How to withdraw in retirement mode

[Travis]

I'm sure this has been mentioned by MMM or others here, but I need some help looking for resources on what to do when you pull the trigger on FIRE with regards to setting up how you'll pay yourself from retirement funds.  Do you just turn on the dividends option on your funds or sell shares on a regular basis?  Do you pull equally from taxable and IRA accounts or is there an order/formula?

[Jags4186]

I'm sure people who have done this will give you a better answer but here is the basics for someone who will be living 100% off of investments before they are of retirement age:

Years 1-5: begin living off of your taxable accounts and Roth contributions (if you have them).  Your withdrawal rate will likely be much greater than 4% on your taxable account--that's okay because you're getting your other monies ready.

Years 1-5: begin rolling over from traditional IRAs to Roth IRAs. You will pay taxes on this conversion.   If you live on a low budget (say 25k/yr) you will pay very modest taxes on this roll over.

Year 6-death:  You can begin withdrawing your entire rollover amount from 5 years previous.


So in practice (ignoring investment gains/losses/inflation/taxes)

Person with $750,000 nest egg.  $125,000 in a taxable account.  $625,000 in IRAs.  25k/yr budget:

Year 1: withdraw $25,000 from taxable account.  Roll $25,000 from IRA to Roth IRA.
End of Year 1:  $100,000 in Taxable, $600,000 in IRA, $25,000 in Rollover Roth IRA

This * 5

Year 5: withdraw $25,000 from taxable account, rollover $25,000 from IRA to Roth IRA
End of Year 5:  $0 in taxable account, $500,000 in IRA, $125,000 in Rollover Roth IRA of which $25,000 is eligible to withdraw without penalty (as it has marinated for 5 years in the Rollover Roth IRA)

 

[Tyler]

It depends so much on your own personal situation that it's hard to generalize.  Taxes (including health premiums), portfolio, percentage split between taxable and tax deferred, and age will all change the recommendations.

I use a portfolio that's more about capital gains than dividends.  About 60% of my investments are in a taxable account, and I'm pretty far from IRS age to start collecting on my IRA.  Personally, here's my plan for the near to mid future:

1) Set all interest and dividends to go to cash and not automatically reinvest.  Live on those first.
2) Sell appreciated assets necessary to make up the difference between #1 and my actual expense needs. 
2a) I also us this process to rebalance my portfolio.  I make sure to keep the capital gains under the threshold to stay in the 0% LTCG tax bracket.  Free rebalance!  If necessary, I split the rebalance between two tax years (Dec and Jan).  Because my portfolio has diverse assets, tax loss harvesting is also an option.
3) If I have room left over under the tax threshold (or if I need more reportable income to qualify for ACA subsidies) I convert a chunk of IRA money to a Roth.  If you carefully manage your expenses/income, the taxes will be minimal and it will expand the money available to you 5 years later.

[Eric]

Here's a couple of blog posts that could help you decide how you'd like to tackle it:

http://jlcollinsnh.com/2014/08/25/stocks-part-xxvi-pulling-the-4/

http://rootofgood.com/roth-ira-conversion-ladder-early-retirement/

[Travis]

Thanks for the input.  I'm planning on two scenarios for my retirement.  First is a military pension at age 44 (I'm 35 now) that will take care of 80-90% of my retirement income.  The second is if I get passed over for promotion and get a prorated early retirement or a severance which means I'll have to work into my 50s.  Currently a third of my portfolio is in TSP with the rest in Vanguard in two Roth IRAs and a taxable account.  I've been looking up how to convert the TSP into the Roth so that I'll be living off of the Vanguard accounts.  If I get the pension things will be much easier, but I'm doing my homework now so if that if that doesn't happen I can figure out a game plan.  I'm really clueless about retirement-age tax planning and whether spending the stash down or redirecting dividends is the way to go.

[forummm]

Thanks for the input.  I'm planning on two scenarios for my retirement.  First is a military pension at age 44 (I'm 35 now) that will take care of 80-90% of my retirement income.  The second is if I get passed over for promotion and get a prorated early retirement or a severance which means I'll have to work into my 50s.  Currently a third of my portfolio is in TSP with the rest in Vanguard in two Roth IRAs and a taxable account.  I've been looking up how to convert the TSP into the Roth so that I'll be living off of the Vanguard accounts.  If I get the pension things will be much easier, but I'm doing my homework now so if that if that doesn't happen I can figure out a game plan.  I'm really clueless about retirement-age tax planning and whether spending the stash down or redirecting dividends is the way to go.

Some stuff on that in here: http://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

Also, spending dividends or reinvesting them and then selling shares later are essentially equivalent.

[Tyler]

Also, spending dividends or reinvesting them and then selling shares later are essentially equivalent.

That's absolutely right from a net profit perspective.  I personally like to not automatically reinvest dividends in retirement for tax purposes.  You already pay taxes on the dividends (depending on your tax bracket, of course), so you might as well use them for expenses.  Also, I like having the flexibility to also use the dividends to rebalance rather than automatically dump them back into the same fund, as that can sometimes save on capital gains taxes come rebalance time.  It's really just a personal preference.

[forummm]

Also, spending dividends or reinvesting them and then selling shares later are essentially equivalent.

That's absolutely right from a net profit perspective.  I personally like to not automatically reinvest dividends in retirement for tax purposes.  You already pay taxes on the dividends (depending on your tax bracket, of course), so you might as well use them for expenses.  Also, I like having the flexibility to also use the dividends to rebalance rather than automatically dump them back into the same fund, as that can sometimes save on capital gains taxes come rebalance time.  It's really just a personal preference.

With specific identification you can choose to sell the reinvested dividends first or last or whenever based on what works for your taxes. And you can rebalance by selling whatever is too high to fund your expenses. Especially once you are retired, the taxation issues from a taxable account are much less restrictive. You're right that it's largely a personal preference.

[seattlecyclone]

Tyler is right that this is something that depends a lot on your individual situation.

In our case, we'll probably have our money split roughly 50% taxable, 25% traditional retirement accounts, 25% Roth at the time of retirement. I expect we'll try to get our AGI as close to 200% of the federal poverty level as possible without going over (because the Affordable Care Act's cost sharing subsidies provide a great incentive to do that).

To that end, we'll likely sell stock from our taxable account (less appreciated shares first) to pay our living expenses. We'll then do Roth conversions to fill up any room that is remaining under the 200% of FPL threshold. If we run out of money in the taxable account, we'll start withdrawing Roth principal and continuing with Roth conversions.

As to your question about dividend reinvestment, I plan to leave that turned on. We'll need to sell some shares regardless, so we might as well have dividends reinvested until we're ready to spend them. As to Tyler's point about dividend reinvestment sometimes causing more capital gains taxes, that can be true, but when it is that means you made more money than if you left the dividend in cash instead of reinvesting it! I'm happy to pay more taxes if it means I have more after-tax money as well.

[forummm]

Tyler is right that this is something that depends a lot on your individual situation.

In our case, we'll probably have our money split roughly 50% taxable, 25% traditional retirement accounts, 25% Roth at the time of retirement. I expect we'll try to get our AGI as close to 200% of the federal poverty level as possible without going over (because the Affordable Care Act's cost sharing subsidies provide a great incentive to do that).

To that end, we'll likely sell stock from our taxable account (less appreciated shares first) to pay our living expenses. We'll then do Roth conversions to fill up any room that is remaining under the 200% of FPL threshold. If we run out of money in the taxable account, we'll start withdrawing Roth principal and continuing with Roth conversions.

As to your question about dividend reinvestment, I plan to leave that turned on. We'll need to sell some shares regardless, so we might as well have dividends reinvested until we're ready to spend them. As to Tyler's point about dividend reinvestment sometimes causing more capital gains taxes, that can be true, but when it is that means you made more money than if you left the dividend in cash instead of reinvesting it! I'm happy to pay more taxes if it means I have more after-tax money as well.

And, under current tax law, your long term capital gains would be taxed at 0% anyway. I don't know that this policy will continue, but taxes in retirement are pretty low if you're not a spendypants.

[seattlecyclone]

Tyler is right that this is something that depends a lot on your individual situation.

In our case, we'll probably have our money split roughly 50% taxable, 25% traditional retirement accounts, 25% Roth at the time of retirement. I expect we'll try to get our AGI as close to 200% of the federal poverty level as possible without going over (because the Affordable Care Act's cost sharing subsidies provide a great incentive to do that).

To that end, we'll likely sell stock from our taxable account (less appreciated shares first) to pay our living expenses. We'll then do Roth conversions to fill up any room that is remaining under the 200% of FPL threshold. If we run out of money in the taxable account, we'll start withdrawing Roth principal and continuing with Roth conversions.

As to your question about dividend reinvestment, I plan to leave that turned on. We'll need to sell some shares regardless, so we might as well have dividends reinvested until we're ready to spend them. As to Tyler's point about dividend reinvestment sometimes causing more capital gains taxes, that can be true, but when it is that means you made more money than if you left the dividend in cash instead of reinvesting it! I'm happy to pay more taxes if it means I have more after-tax money as well.

And, under current tax law, your long term capital gains would be taxed at 0% anyway. I don't know that this policy will continue, but taxes in retirement are pretty low if you're not a spendypants.

Just to clarify, capital gains are most certainly not tax-free for any year in which you plan to purchase health insurance through your state's ACA exchange. They increase your MAGI and therefore decrease the tax credit you get to help pay for insurance. Just because the base tax rate on this type of income is 0% doesn't mean that you'll experience no change in your net tax bill by having this income.

[Scandium]

I'm sure people who have done this will give you a better answer but here is the basics for someone who will be living 100% off of investments before they are of retirement age:

Years 1-5: begin living off of your taxable accounts and Roth contributions (if you have them).  Your withdrawal rate will likely be much greater than 4% on your taxable account--that's okay because you're getting your other monies ready.

Years 1-5: begin rolling over from traditional IRAs to Roth IRAs. You will pay taxes on this conversion.   If you live on a low budget (say 25k/yr) you will pay very modest taxes on this roll over.

Year 6-death:  You can begin withdrawing your entire rollover amount from 5 years previous.


So in practice (ignoring investment gains/losses/inflation/taxes)

Person with $750,000 nest egg.  $125,000 in a taxable account.  $625,000 in IRAs.  25k/yr budget:

Year 1: withdraw $25,000 from taxable account.  Roll $25,000 from IRA to Roth IRA.
End of Year 1:  $100,000 in Taxable, $600,000 in IRA, $25,000 in Rollover Roth IRA

This * 5

Year 5: withdraw $25,000 from taxable account, rollover $25,000 from IRA to Roth IRA
End of Year 5:  $0 in taxable account, $500,000 in IRA, $125,000 in Rollover Roth IRA of which $25,000 is eligible to withdraw without penalty (as it has marinated for 5 years in the Rollover Roth IRA)

This is a good explanation, except you have to remember that the withdrawal, and thus the rollover, has to account for 5 years of inflation. So really it should be $25,000 * 1.03^5. Or whatever percentage you assume for inflation

[forummm]

Tyler is right that this is something that depends a lot on your individual situation.

In our case, we'll probably have our money split roughly 50% taxable, 25% traditional retirement accounts, 25% Roth at the time of retirement. I expect we'll try to get our AGI as close to 200% of the federal poverty level as possible without going over (because the Affordable Care Act's cost sharing subsidies provide a great incentive to do that).

To that end, we'll likely sell stock from our taxable account (less appreciated shares first) to pay our living expenses. We'll then do Roth conversions to fill up any room that is remaining under the 200% of FPL threshold. If we run out of money in the taxable account, we'll start withdrawing Roth principal and continuing with Roth conversions.

As to your question about dividend reinvestment, I plan to leave that turned on. We'll need to sell some shares regardless, so we might as well have dividends reinvested until we're ready to spend them. As to Tyler's point about dividend reinvestment sometimes causing more capital gains taxes, that can be true, but when it is that means you made more money than if you left the dividend in cash instead of reinvesting it! I'm happy to pay more taxes if it means I have more after-tax money as well.

And, under current tax law, your long term capital gains would be taxed at 0% anyway. I don't know that this policy will continue, but taxes in retirement are pretty low if you're not a spendypants.

Just to clarify, capital gains are most certainly not tax-free for any year in which you plan to purchase health insurance through your state's ACA exchange. They increase your MAGI and therefore decrease the tax credit you get to help pay for insurance. Just because the base tax rate on this type of income is 0% doesn't mean that you'll experience no change in your net tax bill by having this income.

Very good point. Thanks for the reminder.