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4 Approaches to Managing Sequence of Risk Return in Retirement

Column by Wade Pfau. Briefly approaches include:

1. Spend conservatively (invest aggressively, but spend so little that you can survive starting concurrently with a down market)

2. Be flexible ("at the extreme ... withdraw[] a constant percentage of remaining assets")

3. Reduce volatility (e.g. with pensions, annuities or other income guarantees, increasing equity allocation over time, ...)

4. Avoid selling at losses (keep 3 year cash buffer - see Buffett, keep line of credit from home equity)

https://www.forbes.com/sites/wadepfau/2017/04/12/4-approaches-to-managing-sequence-of-returns-risk-in-retirement

Comments

  • Only thing I would suggest differently is to have at least 5 years of income needs set aside in cash/CDs/short-term bonds, instead of 3 years.
  • So equity investing is what one does after and only after having set aside 5x annual cashflow. Therefore for only the wealthy. My children, among a great many others, would never equity-invest, or not till their 50s.

    Sketchy advice, to say the least. Ask around and see what kind of response you get to this notion.

    Unused or lightly / prudently used heloc always a good idea, sure.
  • Five years' worth of expenses might make sense if that advice applies to someone who has reached retirement and the sum is net of all other income (e.g., pension, Social Security). Perhaps that's what was meant.
  • @davidrmoran , this is advice for those in retirement. I venture to guess your kids are not retired. Rule of thumb for the working person, your kids, is to have 3-6 months saved cash or 'cash like' for emergencies. Totally different.
  • From the article:
    a rising equity glide path in retirement could start with an equity allocation that is even lower than typically recommended (in safe withdrawal rate research literature) at the start of retirement, but then slowly increase the stock allocation over time.
    I'd like to see more research on this strategy. Seems to go against almost every pundit I've read on this topic.
  • Right, I made a complete hash (worse than that, actually) of trying to depict the route to get from working 30s to 60s retirement prep so as to result in high-multiple cashflow cash.
  • bee said:

    From the article:

    a rising equity glide path in retirement could start with an equity allocation that is even lower than typically recommended (in safe withdrawal rate research literature) at the start of retirement, but then slowly increase the stock allocation over time.
    I'd like to see more research on this strategy. Seems to go against almost every pundit I've read on this topic.
    This made quite a splash, even at MFO, when Pfau and Kitces published their research. In fact, you contributed to one of the threads. How soon they forget:-)
    http://mutualfundobserver.com/discuss/discussion/9501/new-strategy-for-equity-investing-during-retirement-ignites-debate

    Here's Kitces column. It contains a link to their paper.
    https://www.kitces.com/blog/should-equity-exposure-decrease-in-retirement-or-is-a-rising-equity-glidepath-actually-better/
  • edited July 2017
    One thing I've thought about, and I see it in the link of past MFO discussion mfs provided; the government dictates what you will withdraw from your nest egg in the form of RMD. Why does anyone debate the "correct" percentage for withdrawal, 4%, 3%, 2%... whatever, if at 70 you don't have a choice to go lower anyway?

    ron said in Dec, 2013:
    I have used different retirement planning software that has given me good direction. For about last 10 years my RMD, usually about 4%...
  • RMDs are just tax events. Nothing more. The government isn't requiring you to withdraw money from your next egg.

    To abuse the metaphor, you've got eggs in multiple baskets (traditional IRA, Roth, 401k, taxable), and you're just required to move some eggs from one basket to another. You don't have to crack open any of those eggs - the IRS lets you move your investments in kind from your IRA to your taxable account.

    The 4% rule refers to how many eggs you can take out safely, regardless of which basket they come from.
  • >> the IRS lets you move your investments in kind from your IRA to your taxable account.

    But this is the same taxable event as in-IRA selling and receiving the RMD cash directly, right?
  • edited July 2017
    msf said:

    RMDs are just tax events. Nothing more. The government isn't requiring you to withdraw money from your next egg.

    To abuse the metaphor, you've got eggs in multiple baskets (traditional IRA, Roth, 401k, taxable), and you're just required to move some eggs from one basket to another. You don't have to crack open any of those eggs - the IRS lets you move your investments in kind from your IRA to your taxable account.

    BINGO - Actually, the Roth (not subject to RMD) is a tax boondoggle for the wealthiest among us who can easily afford to pay the tax hit up front (from family savings). One reason I don't think it's going away any time soon.

    ---

    Added: I've taken to "withdrawing" my annual RMD at T Rowe by simply moving the correct amount out of TRBUX (IRA) and into TRBUX (TOD). It's that simple. Also, I've checked and have found it's possible (with some important qualifications) to continue converting portions of one's Traditional IRAs to a Roth IRAs, even after reaching mandatory distribution age. Under some circumstances (mainly, I think, market valuations) it might make sense to use RMD withdrawals to cover the tax cost of converting portions of an IRA to a Roth.

    Not intended to be investment or tax advice.
  • Yes. That's the point. All you're required to do is remove a specific amount of assets (the RMD amount) from your IRAs. That is the taxable event.

    After that, what you do with the distributed (withdrawn) assets is up to you. That's why how to deal with RMDs is not so much a retirement planning issue (e.g. 4% drawdown schedules) as it is a tax planning concern (e.g. when to take distributions to minimize the tax consequences of RMDs).
  • beebee
    edited July 2017
    @msf, The days of cman. MaxBialystock...I will try to misremember less. Thanks for this post (repost).

    I do see merit in living within your means (keeping living expenses low) and Investing agressively or as @Ted would say..."Letting the Big Dog Bark".. (stock allocation, not bond allocation should equal your age).

    As a side note, if I were to move, not crack my eggs from a tax deferred status (as a result of RMDs) to a taxable status I would strongly consider owning stocks instead of mutual funds so as to insure that these investment, if not spent, would be inherited with the benefit of the "stepped up basis" provision.

    Q. Are EFTs treated to the same "stepped up basis" provision as stocks in taxable accounts?

  • @Hank

    >> Actually, the Roth (not subject to RMD) is a tax boondoggle for the wealthiest among us

    No it's not, in fact, depending of course on how you define 'wealthiest':

    http://www.schwab.com/public/schwab/investing/retirement_and_planning/understanding_iras/roth_ira/contribution_limits

    Indeed you might say (and many have said) that Roths are specifically prohibited "for the wealthiest among us." Part of the point when it was conceived, actually.
  • edited July 2017
    Hi David - Yes and No.

    (According to your link) the allowable yearly contribution is graduated downward as income increases (presumably to help the poorest among us). However, the lowest step (highest allowable contribution) for a married couple filing jointly is at a "measly" $186,000 annual income. After that $186,000 initial step, you are correct that the allowable Roth contribution decreases. I don't know about the national averages or what incomes are in your area, but I can tell you that a combined $186,000 annual income is not considered a lowly amount in most parts of Michigan.

    But there's a second aspect to all of this. While you and your spouse, just out of college, may be earning only $186,000 annually early in your careers, if from a wealthy family your Ma and Pa (or Grandma and Gramps) can gift money to you from the family's assets. I don't know if it would be legal to pay your Roth contribution tax expenses directly with such gifted money. However, practically speaking what's the difference? If you use that gifted money to pay your basic living expenses and than move the expenses that were deferred by those gifts into paying your Roth tax bill, isn't the result the same? You have a distinct tax advantage over the couple across town who earn the same amount as you, but who have no wealthy family members to help them defer living expenses.

    I love the Roth. However, I had to work very hard to cover the extra tax hit incurred in having one. And came into them relatively late in life. Not sure that's the case with those from wealthier families.


    Here's a couple reality checks:

    Average U.S. Household incomes 2016 - https://www.fool.com/retirement/2016/10/30/heres-the-average-american-household-income-how-do.aspx

    Median Household Income by State - 2015 https://www.advisorperspectives.com/dshort/updates/2016/10/14/median-household-income-by-state-a-new-look-at-the-data
  • bee said:


    As a side note, if I were to move, not crack my eggs from a tax deferred status (as a result of RMDs) to a taxable status I would strongly consider owning stocks instead of mutual funds so as to insure that these investment, if not spent, would be inherited with the benefit of the "stepped up basis" provision.

    Q. Are EFTs treated to the same "stepped up basis" provision as stocks in taxable accounts?

    Virtually all investments receive a stepped up (or stepped down, as in 2008) basis. That includes mutual fund shares, bonds, ETFs, stocks, even your home.

    In the unusual case where the current value is less than cost, it may make sense to sell prior to death to recognize that loss. The tricky part is knowing when you're going to die.

    (You can't take a loss on your residence, however.)
  • msf
    edited July 2017


    Indeed you might say (and many have said) that Roths are specifically prohibited "for the wealthiest among us." Part of the point when it was conceived, actually.

    Just one word: backdoor. (Maybe that's two words?)

    When it was conceived, there was no way for higher earners to contribute to Roths. Now there is.
  • msf,
    Forgive me, what is that way?

    Hank's post seems only to make my point. And is confused to boot --- who said anything about 185k joint income being lowly anywhere? My point. What am I missing?

    Yeah, generational transfers help everything. Not sure this has to do with the point.
    My mil left a non-large pot for her grandchildren, and the one who did not go to grad school got hers every year, as we doled it out to fund her Roth, since the kid herself could not afford to (not on her middling salary; she did hit her 401k fully for match). Those few years of grandma-origin diverted Roth funding were a bull market, so last month she withdrew all of grandma's money plus 10k of the gains for condo downpayment.
    RPP, sure, and a good outcome.
    Nothing to do with Roths and the very wealthy.
    It is not unheard of for a tech-educated couple in this area in jointly earn 90k each after a few years out of school, or right away in some other fields (consulting, law, medicine, blah blah), nor even in Pittsburgh or Atlanta, and those couples are precluded from Roths from the getgo. All I was saying.
  • edited July 2017
    "Hank's post seems only to make my point. And is confused to boot --- who said anything about 185k joint income being lowly anywhere? My point. What am I missing?"

    Look at the schedule you linked in an attempt to refute my earlier comment that the Roth is a tax boondoggle for the wealthy. Your point was probably that, since the schedule shows a decreasing threshold for the allowable dollar amount of annual Roth contributions as incomes (married filing jointly) rise, the wealthy benefit less than lower income couples. Yes - that's accurate and partially proves your point as I alluded.

    However, my comments were to the effect that the highest yearly contribution amounts allowed (either $5,500 or $6,500 depending on age) still favor the category of married couples earning up to $186,000. That income figure ($186,000) may appear "low" on the schedule you linked (compared with the higher incomes listed), but is in reality far above both the national average and median incomes for families as reported in recent years.

    IRAs all favor the people who can afford to contribute the most. (Duh) But an enhanced IRA, like the Roth, favors those who can afford to contribute the most even more. At risk here of going outside my limited knowledge base. But I've seen enough of the Roth to think that for most people it represents a superior long-term tax-advantaged investment vehicle compared to the Traditional IRA. The "kicker" is that one has to have the additional resources beyond their actual contribution to cover the additional taxes a Roth demands early on. That's where the more affluent gain a real advantage.
  • Jeez, did I not say long ago it depends on how you define 'the wealthy'? Your wording, right?

    Look at the income percentiles, for heaven's sake, before going back and forth about this, okay? Did you do that?

    Everyone I have known ever since Roth was implemented whom you or I or anyone would call truly wealthy, in every part of the country, has not been able (allowed) to contribute. Period. And has not. They lament it, but accept it.

    There is no covering "additional taxes a Roth demands." It's after-tax bucks, yes, for sure; everyone gets that.

    Like normal non-retirement investing, except any growth is tax-exempt, woohoo.

    Perhaps you see investment sites as pertaining to trad IRAs and 401k / 403bs only?
  • edited July 2017

    "Jeez, did I not say long ago it depends on how you define 'the wealthy'? Your wording, right?"

    I did not define it. I don't think there's a standard definition of wealthiest as it would apply to a population. It's the supurlative form of the adjective wealthy.* You may apply it to the upper 33% of U.S. households if you like - and again to the upper 25%. My best guess is that the exclusion from investing in a Roth due to excessive earned income probably affects only about 10% of the population. In addition, the limits on contributing to a Roth appear based on levels of annual income - not on net worth. While these are often related, they don't have to be. Certainly one can have a high net worth and still report relatively small amounts of income during some portions of their working life. To have hanged (or or hung?) an entire argument on the meaning of one form of a single adjective seems somewhat narrowly focused.

    "Look at the income percentiles, for heaven's sake, before going back and forth about this, okay? Did you do that? "

    David, I cited national average incomes and median incomes to show that the $186,000 base is a fairly high figure. Did not intend to limit the comment to only the perhaps 10% of population that may be ineligible.

    "Everyone I have known ever since Roth was implemented whom you or I or anyone would call truly wealthy, in every part of the country, has not been able (allowed) to contribute. Period. And has not. They lament it, but accept it."

    You appear to have a lot of rich friends. In terms of dollar amounts, the cut-off appears to be about $200,000 for couples and $133,000 for individuals. That represents approximately 10-15% of tax payers (from browsing census figures and tax reporting articles.) But I can't locate a specific source that would distill the number down neatly.

    "There is no covering "additional taxes a Roth demands." It's after-tax bucks, yes, for sure; everyone gets that."

    Say again?
    Trad IRA - You pay the taxes only when you withdraw the money (could be 40-50 years down the road). With a Roth IRA, you pay the taxes immediately - usually during same year.

    "Like normal non-retirement investing, except any growth is tax-exempt, woohoo".

    Not quite. That growth compounds year after year. The difference over long periods is enormous. Without the tax deferred status (and additional compounding it allows) the growth would be far less. Also remember that a traditional IRA is taxed as "ordinary income" when withdrawn. All the gains you have achieved over those 30, 40 or more years are now being taxed as "income". In some respects (especially later on) that's worse than if the money were in non-sheltered investments where they might incur a lower capital gains tax. By contrast, on a Roth no taxes are paid on normal distributions, Additionally, the RMD doesn't apply to Roths.

    "Perhaps you see investment sites as pertaining to trad IRAs and 401k / 403bs only?"

    Silly, me thinks. One site should be able to accommodate all the various types of approaches.

    Edit/Point of correction- *On reflection, I'm inclined to categorize wealthiest (among us) as initially used as an indefinite pronoun referring to a group. However, as the grammatical name implies, the intent there was to refer to an indefinite group subject to varying interpretations.

  • msf said:


    When it [the Roth IRA] was conceived, there was no way for higher earners to contribute to Roths. Now there is.

    msf,
    Forgive me, what is that way?

    msf said:


    Just one word: backdoor.

    Follow the link. Here it is explicitly: http://www.rothira.com/what-is-a-backdoor-roth-ira

    Also, from Morningstar, 2015: "It has been five years since the income limits on IRA conversions were lifted, effectively putting Roth IRA investments within reach of higher-income individuals who had previously been shut out because they earned too much to make a direct contribution."

    Addressing possible discussion about my use of the word "contribute": the IRS term for these moneys is "conversion contribution". From Pub 590a:
    Converting From Any Traditional IRA Into a Roth IRA ... The amount that you withdraw and timely contribute (convert) to the Roth IRA is called a conversion contribution.
  • Oh, sure, conversions. I thought backdoor meant something fancier. Thanks. Yes, conversions have always been a way, and did get better than at the outset. Shoulda thought of that. See end for worse.

    @Hank, I am baffled that you keep agreeing and yet think there is disagreement. I say aftertax, and you say no, it's aftertax. Reading comprehension, or something

    >> You appear to have a lot of rich friends.

    No, did not say that either, was just citing a sample of the "wealthy".

    Too tiresome to continue. Roths were conceived not to be available to the wealthy. And there are ways around that, to an extent.

    And there were worse ways too; msf and some others may recall this:

    http://politicalconundrum.lefora.com/topic/8137920
  • edited July 2017
    Re - "Too tired to continue"

    Me too.:)

    Thanks @davidmoran You're a good sport.

    Regards
  • haha, don't get called that all the time here
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