The Draw(down): Decumulation in Retirement

Four more years, four more years …. No, it’s not a political campaign but four (or less) more years until my retirement. Sure, I’m getting a little excited about the concept but there is so much to consider. It might seem like I’m a little early writing an article on the topic but it’s never to late to create a high-level plan. This is especially true considering my investment portfolio should double in the next 4 years thanks to an expected high savings rate (60%+).

With so much new cash coming into my investment portfolio before retirement, I consider this an opportunity to develop a high-level plan and accumulate assets that serve the plan. My hope today is to create a framework, identify my income streams, and begin sorting through some important contributing topics. It’s critical to know that what I create today will very likely change by the time I retire in 4 years. But you have to start somewhere and this is a good checklist of items to identify (though the list will grow).

A good starting point will be what my assets should look like in 4 years. Since I received a promotion at work this year, I’ll make some changes that lift all buckets but we’ll use this as the basis for now. Honestly, I’d suspect that I’ll end up with approximately $1,400,000 in investment assets when I’m done. These assets don’t include my 1-payment away debt free home ($450,000) or an estimated value of my $73,000 annual employer pension (valued around $1.7M).

Only half-way through the year, my portfolio currently stands at about $710,000. This puts me about $10,000 ahead of my year-end goal with still half the year remaining.

New (old) forecast – I will make some upward changes at year-end 2021 due to a promotion at work

Income Streams

Probably the best place to start this conversation, other than knowing what my assets (above) might look like, is knowing my income stream sources. We anticipate that our essential expenses (food, housing, transportation, etc…) will run us about $55,000 yearly and discretionary expenses to be about $30,000-$40,000. All told, we’ll assume about $100,000-$110,000 needed to include taxes between the ages of 62-70 years old.

The two charts below are the beauty of my guaranteed income floor. They include pensions, social security, and retiree health benefits. I’ve run the numbers and this easily covers all of my essential expenses. It’s my hope that the investment portfolio is where I cover my discretionary (fun) expenses. As I’ve said nearly 100 times so far on this blog, I’m very blessed to have a fully funded single employer pension and retiree healthcare benefits too.

Anticipated Guaranteed Income Without Drawing From My Investment Portfolio
Guaranteed Income Floor with No Investment Portfolio Draw
Employer Pension

By the time I retire and after nearly 27 years of employment, I’ll be blessed with a company pension that will pay about $73,000 annually. It’s doesn’t have a cost of living adjustment so the day I draw from it both my wife and I will receive lifetime income. Using the Charles Schwab annuity calculator, I’d need about $1,700,000 to create that kind of guaranteed income with an annuity. It’s a fantastic income floor that will cover our essential expenses for nearly 10 years (assuming 3% inflation). The beauty is that’s right when my social security will kick-in at 70 years old.

Social Security

Because of our pension, I’m definitely able to delay taking social security until 70 years old. As a one-income household, delaying my social is important and waiting has benefits. First, my social security is estimated to be about $46,000 annually at 70 versus $38,000 (at 67) or $26,000 (at 62). As important as that is, my wife’s social security (which she’ll take at 62 before converting to 1/2 of mine) will only be $6,000 annually. So, when I take mine at 70 for about $46,000, hers will jump to $23,000. Finally, in the case of my death before hers, she can jump to taking my social security at $46,000.

As you can see, there are several reasons for me to delay until 70. My pension and social security will cover nearly all of our essential expenses for the rest of our lives unless we want to really crank up the discretionary spending. This high income floor provides a lot of peace of mind.

Taxable Dividends (Stocks, Bonds, Etc…)

These are funds in my quickly growing taxable account. Once I’m debt free (targeted for 7/30/21), my savings rate will soar to over 60%+ from it’s current 40%-50% range. With my work promotion (increase in base pay and bonuses), this taxable account should grow in the next 4-years to over $500,000.

For the next 4-years, this account will receive a majority of my free cashflow.

I’d like to think I can generate $15,000-$20,000 in dividends and interest without taking too much crazy risk. Though growth and income will be important to this taxable portfolio, income will be it’s primary purpose.

Other Pensions

Between my wife and I, we’ve got another $2,500 annually from two small pensions that pay at 65 years old. Every bit of income helps so we aren’t dismissing anything. $2,500 annually is like having $80,000 in dividend stocks that pay just over a 3% dividend yield. I earned my small pension after 6 years at a bank during my 20’s and my wife spent a few part-time years as the cook at my kid’s school. Again, every dollar helps.

Retiree Healthcare

This might seem weird to include as an income stream but hear me out. First, the company allows us to keep our exact health insurance until I turn 65 years old. The company pays for a majority of the cost. When I turn 65 years old and Medicare kicks-in, they give us $2,500 each ($5,000 annually) to pay for supplemental healthcare.

So, at 65 they provide up-to a $5,000 credit for me to buy supplemental insurance to back-up Medicare. That is money I don’t have to spend, therefore, it’s an income stream. Again, I’ll take every single dollar I can get. Having this benefit (after 65) is like having $160,000 in stocks yielding about 3%. That’s an additional $160,000 I don’t need because my company is providing it to me.

Non-Qualified 401k (Restoration Fund)

As a highly compensated employee, the IRS limits the amount I can contribute into my company 401k. My employer has allowed us to contribute up to 9% of our income tax-deferred in the NQ 401k. Basically, this is a company bond that pays specific a percent return every year (5.25% in 2021). At retirement, they will pay this out over 5-years and it will be taxed as regular income.

By the time I retire, I plan to have over $200,000 in the account. When I leave (retire), they will then pay it back in 5 separate payments. I’m estimating I’ll receive about $50,000 annually for 5 years. In a time of low interest rates it’s tempting to put the maximum into the account but I’m not wanting to put all my eggs in this basket. They are a BBB+ rated family-owned company with strong cashflows and they do well during recessions but you never know. I’m thinking $200,000 by retirement in this fund will be plenty of risk for the overall portfolio.

Bucket Strategy

As described above, my income floor is excellent with a pension, social security, and a few other items generating income for life. But because I’m delaying social security until 70 and I may delay my pension for a year or two to convert some 401k funds into a Roth IRA, I’m creating a hybrid-approach. An income floor with a bucket strategy.

It’s possible that once I take my social security at 70, I may change my approach but for now I’m focused on using an income floor plus a bucket strategy to manage income and assets. These buckets are only high-level concepts at this time. As I get closer to retirement, I’ll determine exactly how income and cash will flow through the accounts.

NOTE: The 2 far right columns are estimates
Bucket 1 – Cash

I’m going to need more “gap” cash between 62-70 because I’m delaying social security until I’m 70. I’d like to make sure our active lifestyle (much more travel) will be covered in the event of a market downturn. Once I start taking social security, it’s possible I’ll keep only 1-year of expenses just to make sure we’re covered. In fact, it’s possible that after 70 I’ll create a medical bucket of available liquid funds for the eventual need for more doctor visits and health issues.

Before I’m 70 and start taking social security … STOP and PAUSE, let me explain something. Reminder, once I hit 70 I’ll be receiving both a $73,000 annual pension plus social security in the $70,000 range. Just those two alone, along with other unavoidable income (like that’s a problem) will push my over 70 income easily in there $150,000-$200,000 range. This is important because I want (need) to convert my 401k into a Roth IRA and I plan to use my taxable dollars to pay for the taxes. This will create a larger Roth IRA that will be able to grow for 20+ years.

Finally, I’ll be setting aside a Intermittent Expense Fund (described further down) to cover expected but intermittent or irregular expenses. These would include buying a new car or having to put in a new roof on my house. If I contribute to this fund annually then a $25,000 car or a $15,000 new roof won’t become too much of a burden. I won’t have to sell anything to pay for the expected but intermittent expenses. It will be my little slush fund for these types of expenses.

Bucket 2 – Income (with a little growth)

This income (and growth) bucket will feed my cash bucket and it will reside in my taxable account. Dividend stocks, bonds, and REITs will be some of the investments that create income. One item that will feed this account for 5 years is my non-qualified 401k (restoration fund) that will pay me about $50,000 annually over 5-years post retirement.

Basically, this NQ 401k is a bond from my BBB+ employer. I put pre-tax money into the account and I’ll pay income tax on each distribution. Between the pension and these five $50,000 payments I should be in pretty good shape. It’s 67-70 that I’ve got to cover because those $50,000 payments will stop after 67.

I’d be content (though not thrilled) draining most of this account down by the time my wife and I die. I suspect that travel, gifts, healthcare, and maybe even LTC will drain this account. We’ll still have a high guaranteed income floor of pension, social security, and a couple of other small items for the rest of our lives.

Bucket 3 – Growth

This final bucket will be my Roth IRA bucket and I hope to protect it at all costs. It will grow tax free and serve as our last resort for medical or LTC items that our income streams and bucket 1 & 2 can’t cover. Personally, I just don’t see us needing to dip into this account but life can be a little funny at times.

Finally, this account (along with our home) will be the main source of inheritance for our two kids. By the time I’m 85, my kids will be 58 and 55 and ready to retire (if they aren’t earlier than that). It’s possible I’ll make them the payable on death receipients of the account assuming my wife has everything she’ll need. It’s even possible I’ll be able to use it to help them retire early too.

Miscellaneous Retirement Items

Though I’ve touched on some of these items already, I’d like to document the thinking separately because the thinking may change over time. They are in no specific order.

Long-Term Care (LTC) Insurance

LTC insurance is such a difficult subject but it’s so personal too. I’ve gone back and forth on this topic and I’ve got to make a final decision before I turn 60 (which is when premiums go up). The main issues I have with LTC insurance are: (1) will it be there when you need it, (2) will the insurance company change the terms of the deal, and (3) like number 2 but will the premiums go up? Because insurance companies screwed up on pricing the product, many/most changed the terms on their policies and many people saw premiums go sky high.

Many insurance companies stopped selling the product. It’s just an unpredictable situation for both the insurance company and the policy holder. And because of that, I’ve decided not to get LTC insurance at this time. That thinking may change within the next 2 years (before I turn 60) but I’m doubting it will unless the situation becomes more stable.

We’ve got a $450,000 debt-free home we could sell and use for LTC, if necessary. Also, we should have enough assets to handle some form of LTC. Again, it’s an unpredictable topic and I know the probably is high that one or both of my wife and I will need some form of care. We’d like to have some care in-home for as long as possible. So, as of now we’ll not be getting a LTC policy which means we’ll self-insure.

Delaying Pension?

If I retire at 62, there is a possibility I delay the pension for 1-2 years. For every year we delay, we are only gaining a 4% increase in the pension each year until I reach 65. For now, I’ve got myself taking it at retirement but it may be delayed if it benefits me tax-wise.

By delaying 1-2 years, it gives me the ability to convert some/all of my 401k to a Roth IRA post-retirement. The only problem with delaying is I’d have to make up the nearly $100,000 I’d receive in pension benefits. That $100,000 could be used to pay taxes on the entire conversion so it’s a complex decision. I’ll probably consult with a tax advisor before making any final decisions.

Delay Social Security

This one is fairly easy for me. Since I’m the single breadwinner of the family, it makes absolute sense for me to delay as long as possible. My wife will take her small social security at 62 ($6,000 annually) and then receive 1/2 of mine when I turn 70 (she’ll be 71 1/2 at that time). When I turn 70, she’ll go from $6,000 annually to about $23,000.

More importantly, if I die before her, she will receive my social security (estimated at $46,000 annually). If I took my social security at 67 then she’d only received about $38,000 annually. That’s a big difference, therefore, I’ll delay social security until 70 years old.

Roth IRA Conversion

Since my pension, social security, dividends, and other income will put my income somewhat high past 70 years old, I’ve got to convert my 401k to a Roth IRA. In fact, I’ve got to convert to the Roth IRA before I receive social security. If I didn’t, my taxes would be high and any mandatory distributions would be hit hard with taxes.

Also, I would like to pay the taxes on the conversion out of my taxable account. This insures my Roth IRA will achieve it’s maximum size. My Roth IRA will serve some important purposes: (1) last line of defense for our old age, (2) inheritance for the kids, (3) the growth portion of our portfolio, (4) potential LTC funds, and (5) tax efficiency.

Life Insurance

11 years ago (age 47), I got a $1,000,000 life insurance policy on my life with a 20-year term policy. It finishes when I turn 67 and it costs about $2000 annually. Honestly, I really don’t need it once I retire but I’ll likely keep it the remaining 5 years of it’s term until I retire at 62. It provides me with some piece of mind that my wife and kids will be fine upon my death.

What’s likely to happen is it will be a year-by-year decision post-retirement. If I come into a windfall (inheritance, lucky stock pick, lottery, etc…) post-retirement then I’ll probably cancel it but it’s pretty cheap for $1,000,000 at that point in my life. Again, I’ll probably keep it but I’m open either way and I’m glad it’s there.

Health Insurance

Our healthcare is covered, thanks again to my current employer. If I retiree early (65 is normal retirement in their system), they provide the exact same health insurance that I receive at work today. And at the exact same price. What a benefit. I know people that retire at 55 (which is when you can retiree early at my employer) and this retiree health insurance is a huge benefit.

Once I turn 65, I get sign-up for Medicare just like everyone else. My employer then gives my wife and I a total of $5,000 combined annually to purchase supplemental insurance. If we live to see 90 years old, that is an additional $125,000 they will have provided to cover supplemental health insurance. Again, truly blessed to have this benefit.

Medical Bucket?

I’m toying with the idea of creating a medical bucket. In fact, my first version of the bucket strategy actually included 4 buckets, with one of those being a medical bucket. This would be for items like major surgery, long-term medical issues, or possibly even long-term care. As you can see from me only providing 3 buckets for now (Cash, Income, Growth), I’m not creating a 4th bucket but I’ll continue noodling on the subject. Perhaps when my social security starts paying at 70, I’ll consider directing some annual funds to a medial bucket. It’s inevitable to we’ll have these expenses so we might as well plan for them.

The real question is how will I pay for any significant medical issue that might need $100,000 outlay? I suppose I could cash in some stocks, bonds, or other investments and that’s probably the best way to go. The important thing is we’ll need to pay for something major (medical) at some point in our lives – could be in our 60’s, 70’s, or 80’s – but we’ll need a plan to address it. More to come on this topic but it’s important we put it on the radar.

Intermittent Expenses (car, roof, etc…)

I’ve been trying to figure out how to pay for ongoing, irregular/intermittent, and somewhat expensive expenses that will occur throughout my retirement. The list I’ve captured below is a start and I’m sure I’ll think of more things as they occur. I’ll probably create a sinking fund where I’ll pay into it annually to cover the items you see on the list.

In the example above, I’ll pay about $7,042 annually into the sinking fund to cover these expenses as they occur. Creating a sinking fund reduces the hardship when they occur and I’m less likely to have to sell assets to cover these costs. Something like a car or roof replacement can be expensive. What happens if you need to replace your car and roof in the same year? That could be a $40,000 cost, which likely means we’ll have to sell something to fund the expense unless they occur years after starting the fund.

The list will evolve and so to will the anticipated costs and expected life of each item. It’s more art than science. And if you look closely at the list, these are mainly essential expenses (versus discretionary). Our spending on discretionary expenses can be flexed very easily. We can delay vacations or providing gifts one year if necessary. But these items occur when they occur. Sure, I could delay getting a new couch or chairs but when they wear out they get uncomfortable so you can’t wait too long to replace.

Sequence of Returns Risk

After all the horrible investments I’ve made over the years (described in the early writings of this blog), I’ve become a fairly conservative guy. And given that I’ve got a pension that will pay me around $73,000 annually, I really don’t need to be conservative … I could take more risk.

Today, with 4 years until retirement, my stock allocation is sitting at around 30%. With a good pension, I’d normally have a 50% stock allocation going into retirement but not with an S&P 500 P/E ratio sitting at around 40. I’d be much more comfortable it was half (20 or less) that but there is just no reason to take extra risk right now.

The most important thing to my investment portfolio today is my savings rate. I expect my portfolio to double in 4 years and that will happen because I’ll have no debt and a high income until I reach retirement. My savings rate will be 65%+ and I’ll be putting those funds into cash, bonds, and some stock opportunities when they arise.

About 5 years after retirement, I’ll be moving my stock allocation higher to around 50-60%. And once my social security starts, it will partner with my pension to create a pretty good guaranteed income floor. So, around 70 years old, I can see my stock allocation being over 60% with most of my Roth IRA being in growth investments. That’s my thinking today but I’m sure it will evolve. The bottom line is I’m sitting at a 30% stock allocation right now and that will evolve at the market moves.

Summary

What I’ve provided in this article is a high-level outline plus my thinking on certain retirement items. What you don’t see is the specific mechanics of how I’ll move money around while trying to keep things as simple as possible. You also don’t see firm details on what my stock allocation will be either. With the stock market so high right now, I’m in no hurry to have a high allocation at these levels.

This article doesn’t cover everything but, since I’m 4 years away from retirement, it will provide a good basis to work from as I firm this up each year. You could consider this as DRAFT 1 of my plan. As I get closer to retirement, the details become more clear and concrete. I’ve still got lots to consider and many decisions to make but this plan is a good framework.

Thanks for reading!

Mr. TLR