19/20. Converting your nest egg into income.

19/20. Converting your nest egg into income./4% withdraw rate.


So you have spent most of your working life (Hopefully) accumulating retirement savings. Now you need to turn this nest egg into a stream of income. You will need a budget (See post # 3 make a budget) so you can determine how much income you will need in retirement. You will also need to know how much you will receive monthly in Social Security and Pension income. Subtract the SSI and Pension total from your budget and that is your goal minimum. Ideally you would be able to meet that goal with an interest stream coming from your portfolio. I will discuss how to do this below. You may also have to withdraw some of the principle in your portfolio if you can not meet your monthly goal from SSI, pension, and investment interest alone. 


The conventional wisdom says you should not withdraw more than 4% of your portfolio a year. 4% plus an annual adjustment for inflation should allow you to retire at a ripe old age and not run out of money. In my opinion 3% is a safer rate and it allows you some leeway if medical bills or emergency home repairs rear their ugly heads.


To maintain tax efficiency you want to tap your taxable accounts first.
This allows the tax sheltered accounts to grow unfettered. Next you should tap your traditional IRA/401k so your Roth has a greater chance for tax free growth. If you are retiring early keep in mind that 401k/403b's can be tapped at age 55 and Roth/IRA's at age 59.5. This is one of the only reasons not to consolidate your accounts to Roth/IRAs to get lower fees. If you are danger of being bumped into a higher tax bracket you may want to tap your Roth IRA to keep your income below that bracket.


Let's get into making adjustments so you can start living on your retirement portfolio.


Bond ladders - A bond ladder is a collection of bonds that mature at a regular pace. To make a ladder divide your money by 5 and put the first 5th in a bond that matures in 5 years . The second 5th in a 4 year bond. The third 5th in a 3 year and so on. When the 1 year bond comes due put that money in a new 5 year bond. When the 2 year bond comes due put that money in a new 5 year bond and so on. After 5 years of this you will have five 5 year bonds. This is a bit of an oversimplification. You will most likely buy a basket of bonds. You can also spread the ladder over ten years if the yields work out better. The interest from this ladder should dump into another account such as a checking or money market account.


CD ladders - You can apply the same laddering technique to CD's. A CD ladder would be a little safer. So I might mix the two types to manage risk.


Annuities - There are so many types of annuities out there. Most of them are way too expensive and are a bad fit for 99% of investors. That said there may be room in your portfolio for an Immediate Annuity. Basically you give an insurer a lump sum and they pay you a monthly income for life. The fees from annuities can range from 1.5-6% which breaks my 1% rule. Plus annuities are insurance products so they are not currently regulated. So you will probably never know how much you are actually paying. If the insurer goes out of business you will loose your monthly check and the lump sum you already parted with. Too many downsides for me.


You will want to change your reinvestment settings. When you are working you should have any dividends reinvested into the same stock, ETF, or mutual fund to help compound your growth. In retirement you can redirect this dividend stream to another account such as a checking or money market account. The key is liquidity or immediate access. 


To wrap this up, your income in retirement will come from the following sources.

1.  Social Security 
2.  Pensions
3.  Interest stream from investments and ladders
4.  3% of your total portfolio  

          a. Taxable investments 

b. Traditional IRA/401k/403b

c. Roth IRA/401k/403b

In that order. If you do not need to tap #3 or #4a-c you will be able to retire comfortably and pass on your nest egg!  But if you do you tap all of the above you still have very good chance of retiring comfortably.




Sources
http://www.investopedia.com/terms/f/four-percent-rule.asp#axzz1sp3P7gff

www.ssa.gov

18. When to take Social security.

18. When to take Social security.


You basically have three choices. Take it early. Take it at "full retirement age". Wait until you're 70. The general rule is to wait as long as possible. That way you get the largest total benefit over the coarse of your life. But if you have a hard time making your bills without the benefits, Are in poor health, or you are the lower earning spouse and your spouse can wait for a higher benefit. Then you are a good candidate for early benefits. You should probably wait if you are still working, In good health with longevity running in your family, Or are the higher earning spouse and want to leave the largest possible benefit for your spouse. Here is a chart showing who is eligible when.

If you were born in ...	Your full retirement age is ...
1937 or earlier	65
1938	65 and 2 months
1939	65 and 4 months
1940	65 and 6 months
1941	65 and 8 months
1942	65 and 10 months
1943-1954	66
1955	66 and 2 months
1956	66 and 4 months
1957	66 and 6 months
1958	66 and 8 months
1959	66 and 10 months
1960 or later	67

The earliest you can start receiving Social Security retirement benefits is age 62. If you start your retirement benefits at age 62, your monthly benefit amount is reduced by about 30 percent.

• 63 is about 25 percent;
• 64 is about 20 percent;
• 65 is about 13.3 percent; and
• 66 is about 6.7 percent. 

If you delay taking Social Security benefits beyond the full retirement age they are increased by a certain percentage (depending on date of birth). The benefit increase no longer applies once you reach age 70.

Year of Birth*	Yearly Rate of Increase	Monthly Rate of Increase
1933-1934	5.5%	11/24 of 1%
1935-1936	6.0%	1/2 of 1%
1937-1938	6.5%	13/24 of 1%
1939-1940	7.0%	7/12 of 1%
1941-1942	7.5%	5/8 of 1%
1943 or later	8.0%	2/3 of 1%
Note: If you were born on January 1st, you should refer to the rate of increase for the previous year. *

This chart helps you visualize the different retirement age scenarios,



^


The different types of Social Security claims are

• Personal benefits are when you receive SSI benefits based on your work record. 

• Spousal benefits are when your receive benefits up to 50% of your Spouses work record. If both spouses are enrolled in the SSA system you can take either your benefit or up to 50% of your spouses benefit. Whichever is greater. Taking a Spousal benefit does not affect what the higher earning Spouse will receive under their own Personal benefit. Divorce complicates things some. Under certain conditions you can apply for 50% of an Ex-Spouses benefits. Please check with http://ssa.gov for more info.

• Disability benefits can be applied for anytime you become disabled for longer than 12 months and can no longer work. You must be "insured" meaning that you have worked and contributed to your SSI for a certain minimum amount of time. These are on a case by case basis so again I need to refer you to http://ssa.gov for more info.

• Death benefit - A surviving widow or widower may be eligible to receive a special death benefit payment of $255.00 on the worker's record. This payment can be made only once to a spouse or minor children who meet certain requirements.
  

• Survivor benefits is most commonly when you receive your deceased spouses benefits because it is larger than yours. Again, So many options and permutations. Please visit http://ssa.gov for more info.

62/70 split - There are ways to maximize your benefits as a married couple. Here is one example. Let's say that a retired couple are both 62 and only the man worked enough to qualify for SSA personal benefits. They both apply for benefits but then the husband suspends his payments. This allows for a larger check for him the longer he waits. This also qualifies his wife for up to a 50% Spousal benefit since he is now in the system. She gets the largest possible benefit she could get and by waiting until 70 he gets the his largest total benefit possible. If the man waits to apply for SSA benefits until 70 his wife can not receive benefits until then due to her lack of a work record.

It's little known that your medicare premiums part B&D and taxes are withheld from your gross amount. So the amount you see on your SSA statement might not be what you actually get. If you take your benefits early thinking that you can make it on the reduced amount you may be in for a big surprise at age 65 when Medicare kicks in.


When you take your SSI benefits you have a year to change your mind. You will need to repay all of your benefits to reset your benefit calculations. You can only change your mind once though. Another option is to just suspend your benefits. Your payment amount will grow as long as you wait.

Sources
 * http://ssa.gov
 
^ http://www.schwab.com/public/schwab/resource_center/expert_insight/retirement_strategies/planning/when_should_you_take_social_security.html 

 http://www.cbsnews.com/8301-505146_162-51396960/when-to-take-social-security-benefits/

17. Challenges of retiring early.

17. Challenges of retiring early.

Let's say you have saved $600,000 by age 55 and you are thinking about retiring early. Let's discuss the challenges of this approach.  

Savings Calculator - This should be your first step. Run your numbers through a couple of online retirement calculators to see if they think you can retire early. CNN/Money has a great one. AARP and Fidelity are good as well. Run them all and get a good concensus.

Health insurance - This is a biggie. If you can not wrangle your Health insurance, retiring early will be a huge challenge. You are not eligible for Medicare until age 65 (currently). So that leaves 9.5 years that you need to cover your own health coverage. Consider using a high deductible health plan paired with a tax differed HSA to get you through this period. If you are self employed you are already familiar with these challenges. Ironically it may be easier to pull the trigger and retire early if you are self employed.


Less Tax sheltering - If you stop working and have no earned income you can not participate in an Roth/IRA. The US government considers earned income as Wages, Salary, Tips, Union strike benefits, Long term disability, and Net earnings from self employment. This means your tax differed accounts must carry themselves with growth and dividends alone. Obviously you will no longer be able to participate in your 401k/403b once you retire. This means your only tax shelters left are tax exempt bonds and annuities. I hate annuities. They are an insurance product so they are not regulated by the SEC and have no guarantee either. If the insurance company goes out of business kiss your money goodbye! More on the evils of annuities in a future post.

4% withdraw rate - The rule of thumb for a withdraw rate retiring at age 65 is 4%. This should allow you to make it to age 100 without running out of money. If you retire early this percentage has to drop. If you can live on 2%-3% of your portfolio at age 55 then you might be a good candidate for early retirement.

Social Security - Currently you can start receiving (reduced) SS benefits at age 62. This will probably be increased to 63 or 64 very soon. If you want to make sure you get your full benefits you currently have to wait until age 65-66 depending on the year you were born. Can you live on only your money for 9.5 years?

You are not eligible to withdraw from your Roth/IRA - Until you hit age 59.5 you can not touch your Roth/IRA accounts. If you do you will be hit with ordinary income taxes plus a 10% penalty. That leaves you 4.5 years before you should take any money from your Roth/IRA accounts. You can start withdrawing from your 401k/403b at age 55. This is one of the only arguments for waiting to roll-over your 401/403b into your IRA. Can you live on your regular savings/brokerage and 401k/403b accounts for 4.5 years? 


The exception - Internal revenue code 72(t)(2)(a)(iv) - There is a way to start tapping your Roth/IRA before age 59.5. You must take "substantially equal periodic payments." To be honest this option gets me a little nervous. If I were to employ the 72t option I would use my accountant to help me through the details. I have included some sites that do a better job explaining 72t than I ever could.


http://www.retireearlyhomepage.com/wdraw59.html
http://www.section72.com/html/72_t_.html
http://www.irs.gov/pub/irs-drop/rr-02-62.pdf

16. Adjust your asset allocation as you age.

16. Adjust your asset allocation as you age.

As you age you will need to adjust your asset allocation. When you get closer to retirement you want to ratchet down risk and build up your stable investments. If you experience a set back in your 20's you have plenty of time to recover. If you get hit in your 60's it will lower the income you have in retirement. You may even have to work longer. 

Since I have a slightly above average risk tolerance I set my stable investments to my age. I let it get a little equity heavy as I progress until I hit the 5th year of that tolerance level. I do this to add a little bit of risk tolerance to my portfolio. I am 41 years old and my current asset allocation is 60% Equities and 40% Stable investments. I will keep this allocation until I hit 45. 

At age 45-50 my asset allocation will be 55% Equities and 45% Stable.
At age 50-55 my asset allocation will be 50% Equities and 50% Stable.
At age 55-60 my asset allocation will be 45% Equities and 55% Stable. 
At age 60-65 my asset allocation will be 40% Equities and 60% Stable. 
At age 65-70 my asset allocation will be 35% Equities and 65% Stable. 
At age 70-75 my asset allocation will be 30% Equities and 70% Stable. 
At age 75-80 my asset allocation will be 25% Equities and 75% Stable. 
At age 80-85 my asset allocation will be 20% Equities and 80% Stable. 
At age 85-90 my asset allocation will be 15% Equities and 85% Stable. 
At age 90-95 my asset allocation will be 10% Equities and 90% Stable. 

When you re-balance your portfolio it's a great time to check your asset allocation and adjust for your increasing age. Your risk tolerance may change over time as well. The rule of thumb is to set your stable investments to match your age. If you have more risk tolerance you can subtract 10% from your age, If you are more pessimistic about equities you can add 10% to your age. These are extremes in risk tolerance. I would not in percentage exceed + or - 10 of your age. 

In your 50's you may want to start trading in bond funds for individual bonds. The reason for doing this is that individual bonds have a face value that you can count on. A bond fund can theoretically lose all of its value. Individual bonds add even more stability to your stable investments. Some financial advisers prefer individual bonds for life. While this would be ideal, the individual bonds would require more homework or an adviser who is adept at bond picking. More on using a financial adviser when nearing retirement in future posts.

15. Save for your goals.

15. Save for your goals. Down payment on a house. college fund for your kids. Vacation of a lifetime. etc....
 
Let's say you want to save for a down payment on a house and save for your child's college education. The college savings is a long term goal and the down payment is a short term goal.

Go to your companies payroll dept or person and ask to redo or update your direct deposit form. Have two predefined amounts deposited in two separate accounts. The Down payment savings should go to a liquid savings account that has as good of an interest rate as possible. I would use an online savings account for this. You should be able to find 2% out there. Check bankrate.com for the best interest rate. The college fund should go to a 529 tax exempt education savings plan. The 529 is tax advantaged so it's the obvious choice for educational goals. More on 529's in a later post. 

If your goal was more than 5 years out and not educational I would recommend using your online brokerage account. That way you could invest the money long term. 

For the self-employed. You need to treat these monthly savings goals as if they were bills. Put the monthly amount and the goal down in your budget. You can use an online bill pay service to set up regular monthly deposits. It's as close to auto-pilot as you can get while self-employed.

If you have a specific amount as a goal lets say $2000 in two years. Divide 2000 by the number of pay periods between now and then, in this case it's 52. That gives you $38.46 or $39 deducted from each paycheck. You can redirect multiple amounts to multiple accounts. You won't even notice it's gone. This is how I fund my wife's Roth IRA. The self-employed divide 2000 by 24 months which gives you $78. Pay $78 per month to your goal account as if it were a bill.

Looking at your goals totals can be overwhelming. Breaking them down to small monthly chunks makes it much easier. If you can save for those goals on auto-pilot, even better.

14. Open an online discount brokerage account.

14. Now that all of your tax shelters (Roth/IRA 401k/403b) are maxed out open an online discount brokerage account.


Once you are sufficiently saving for retirement by maxing out your tax shelters, It's time to open a taxable brokerage account. For convenience I have one at the same place I keep my Roth/IRA. This is a great place to invest money that would otherwise sit idle in a bank account (Not your emergency fund!). It's also a good place to put any found or sudden money. As always, Watch those fees!


Tax efficiency - There is another way to think about diversification when using a brokerage account. If you put tax advantaged investments in your taxable brokerage account you can free up potential in your non-taxable Roth/IRA or 401k/403b. Since Treasuries or Municipal bonds are already tax exempt you could hold these types of investments in a taxable brokerage account. 


I am not quite there yet but I do have a brokerage account just in case. My Roth IRA is maxed out but until my 403b is maxed out I won't touch the brokerage account. I am ready for any found money though!

13. Re-balance annually.

13. Re-balance annually. 


Every year you need to re-balance your investments. Don't forget to adjust your asset allocation as you age (See steps 12a-12c). Use this adjusted allocation as your goal. Your Birthday or the New year are great cues to remind you to re-balance. 

Re-balancing means selling issues that you are overweighted in. You then buy into investment classes that you are underweighted in. For a simple example let's say I set my Small Cap allocation to 5% of my portfolio. Last year that grew to 7%. I also set my international stock fund to 5%. Last year it fell to 3%. To keep my investments in line with my asset allocation I should sell 2% of the Small Cap fund and buy 2% of the international fund. This forces you to sell high and buy low.


Keep in mind the 1% rule of expenses. If it would cost more than 1% to re-balance don't bother. This happens in the beginning of your investment life. Values are so small it doesn't make sense to sell. In this case you want to buy into balance. This is done by monthly buying into the class you are lowest in until you hit your allocation in that class. Then move on to the next lowest class. 

Here is an example of a 50 year old with a little over 100k invested. With a $4.00 transaction fee you can move up to $400.00 at a time. If you are out of balance by less than that, It is not worth the fee to re-balance that class.

Age 50 Mortgage 90% payed off	Old total	Sell	Buy	Fee	New total	Goal
7% Large Cap stock fund	6,500.00		500.00	4.00	7,000.00	7,000.00
6% Mid Cap stock fund	7,256.00	1,256.00		4.00	6,000.00	6,000.00
6% Small Cap stock fund	8,400.00	2,400.00		4.00	6,000.00	6,000.00
10% International stock fund	7,400.00		2,600.00	4.00	10,000.00	10,000.00
6% Growth stock fund	6,050.00				6,050.00	6,000.00
7% Value stock fund	6,223.00		756.00	4.00	6,979.00	7,000.00
8% Emerging market stock fund	8,500.00	500.00		4.00	8,000.00	8,000.00
5% US bond fund	4,100.00		900.00	4.00	5,000.00	5,000.00
10% TIPS bond fund	11,700.00	1,700.00		4.00	10,000.00	10,000.00
7.5% International bond fund	6,400.00		1,100.00	4.00	7,500.00	7,500.00
7.5% Corporate bond fund	7,300.00				7,300.00	7,500.00
5% Cash in a Money market	5,025.00				5,025.00	5,000.00
5% CD's	4,000.00				5,000.00	5,000.00
10% Real estate value	10,000.00				10,000.00	10,000.00

I have an asset allocation excel spread sheet starter I can email you if you like. You plug in your numbers and it will do the math for you. Just drop me a line at thefettler@yahoo.com