: “Choosing The Highest Safe Withdrawal Rate At Retirement”
- On October 13 on Michael Kitces’ podcast, Bengen made another explicit SWR recommendation: “[I]n a very low inflation environment like we have now, if we had modest stocks, I wouldn’t be recommending 4.5%, I’d probably be recommending 5.25%, 5.5%” It’s not clear what made him raise the SWR by another 0.25-0.50%, though.
And the whole discussion was quickly picked up in the personal finance and FIRE community:
The main rationale for increasing the SWR: inflation has been really tame recently and will stay subdued over the coming years and even decades. That’s his forecast, not mine! Hence, Bengen makes the case that we’d have to make smaller “cost-of-living adjustments” (COLA) to our withdrawals. Smaller future aggregate withdrawals afford you larger initial withdrawals, according to Bengen. But as you might have guessed, the calculations that justify the significantly higher withdrawal rate don’t appear so convincing once look at the details…
Continue reading “Can we raise our Safe Withdrawal Rate when inflation is low? – SWR Series Part 41”
October 14, 2020
Welcome to a new installment of the Safe Withdrawal Rate Series! 40 Parts already! If this is the first time you encounter this series, I recommend you check out the landing page here to find your way around.
Today’s post is about a question I’ve encountered quite a few times recently. If Sequence of Return Risk means that you face the danger of retirement ruin from liquidating (equity) shares during a down market early during retirement, why not avoid touching your principal altogether and simply live off the dividends only in retirement? Sounds reasonable, right?
But by solving the “running out of money” problem we create a bunch of new questions, such as:
- Will the principal keep up with inflation over a typical retirement horizon?
- Will your dividend payments keep up with inflation over time?
- How much volatility in the dividend payments would you have to expect?
So, in other words, the “dividend only” strategy – simple as it may seem – is somewhat more complicated than your good old Trinity-style 4% Rule simulations. In the Trinity Study, failure means you run out of money before the end of the retirement horizon – simple as that. With the dividend-only approach, failure can come in many different shapes. For example, you may not run out of money but the volatility of dividends could be too high and/or you face deep and multi-year (or even multi-decade!) long drawdowns in dividend income and/or you have to live like a miser early on because the dividend yield is so low. All those are failures of sorts, too. Then, how good or how bad is this dividend-only approach? Let’s take a look…
Continue reading “Should we preserve our capital and only consume the dividends in retirement? – SWR Series Part 40”
August 31, 2020
Recently, there’s been some discussion in the FIRE community about a controversial post written by Sam, a.k.a. “Financial Samurai,” claiming that in light of the current record-low bond yields, specifically, the sub-1% yield on the 10-year Treasury bond, we now all have to scale back our early retirement safe withdrawal rates to… wait for it… only 0.5%! Of course, I’m one of the more cautious and conservative planners in the FIRE community, see my Safe Withdrawal Rate Series, but even I would not push people to less than 3%, even in light of today’s expensive asset valuations.
So, 0.5% seems a bit crazy low to me. What’s going on here? It’s pretty simple; the 0.5% number relies on several mathematical, financial and just plain logical flaws. Let’s unpack them all… Continue reading “Do we really have to lower our Safe Withdrawal Rate to 0.5% now?”
August 25, 2020
A lot of people – online and offline – have been asking about my opinion on the economy. When will the recession be over? Is the recession over already? How does the recession stack up with other events in the past? What are the risks going forward?
So many questions! Let’s take a look…
Continue reading “The Shortest Recession Ever? My Thoughts on the State of the Economy”
August 5, 2020
In the 3+ years, while working on the Safe Withdrawal Rate Series, I regularly get this question:
What’s my assumption for rebalancing the portfolio?
In the simulations throughout the entire series, I’ve always assumed that the investor rebalances the portfolio every month back to the target weights. And those target weights can be fixed, for example, 60% stocks and 40% bonds, or they can be moving targets like in a glidepath scenario (see Part 19 and Part 20).
In fact, assuming monthly rebalancing is the numerically most convenient assumption. I would never have to keep track of the various individual portfolio positions (stocks, bonds, cash, gold, etc.) over time, but only the aggregate portfolio value. If the portfolio is rebalanced back to the target weights every month I can simply track the portfolio value over time by applying the weighted asset return every month.
But there are some obstacles to rebalancing every single month:
- It’s might be too much work. Maybe not necessarily the trading itself but keeping track of the different accounts and calculating the aggregate stock and bond weights, potentially making adjustments for taxable accounts, tax-free and tax-deferred accounts, etc.
- It might involve transaction costs. Even in today’s world with zero commission trades for ETFs, you’d still have to bear the cost of the bid-ask spreads every time you trade.
- Even if you hold your assets in mutual funds (no explicit trading costs) there might be short-term trading restrictions prohibited you from selling and then buying (or vice versa) too frequently.
- It might be tax-inefficient. If an asset has appreciated too much you might have to sell more of it than your current retirement budget to bring the asset weight back to target. But that would mean you’ll have an unnecessarily high tax bill that year. Of course, this tax issue could be avoided by doing the rebalancing trades in the tax-advantaged accounts, not in the taxable brokerage accounts.
And finally and maybe most importantly, there might be a rationale for less-than-monthly rebalancing: it might have an impact on your Sequence of Return Risk. So, especially that last point piqued my interest because anything that might impact the safety of my withdrawal strategy is worth studying.
So, on the menu today are the following questions:
- Under what conditions will less-frequent rebalancing do better or worse than monthly rebalancing and why?
- How much of a difference would it make if we were to rebalance our portfolio less frequently?
- Could the “right” rebalance strategy solve or at least alleviate the Sequence Risk problem?
Let’s take a look… Continue reading “How often should we rebalance our portfolio? – SWR Series Part 39”