Techniques for accounting for SORR during SEPP 72(t) withdrawals?

[FLBiker]

I've been modelling drawdown strategies, and I'm looking for advice on how best to account for SORR while doing SEPP 72(t) withdrawals.  DW and I will both likely use SEPP withdrawals as part of our drawdown strategy, which will force us to make regular withdrawals, regardless of market performance.  My thinking is that we'd convert a year withdrawal's worth of holdings in each impacted account into cash and, if markets are up, we'd sell holdings and withdraw that (leaving the cash alone).  If markets were down, we'd withdraw the cash (and leave the holdings alone), restocking the cash when the markets rebound.  Does this seem reasonable?  Are their any other approaches I should consider?  Thanks!

[reeshau]

Having an extra year in cash isn't going to help SORR; it's going to exacerbate it--if that cash is a non-productive part of the stache that you are calculating 4% from.  If you are accounting for it as an emergency fund, then yes that will help you get through down markets.  The average bear market is 289 days, although a number of them have gone on for more than 18 months.  Extra cash to give you an option for withdrawal can help you bypass that.

I would also say: a SEPP withdrawal doesn't make you spend it.  On withdrawal, you could also reinvest it in a taxable account.  So, you wouldn't necessarily have to have the cash in several different places; you could also accumulate it outside of your IRA's and have it in one spot.

[secondcor521]

In addition to the comment reeshau made, what you're describing is also market timing and has those disadvantages:  you're likely to be suboptimal in your choices about when to sell and when to refill, and you also might be stressed out about making those decisions.

On your question, there are several techniques to consider.

The easiest is what reeshau mentions:  Take the withdrawal but don't necessarily spend it.  There might be some tax inefficiency because you'd pay taxes on money you didn't need for some years...eh.

Another option is to consider a Roth conversion ladder.  Other than the hassle of priming the pump by having 4-5 years of spending available before starting, it is much more flexible than an SEPP program.  I was planning on SEPP for years before I read about Roth conversion ladders; I decided to switch because I already had the pump already primed.

You are allowed a one time switch to the RMD method.  So you can always do that if your IRA is getting small enough to worry about.  This means that you just are exposed to normal SORR risk and there is no additional risk because you happen to be doing an SEPP.

You can also have multiple SEPPs.  To do this you would need to split your IRA into multiple IRAs.  The technique I think that works best is to split your IRA into two:  a smaller IRA sized to provide you with the withdrawal amount you want based on the highest interest rate permitted, and a larger reserve IRA.  Start the SEPP on the smaller IRA.  If it's ever not enough spending-wise, then split the reserve IRA and start a second SEPP.  Lather, rinse, repeat.  If you want to get super complicated, each IRA can have a different SEPP:  different interest rate, different start date, different IRA size.  Since you're married, you can also obviously do this separately for both spouses - i.e., your spouse can have a different SEPP plan than you do.

The RMD method, while producing the smallest withdrawal relative to the size of the IRA, does get recalculated every year, so just using that method would help with the ebb and flow - smaller withdrawals after a bad year, larger withdrawals after a good year.  This creates another issue, which is to make sure your lifestyle is funded even in the down years.

Another general principle is to build up more margin.  I have a WR of 1%, so I don't worry about SORR.

[FLBiker]

a SEPP withdrawal doesn't make you spend it.  On withdrawal, you could also reinvest it in a taxable account.

This is very helpful, thanks!  It's obvious, but I hadn't really thought about it that way.  We're planning to keep a year (or perhaps even two) in cash to avoid having to sell (and, in our case, exchange currencies) at inopportune times, but of course we don't need to do that within our 403bs.  Thanks for pointing this out!

Another option is to consider a Roth conversion ladder.  Other than the hassle of priming the pump by having 4-5 years of spending available before starting, it is much more flexible than an SEPP program.  I was planning on SEPP for years before I read about Roth conversion ladders; I decided to switch because I already had the pump already primed.

Sorry -- I should have mentioned this: we're US citizens who moved to Canada (and became citizens).  Canada recognizes our Roths (which is great) but we can't contribute to them while resident in Canada so a Roth Conversion Ladder is off the table for us.

You can also have multiple SEPPs.  To do this you would need to split your IRA into multiple IRAs.  The technique I think that works best is to split your IRA into two:  a smaller IRA sized to provide you with the withdrawal amount you want based on the highest interest rate permitted, and a larger reserve IRA.  Start the SEPP on the smaller IRA.  If it's ever not enough spending-wise, then split the reserve IRA and start a second SEPP.  Lather, rinse, repeat.  If you want to get super complicated, each IRA can have a different SEPP:  different interest rate, different start date, different IRA size.  Since you're married, you can also obviously do this separately for both spouses - i.e., your spouse can have a different SEPP plan than you do.

Yes, I was planning to do this.  We've already got our accounts split up a bit (although I'll explore splitting them further) and I was only planning to start a SEPP on one of them (or one for each of us) at the beginning.  Regardless, that wouldn't be enough for all of our expenses, but we have other sources (e.g. 457bs, taxable accounts, etc.) that we'd make up the remainder with.  Thanks!

[secondcor521]

Another option is to consider a Roth conversion ladder.  Other than the hassle of priming the pump by having 4-5 years of spending available before starting, it is much more flexible than an SEPP program.  I was planning on SEPP for years before I read about Roth conversion ladders; I decided to switch because I already had the pump already primed.

Sorry -- I should have mentioned this: we're US citizens who moved to Canada (and became citizens).  Canada recognizes our Roths (which is great) but we can't contribute to them while resident in Canada so a Roth Conversion Ladder is off the table for us.

Roth conversions are not Roth contributions.

[Ron Scott]

I think the general approaches, that others are steering you towards here, are A) don’t NEED to spend the most your WR says you CAN spend, and B) don’t divest equities at a low just to fund living expenses.

Given you’ve avoided those death traps there are a number of avenues to walk.

[Telecaster]

I've been modelling drawdown strategies, and I'm looking for advice on how best to account for SORR while doing SEPP 72(t) withdrawals.  DW and I will both likely use SEPP withdrawals as part of our drawdown strategy, which will force us to make regular withdrawals, regardless of market performance.  My thinking is that we'd convert a year withdrawal's worth of holdings in each impacted account into cash and, if markets are up, we'd sell holdings and withdraw that (leaving the cash alone).  If markets were down, we'd withdraw the cash (and leave the holdings alone), restocking the cash when the markets rebound.  Does this seem reasonable?  Are their any other approaches I should consider?  Thanks!

IMO, trying to avoid selling when the markets are down is a little bit of a boogie man.   For one, how do you know when you are at the market top or bottom and it is time to fill the other bucket?   And the standard withdrawal strategy already does this automatically to a certain degree by simply rebalancing.   If markets are down at rebalance time and you are underweight stocks, you sell bonds and buy stocks.   

And philosophically, this is why the 4% "safe" withdrawal rate exists.  If you are withdrawing so much money you are pushing up against SORR then you are withdrawing too much.   

[Ron Scott]

IMO, trying to avoid selling when the markets are down is a little bit of a boogie man.   For one, how do you know when you are at the market top or bottom and it is time to fill the other bucket?   

Sure. We can’t talk about selling at a market “top or bottom” because these are unknown. I don’t rebalance personally, but that’s an option many thoughtful people find attractive. It’s all good.

However, we can discourage people from putting themselves in a position where they NEED to sell equities at a low just to fund their living expenses. Tools like asset allocation, asset location, emergency buckets, etc. can handle this.

[Telecaster]

However, we can discourage people from putting themselves in a position where they NEED to sell equities at a low just to fund their living expenses. Tools like asset allocation, asset location, emergency buckets, etc. can handle this.

Why do we need to discourage this?  Mathmatically, if you sell over time you will get the average market return over time.  Emergency buckets are an illusion because the emergency bucket is still part of your portfolio.  In reality, there is only one bucket:  Your portfolio. 

There are different ways to construct the bucket of course.  Historically, different bucket constructions have had different survival rates.  But there is no evidence that separating your finances into different buckets improves survivability, because again, in reality there only is one bucket.*

*It is useful to think of portfolio in buckets for tax reasons, but that's not what we're talking about here.   

[bacchi]

McClung, in Living Off Your Money, has done extensive back testing on which assets to sell for withdrawals. Historically, selling bonds works better than selling equities in a down market. The bond supply is then replenished in an exuberant market. This decreases the need to sell low and forces a sale of equities when the account holder is rolling in dough, usually when CAPE is high.

This is somewhat similar to what the OP suggested in the first post except for bonds instead of cash. Also, in case it's not clear, equities aren't sold for bonds when the market is merely up but when it's really up.

[DK]

I've been modelling drawdown strategies, and I'm looking for advice on how best to account for SORR while doing SEPP 72(t) withdrawals.  DW and I will both likely use SEPP withdrawals as part of our drawdown strategy, which will force us to make regular withdrawals, regardless of market performance.  My thinking is that we'd convert a year withdrawal's worth of holdings in each impacted account into cash and, if markets are up, we'd sell holdings and withdraw that (leaving the cash alone).  If markets were down, we'd withdraw the cash (and leave the holdings alone), restocking the cash when the markets rebound.  Does this seem reasonable?  Are their any other approaches I should consider?  Thanks!

I'm actually looking at starting one myself, it's at 5.61% i believe as long as its started this next month. My plan for SORR is to keep a years worth of withdrawal in cash equivalents, and then add to it monthly from stocks as long as market isn't >25% off its high. So basically a sinking fund to help not sell at the worst drops that come around at least every decade. Then also keeping in mind since a SEPP is fixed, the SWR is actually a lot higher than 4% since its not getting inflation adjusted every year.

[FLBiker]

Another option is to consider a Roth conversion ladder.  Other than the hassle of priming the pump by having 4-5 years of spending available before starting, it is much more flexible than an SEPP program.  I was planning on SEPP for years before I read about Roth conversion ladders; I decided to switch because I already had the pump already primed.

Sorry -- I should have mentioned this: we're US citizens who moved to Canada (and became citizens).  Canada recognizes our Roths (which is great) but we can't contribute to them while resident in Canada so a Roth Conversion Ladder is off the table for us.

Roth conversions are not Roth contributions.

I agree, but I'm not sure how these conversions are viewed by the CRA (in other words, if they consider them to "contaminate" the Roth IRA).  I'll do some more research on this.  Regardless, the priming the pump step might be dealbreaker since taxes are higher here.