The 4% withdrawal rule and taxes

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jason
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The 4% withdrawal rule and taxes

Post by jason » Wed Mar 12, 2014 11:12 pm

I think most of the people in this forum agree that the 4% withdrawal rule in retirement will work with the PP.  I would take out 4% of the value of my entire portfolio from the cash position each year, and then rebalance when cash goes below 15%, right?  For example, if I have a $1 million PP, I would have around $250,000 in cash.  At a 4% withdrawal rate, I would withdraw $40,000 this year from the cash position.  Doing this every year could force me to rebalance much more often that I would if I was not taking withdrawals, and this is likely going to cause negative tax consequences, right?  Do I need to worry about the extra taxes I will be incurring due to frequent rebalancing, or will I be fine as long as I only take out 4% per year, and rebalance to 25% X 4 when my cash position drops below 15%?
Last edited by jason on Wed Mar 12, 2014 11:15 pm, edited 1 time in total.
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Tyler
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Re: The 4% withdrawal rule and taxes

Post by Tyler » Thu Mar 13, 2014 1:00 am

jason wrote: I would take out 4% of the value of my entire portfolio from the cash position each year, and then rebalance when cash goes below 15%, right?
Yep. 

The good thing about withdrawing from cash is that the taxes in most years will be very low.  At current interest rates much of the bond interest is offset by the standard deduction and personal exemptions, and qualified dividends + long term capital gains (small anyway when you're just selling ST bonds) are tax free if your taxable income is below $72.5k (married filing jointly).  For your example of withdrawing $40k a year, from what I can tell most years you'll pay virtually no federal tax (although this could get trickier once SS, IRA distributions, and other retirement income kick in, so YMMV).

The trick is to plan the rebalance when that comes up every few years to minimize capital gains taxes.  Since you control the capital gains timing, one option is to spread the rebalance across two tax years to stay in the preferable brackets for each.  There's also tax loss harvesting you can use to your advantage.  The biggest issue is managing a large gold rebalance (because of the collectible tax treatment). 

Also, keep in mind any tax-deferred accounts are very handy for rebalancing tax-free in retirement (especially the gold allocation).  And any new money you earn (if you're out trying something fun in retirement) also gives you flexibility to leave the portfolio alone or potentially buy lagging assets. 

TL;DR: The PP is pretty darn tax efficient in retirement.
Last edited by Tyler on Thu Mar 13, 2014 1:12 am, edited 1 time in total.
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jason
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Re: The 4% withdrawal rule and taxes

Post by jason » Thu Mar 13, 2014 1:41 am

Tyler wrote:
jason wrote: I would take out 4% of the value of my entire portfolio from the cash position each year, and then rebalance when cash goes below 15%, right?
Yep. 

The good thing about withdrawing from cash is that the taxes in most years will be very low.  At current interest rates much of the bond interest is offset by the standard deduction and personal exemptions, and qualified dividends + long term capital gains (small anyway when you're just selling ST bonds) are tax free if your taxable income is below $72.5k (married filing jointly).  For your example of withdrawing $40k a year, from what I can tell most years you'll pay virtually no federal tax (although this could get trickier once SS, IRA distributions, and other retirement income kick in, so YMMV).

The trick is to plan the rebalance when that comes up every few years to minimize capital gains taxes.  Since you control the capital gains timing, one option is to spread the rebalance across two tax years to stay in the preferable brackets for each.  There's also tax loss harvesting you can use to your advantage.  The biggest issue is managing a large gold rebalance (because of the collectible tax treatment). 

Also, keep in mind any tax-deferred accounts are very handy for rebalancing tax-free in retirement (especially the gold allocation).  And any new money you earn (if you're out trying something fun in retirement) also gives you flexibility to leave the portfolio alone or potentially buy lagging assets. 

TL;DR: The PP is pretty darn tax efficient in retirement.
Thank you for the reply.  Sorry, I was only using the $1 million example because it was a round number.  The actual amount I have is $5.5 million, so I would be taking out around $220,000 for the year, which is 4%.  Is that still fine to do?  I think that changes the tax scenarios significantly.
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Re: The 4% withdrawal rule and taxes

Post by Tyler » Thu Mar 13, 2014 10:00 am

Yeah, that's a bit different.  The PP is still more tax efficient than many other options, but with that level of income I personally think a tax professional would be well worth the investment.
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Re: The 4% withdrawal rule and taxes

Post by ns3 » Thu Mar 13, 2014 4:26 pm

jason wrote: Thank you for the reply.  Sorry, I was only using the $1 million example because it was a round number.  The actual amount I have is $5.5 million, so I would be taking out around $220,000 for the year, which is 4%.  Is that still fine to do?  I think that changes the tax scenarios significantly.
I'm assuming you're mostly in taxable (and I think I remember from one of your posts that you are). I think this is good for you. I just looked up your MRD at 5.5 million and it would be $281k the first year from an IRA, peaking around a million in the latter years. Painful to think of the ordinary income taxes due on that much income. Glad I don't have 5.5 million (just kidding).

Personally, I use the 4% rule when I'm making my retirement plans but I have no idea what the reality of the situation will be (not far away). Hoping to spend less.
Last edited by ns3 on Thu Mar 13, 2014 7:03 pm, edited 1 time in total.
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Re: The 4% withdrawal rule and taxes

Post by rocketdog » Sun Apr 13, 2014 3:53 pm

Not that this impacts someone who's purely PP, but I recently read a controversial article titled "Reducing Retirement Risk with a Rising Equity Glide-Path" that makes the argument that retirees should gradually increase their equity positions over time.  This goes against the traditional advice of gradually shifting out of equities and into bonds during retirement.  Interesting study, though I'm not entirely convinced (yet):

http://papers.ssrn.com/sol3/papers.cfm? ... id=2324930
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Re: The 4% withdrawal rule and taxes

Post by Ad Orientem » Sun Apr 13, 2014 6:13 pm

I actually favor something in the 3% range, assuming you can live comfortably, for those retiring at a normal age. But then I'm pretty conservative and cursed with a touch of fiscal paranoia.
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