Asset Sequencing Retirement

A retirement planning tool is only as good as its assumptions and inputs. Share your thoughts or ask questions about the internals of the simulation, built in planner assumptions, or planner inputs.
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gg80108
Posts: 9
Joined: Sat Oct 18, 2014 3:07 pm

Asset Sequencing Retirement

Post by gg80108 »

I am 63 taking social security and retired, no other income. I have Cash, NQ brokerage account and IRA Account.
I dont want to pay taxes on our Social Security(till we have too) but figured if I used cash to supplement my social security until the RMDs kick in ,age 70, then use the investment money, might solve the problem.

The NQ brokerage account is set up for growth and dont expect much taxable dividend income there.

Our requirements are $90k a year,, social security is 40k and 60k has to come from somewhere else (cash). We do have more then enough cash to kick in 60k a year for 7 years. The NQ brokerage has about $500k and the IRA accounts have $1.5m.
(if the market sucks for the next 7 years we might have to use the cash anyway)

Wanted to run some numbers to verify spending ones cash first is better then drawing on the brokerage accounts right away..

Need help on where to put the inputs.. Didnt see an option on the payouts to use the cash first or what category cash goes into.

Seems like this is what it looks like annually
years 1-7 $40k social security + $60k cash = 100k
years 8- $40k social security + $60k portfolio(RMDS min+ NQ funds = 100k

txs
Don

jimr
Posts: 580
Joined: Thu Feb 28, 2008 6:48 pm

Re: Asset Sequencing Retirement

Post by jimr »

My sense is that you're trying to measure a difference that's smaller than the resolution of the tool. It's kind of like trying to gap a spark plug with a tape measure.

Spending from only the cash part of your holdings will result in a smallish increase in the overall risk level of your total portfolio each year, compared to taking withdrawals so that your combined asset allocation (including cash) stays steady. After 7 years, with the cash only draw down approach, you'll have a more risky overall portfolio (all things equal) compared to withdrawing cash and rebalancing the overall portfolio after withdrawals each year.

So really, this is a little like to comparing the results of a moderate risk portfolio vs a high risk portfolio. The high risk portfolio may show 'better' results in terms of probability of success or ending portfolio value. However those better results likely come with greater uncertainty, because the model is less robust with higher risk portfolios since the true risks of unexpected bad things happening are tougher to model (the so-called fat tails problem).

To put try some numbers with this, I set up a plan with the following inputs:

current age=63,
retirement age=63

taxable portfolio=$1M
tax deferred portfolio=$1.5M

Investment Style: Moderate
Spending Policy: Stable

annual retirement income: $40k
income start age: 63
annual retirement spending: $100k

Blending the cash with the rest of the taxable portfolio is roughly equivalent to spending down the cash and portfolio assets together, keeping the overall asset allocation and risk level steady.

With these inputs, I ran the planner.

Next, to very roughly simulate holding the cash balance and not spending it, which results in an lower overall taxable portfolio risk, I the I clicked additional inputs and added an entry to the top table as follows:
Taxable Return, start=Start of Plan, end=Age 70, rate=6.0%, std dev=4.3%

This sets the return of your taxable portfolio (NQ brokerage + cash) to only 6% to account for the higher amount of cash compared to if you spent the cash down.

I ran the planner again, and clicked 'Show all runs' on the main page to see the results from the two different tests.

The difference turned out to be very small. The ending portfolio balance was between $3.478M and $3.679M and the probability of success ranged from between 98.0% and 99.2%. IMO, that's well inside the planner's margin of error, so realistically, these results aren't meaningfully different.

Still, it's an interesting experiment. You might also want to test what happens if you delay social security payments until a later age. I've read that before age 70, delaying benefits can be a good bet for some people.

Hope that helps,

Jim

gg80108
Posts: 9
Joined: Sat Oct 18, 2014 3:07 pm

Re: Asset Sequencing Retirement

Post by gg80108 »

Txs,, this is making things clearer. Think the first aha is that the "Taxable Account" designation, in reality it should be "Maybe Taxable Account", since depends on the basis of the asset on withdrawals.. Though taxable account is the common term...

Is there a way to represent the cash in the Taxable Account better, since "cash" now days pays close to nothing (and is 25% of the taxable portfolio and no way making the returns of the Investing STyle), and will remain part of the re-balancing strategy..
In the Investing Styles, Cash should be a position in the mix(IMHO). One retiring cannot afford the risk (if u can) of having all your assets in the market, if you are not working anymore.

Inflation setting
How is the inflation input taken into account? Usually one sees the expenses go up by the inflation amount, but one hopes to offset this with market positions in the Taxable Account, so is this really wash?

This little exercise of keeping our Social Security non taxable till the RMDs kick in, will save me $8500 on taxes annually with $1000 savings on Obamacare, which is significant at least to me.

Don

jimr
Posts: 580
Joined: Thu Feb 28, 2008 6:48 pm

Re: Asset Sequencing Retirement

Post by jimr »

gg80108 wrote:Think the first aha is that the "Taxable Account" designation, in reality it should be "Maybe Taxable Account", since depends on the basis of the asset on withdrawals.. Though taxable account is the common term...
This is another area where the model trades precision for simplicity. The model carries the taxable portfolio at a 100% basis. Each year, all gains are taxed at 100%. This is obviously a huge simplification, but you can adjust for it by 1) reducing your portfolio balance by the taxes that will eventually be due on unrealized gains or 2) adjusting the investment tax rate. Since taxes are complex, different for each investor, and highly changeable, it didn't make sense to go crazy with precision here.
Is there a way to represent the cash in the Taxable Account better, since "cash" now days pays close to nothing (and is 25% of the taxable portfolio and no way making the returns of the Investing STyle), and will remain part of the re-balancing strategy..
In the Investing Styles, Cash should be a position in the mix(IMHO). One retiring cannot afford the risk (if u can) of having all your assets in the market, if you are not working anymore.
The investment styles are rough guesses for getting started. In reality, accurately predicting future rates of return and assessing overall portfolio risk is an art unto itself. This is well beyond the scope of a tool like this, which is why I included the custom option.

Once you've done a basic initial analysis, using custom and plugging in values for return and standard deviation based on your asset allocation and predictions of future results makes more sense. If you use an investment advisor or service, they should be able to give you good numbers to plug in here, based on your asset allocation (including cash), risk tolerance, and any economic prediction models they use. If you're investing on your own, you'll probably want to do some googling to try to come up with suitable values appropriate for your circumstances.
How is the inflation input taken into account? Usually one sees the expenses go up by the inflation amount, but one hopes to offset this with market positions in the Taxable Account, so is this really wash?
The essential thing is that all dollar amounts reported by the planner are shown in today's value dollars. For example, in a given scenario the tool may show an ending portfolio value of $3m. That $3m is a real value and not a nominal one, which means it has the same purchasing power as $3m has today. In nominal terms, the balance could be closer to $4m or $5m, depending on the cumulative inflation over the life of the plan.

A good way to visualize this is to set the spending policy to stable and zero out the 'Annual Retirement Spending' field on the main window. Then, in the bottom table of additional inputs, create an 'other expenses' cash flow starting at retirement and ending at the end of plan. Use the 'No Cola' option (no cost of living adjustment ). Run the planner and look in the detailed output tab at the year to year spending amount. You'll notice the annual spending amount decreases in real value by the inflation rate each year. Next, edit the cash flow entry you created in additional inputs and set the Cola type to 'Track Inflation'. Run the planner again and this time in the detailed output tab, you'll see that the annual spending amount stays constant each year to indicate that the spending amount is exactly keeping up with inflation.

Please keep the questions coming. I'm sure others will read through this thread and benefit from the time you took to write up your questions.

Jim

gg80108
Posts: 9
Joined: Sat Oct 18, 2014 3:07 pm

Re: Asset Sequencing Retirement

Post by gg80108 »

I was experimenting with my Turbo Tax to get some ballpark numbers for the Income Tax Rate input, TT gave me two numbers, Effective tax rate 8.57% and Tax Bracket 15%.. Which should I use for the Income Tax Rate input?

Was also looking at the columns detailed view to find the $40k of Annual Retirement income I entered, but did not readily see a column for this. Is it combined some where?

Don

jimr
Posts: 580
Joined: Thu Feb 28, 2008 6:48 pm

Re: Asset Sequencing Retirement

Post by jimr »

gg80108 wrote:I was experimenting with my Turbo Tax to get some ballpark numbers for the Income Tax Rate input, TT gave me two numbers, Effective tax rate 8.57% and Tax Bracket 15%.. Which should I use for the Income Tax Rate input?
I'm not familiar with the Turbo Tax tool, but my guess is that effective tax rate is what you want. That's most likely your average tax rate. The tax bracket or marginal tax rate wouldn't be good to use since that indicates the amount of additional tax you'll owe on an additional dollar of income beyond your current income.
Was also looking at the columns detailed view to find the $40k of Annual Retirement income I entered, but did not readily see a column for this. Is it combined some where?
The after tax amount should be displayed in the column 'After Tax Income'.

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