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Revisiting my favorite topic: What withdrawal rate can you make from a portfolio without significant risk of going broke before you die? This isn't a new topic, nor are my ideas original. Rather, they are a blend of the results of the Trinity Study, David Braze's (TMFPixy) article "How Much Are You Gonna Take?" and an article by Frank Armstrong. Links to the other articles can be found in Pixy's article:

http://www.fool.com/retirement/manageretirement/manageretirement7.htm

My plan relies on the following two assumptions:

1. I am not the least bit worried about how much I can leave my kids. They will very likely be very well set on their own.

2. I'll retire at 63 or 64. If the market sours early on (probably the biggest danger to my plan), I could go back to work for a year or two.

3. My Social Security benefits will provide fully 35% of my "minimum wage", which tends to soften the effects of market downturns somewhat.

The literature referred to above is extremely valuable, especially in suggesting a general direction. But I believe it would be a mistake to rely on withdrawal rates and probabilities of success too heavily. First, there is really not enough data available to warrant quoting probabilities of 100%. "The worst storm ever recorded for the city of ..." is a phrase you hear every so often. This could apply to economics as well as meteorology, couldn't it? Second, The behavior of the market and of the economy isn't governed by the same rules that applied in the past. The rules have changed, and we might expect the behavior of the market to change.

At some point in all our lives, we were naive enough to believe that we could accumulate a reasonable sized nest egg, and then "live off the interest". Now we know that it's a bit more complex than that. The fixed strategy of the Trinity study leads to unacceptably low (IMHO) withdrawal rates, while at the same time resulting in unacceptably high terminal values. I think a more flexible strategy is called for.

The first thing my plan calls for is a nest egg about 25% greater than what is required to maintain my standard of living. This will delay my retirement for a year or two, depending on the market. Better to pay a small price up front. After all, it's not as though I'm digging coal for a living. (I might well have a different outlook if I hated my job.)

The second thing my plan calls for is the managed growth of my nest egg, after adjusting each year for inflation, of course. This growth of about 2% per year is continued until age 75-80 (maybe depending on my health and that of my wife). In the later stages, a moderate reduction of principal (about 3%) will be programmed each year. I could be in trouble if I live to be 110, but I could also be in trouble when the comet hits. C'est la vie.

Asset allocation is an interesting feature of the plan. Instead of allocating on the basis of some arbitrary rule or general principle, my asset allocation is based on the premise that I will have to draw my income solely from cash and other fixed income securities if and when the market goes into the tank. I will cut back living expenses to a predetermined minimum level (which happens to be about 4.5% of my projected assets) and 20% of my nest egg will last me about five years, given that there will be some interest and dividend income.

It is no coincidence that the assets devoted to fixed income stuff is the same size as the "buffer" alluded to above. This allows me to invest the remainder aggressively, within reason. (I'm not going to the riverboat to bet it all on red!) The point is that the allocation is based on a definite strategy. This frees me from worrying whether I'm being conservative enough or aggressive enough. All I'm doing is to make it unnecessary to sell any stock for at least five years. Five years is my personal figure (and one found frequently here at The Motley Fool), but others might like a different number -- YMMV.

Here's how it works: Each year I plan to set aside my "minimum wage" in a cash account that holds two years worth of minimum living expenses at the start of each year. I then adjust my nest egg target for inflation, and if the remainder is less than my target, I go into austerity mode. If I have an excess, it will be split more or less evenly between more spending (think mai tais) and increased capital. First, I take care of minimum living expenses, then inflation, then programmed growth, then high living. The final step is to rebalance the portfolio. My personal taste in asset allocation:

8% Cash
12% Bonds
40% SPY and/or Rule Makers
25% DIA and/or Foolish 4
15% QQQ and/or Rule Breakers

The plan is not difficult to formulate, and if assets stray very far in either direction from the target, it can (and should) be reformulated.

If this has any merit, it lies in the conviction that one should plan for a nest egg 25% larger than what is needed to generate the desired income.

Comments?



Tim

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I wrote:

>>My plan relies on the following two assumptions:

1. I am not the least bit worried about how much I can leave my kids. They will very likely be very well set on their own.

2. I'll retire at 63 or 64. If the market sours early on (probably the biggest danger to my plan), I could go back to work for a
year or two.

3. My Social Security benefits will provide fully 35% of my "minimum wage", which tends to soften the effects of market downturns somewhat.>>


There are three kinds of people in this world: Those who can count, and those who can't. :-)


Tim
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eldynamite wrote,

Here's how it works: Each year I plan to set aside my "minimum wage" in a cash account that holds two years worth of minimum living expenses at the start of each year. I then adjust my nest egg target for inflation, and if the remainder is less than my target, I go into austerity mode. If I have an excess, it will be split more or less evenly between more spending (think mai tais) and increased capital. First, I take care of minimum living expenses, then inflation, then programmed growth, then high living. The final step is to rebalance the portfolio. My personal taste in asset allocation:

8% Cash
12% Bonds
40% SPY and/or Rule Makers
25% DIA and/or Foolish 4
15% QQQ and/or Rule Breakers

The plan is not difficult to formulate, and if assets stray very far in either direction from the target, it can (and should) be reformulated.

If this has any merit, it lies in the conviction that one should plan for a nest egg 25% larger than what is needed to generate the desired income.


I think your plan is very workable and conservative.

It's similar to the "Pay Out Period Reset" model discussed a few months ago, see link:

http://www.geocities.com/wallStreet/8257/popr.html

intercst

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Whoops!

That Geocities link doesn't work. Try this one.

http://home.earthlink.net/~intercst/popr.html

intercst
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eldynamite Date: 1/25/00 11:46 PM Number: 18233
-----------------------------------------------------

<<Revisiting my favorite topic: ...>>

Good post!

<<8% Cash
12% Bonds
40% SPY and/or Rule Makers
25% DIA and/or Foolish 4
15% QQQ and/or Rule Breakers
>>

That might work, although I might personally prefer:

25% Cash at relatively short-term interest
25% DIA
25% SPY
25% QQQ

If I start out with a separate living fund with about one year's expenses to which I annually add about 5% of the value of the portfolio (or 20% of the cash in the portfolio) and reallocate or rebalance annually so as to return the portfolio to its original percentages, I should add to the separate living fund each year a greater or lesser amount depending upon how the portfolio has done, increasing the portfolio cash during good times while selling equities at higher prices, decreasing the portfolio cash during bad times while buying equities at lower prices, and thereby living forever, at least financially.

The primary goal is to survive financially, and it does not bother me to leave something to others and/or to reduce the national debt a bit by paying a bit (up to 55%) in estate taxes, if necessary.

I do not know how long I may live and I have no desire, and I hope I will have no need, to totally exhaust or consume everything before I go.

DHatch

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for DHatch:

. . .thereby living forever, at least financially . . .I do not know how long I may live and I have no desire, and I hope I will have no need, to totally exhaust or consume everything before I go.

My feelings and plan, exactly. I manage my retirement assets to keep their total purchasing power just about constant over the next 35 years, while carrying the burden of inflation, income taxes and my living expenses. Glad to find some one else who acts as if he's immortal.

. . .it does not bother me to leave something to others and/or to reduce the national debt a bit by paying a bit (up to 55%) in estate taxes, if necessary.

Here I quietly disagee. My IRA would be hit with both income taxes and estate taxes if I keeled over this moment, except that I have named a tax-exempt foundation as its beneficiary. The tax bill would have been 39.6% income tax plus maybe 55% estate tax on the remainder. <scream> Confiscatory! Outrageous! etc! As P. J. O'Rourke says, giving money to the government is like giving liquor and car keys to a teen-ager. </scream> I plan to use tax-exempt bequests to assure that I have little or nothing left in my estate beyond the federal estate tax exemption.

When the people of California were allowed to vote on the matter, they repealed the state's estate tax in the early 1970's. Popular preference is arguably the same today, nation-wide, but I doubt that the estate tax will die before I do.

Regards,

Chips
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<<<<When the people of California were allowed to vote on the matter, they repealed the state's estate tax in the early 1970's. Popular preference is arguably the same today, nation-wide, but I doubt that the estate tax will die before I do.>>>>

According to secondary sources (I have not read all the proposals), all recent proposals to abolish the FET also abolish the step-up in basis that occurs for assets upon the death of the owner.

I do not know the percentages, but many more estates (and heirs) benefit from the step-up in basis, than are hurt by the FET.

Be careful what you wish for.

Just my $0.02. Regards, JAFO
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Greetings, Tim, and welcome. You wrote in part:

<<It is no coincidence that the assets devoted to fixed income stuff is the same size as the "buffer" alluded to above. This allows me to invest the remainder aggressively, within reason. (I'm not going to the riverboat to bet it all on red!) The point is that the allocation is based on a definite strategy. This frees me from worrying whether I'm being conservative enough or aggressive enough. All I'm doing is to make it unnecessary to sell any stock for at least five years. Five years is my personal figure (and one found frequently here at The Motley Fool), but others might like a different number -- YMMV.

Here's how it works: Each year I plan to set aside my "minimum wage" in a cash account that holds two years worth of minimum living expenses at the start of each year. I then adjust my nest egg target for inflation, and if the remainder is less than my target, I go into austerity mode. If I have an excess, it will be split more or less evenly between more spending (think mai tais) and increased capital. First, I take care of minimum living expenses, then inflation, then programmed growth, then high living. The final step is to rebalance the portfolio. My personal taste in asset allocation:

8% Cash
12% Bonds
40% SPY and/or Rule Makers
25% DIA and/or Foolish 4
15% QQQ and/or Rule Breakers

The plan is not difficult to formulate, and if assets stray very far in either direction from the target, it can (and should) be reformulated.

If this has any merit, it lies in the conviction that one should plan for a nest egg 25% larger than what is needed to generate the desired income.

Comments?>>


It sounds like a well-thought out and well-developed strategy to me. I see no reason you can't be more than reasonably successful using it.

Regards..Pixy
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According to secondary sources (I have not read all the proposals), all recent proposals to abolish the FET also abolish the step-up in basis that occurs for assets upon the death of the owner.

I do not know the percentages, but many more estates (and heirs) benefit from the step-up in basis, than are hurt by the FET.

Be careful what you wish for.


It's all a matter of relative fairness. If I die, and have paid tax on all my income for my entire life, and saved some of it, why should the government be able to take half of it just because I die ? I think estate taxes ought to be abolished completely.

But for income which hasn't been taxed yet - such as 401(k)'s, IRA's, and assets with capital gains, there is no reason why they shouldn't be taxed just because I die !

The fairest approach in todays system would be to abolish estate taxes, abolish the step-up, and require IRA's and 401(k)'s to be taxed as they are paid out to the beneficiaries. The assets would be distributed and capital gains taxes would be due when they are sold by the beneficiaries. (using the original basis, of course)

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I think that the proposals to abolish the step up are really intended to sabotage the idea of abolishing the FET, precisely because so many estates benefit from that step up. Here are some results from this site for computing inheritance taxes --

http://www.sunlife-usa.com/cgi-bin/sunlife2.pl --
Your taxable estate tax total is $1350000.00 .*
Your calculated estate tax total is $ 270750.00 .

So, if I've got this right, an estate that was composed solely of 1.35 mil in unrealized capital gains would pay 20% under the present law and, if capital gains without step-up replaced present law, would still pay 20%. Seems to mean that any estate with less than 1.35 mil in unrealized capital gains is better off under present law that under the (sabotaged) proposals to abolish FET.

http://www.brentmark.com/estaterepeal.htm talks about FET. Excerpt: "Four reasons were given for possible repeal: more people becoming subject to the tax, the relatively tiny portion of revenue raised, powerful lobbies opposing the tax, and arguments by economists that the tax is counterproductive."

http://www.heritage.org/taxcut/chapt6.html says "The estate tax has few friends, other than tax attorneys, and raises very little revenue at a heavy cost to the economy. . . (The FET) raises very little money -- in fact, it may cost the government and the taxpayers more in administrative and compliance fees than it raises in revenue. As this study has shown, the economic cost of the estate tax is many times greater than the revenue it produces, and its reach into American households extends far beyond those few that pay it."

The FET has raised only about 1% of the government's revenue in the last two decades, so there is no great need to impose the no-step-up rule to recoup revenue lost from FET repeal. These sites argue that economic activity would be so stimulated by FET abolition, there would be a net GAIN in federal revenues. (Who knows? I'm only quoting. I predict with fair confidence that the public still supports FET repeal and Congress does not.)

http://www.deathtax.com/deathtax/economics.html gives arguments for and against. Excerpt:
"The Economics of the Estate Tax, A Joint Economic Committee (JEC) Study, December 1998. (The JEC is one of four Joint Committees of Congress representing bipartisan representation from the Senate and the House of Representatives) The study examines the arguments for and against the federal estate tax and concludes that the tax generates costs to taxpayers, the economy and the environment that exceed its potential benefits."
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markr33:

[my prior post] <<<<According to secondary sources (I have not read all the proposals), all recent proposals to abolish the FET also abolish the step-up in basis that occurs for assets upon the death of the owner.

I do not know the percentages, but many more estates (and heirs) benefit from the step-up in basis, than are hurt by the FET.

Be careful what you wish for.>>>>

"It's all a matter of relative fairness. If I die, and have paid tax on all my income for my entire life, and saved some of it, why should the government be able to take half of it just because I die ? I think estate taxes ought to be abolished completely.

But for income which hasn't been taxed yet - such as 401(k)'s, IRA's, and assets with capital gains, there is no reason why they shouldn't be taxed just because I die !

The fairest approach in todays system would be to abolish estate taxes, abolish the step-up, and require IRA's and 401(k)'s to be taxed as they are paid out to the beneficiaries. The assets would be distributed and capital gains taxes would be due when they are sold by the beneficiaries. (using the original basis, of course)"


No particlar argument from me, and your position appears consistent to me. I assume you also favor abolition of the GST? Are you concerned at all about dynastic accumulations of wealth?

You did not save just a little money if you are risk of losing 50% to FET. For 2000, the first 675k would escape FET; although I do not know the brackets off the top of my head, they do not start at 50%.

I wish I had better numbers, but I suspect that way more than 50% of all estates do not have FET issues (and I suspect that the number is north of 80%) and the benficiaries of all those estates do benefit from the step-up in basis.

If you accept the idea of a graduated income tax system, then the current FET is more or less in line with that idea. Clearly, if you favor a flat tax, or value added tax, then the current FET is out of step with your thinking.

Just my $0.02. Regards, JAFO


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Chipsboss: "I think that the proposals to abolish the step up are really intended to sabotage the idea of abolishing the FET, precisely because so many estates benefit from that step up. Here are some results from this site for computing inheritance taxes --

http://www.sunlife-usa.com/cgi-bin/sunlife2.pl --
Your taxable estate tax total is $1350000.00 .*
Your calculated estate tax total is $ 270750.00 .

So, if I've got this right, an estate that was composed solely of 1.35 mil in unrealized capital gains would pay 20% under the present law and, if capital gains without step-up replaced present law, would still pay 20%. Seems to mean that any estate with less than 1.35 mil in unrealized capital gains is better off under present law that under the (sabotaged) proposals to abolish FET.

http://www.brentmark.com/estaterepeal.htm talks about FET. Excerpt: "Four reasons were given for possible repeal: more people becoming subject to the tax, the relatively tiny portion of revenue raised, powerful lobbies opposing the tax, and arguments by economists that the tax is counterproductive."

http://www.heritage.org/taxcut/chapt6.html says "The estate tax has few friends, other than tax attorneys, and raises very little revenue at a heavy cost to the economy. . . (The FET) raises very little money -- in fact, it may cost the government and the taxpayers more in administrative and compliance fees than it raises in revenue. As this study has shown, the economic cost of the estate tax is many times greater than the revenue it produces, and its reach into American households extends far beyond those few that pay it."

The FET has raised only about 1% of the government's revenue in the last two decades, so there is no great need to impose the no-step-up rule to recoup revenue lost from FET repeal. These sites argue that economic activity would be so stimulated by FET abolition, there would be a net GAIN in federal revenues. (Who knows? I'm only quoting. I predict with fair confidence that the public still supports FET repeal and Congress does not.)

http://www.deathtax.com/deathtax/economics.html gives arguments for and against. Excerpt:
"The Economics of the Estate Tax, A Joint Economic Committee (JEC) Study, December 1998. (The JEC is one of four Joint Committees of Congress representing bipartisan representation from the Senate and the House of Representatives) The study examines the arguments for and against the federal estate tax and concludes that the tax generates costs to taxpayers, the economy and the environment that exceed its potential benefits."


Nice post. I glanced at the websites and they are long on general discussion and conclusions and short on the details and assumptions. I do not currently have time to track down and read the underlying documents. We all know that the devil is in the details. Personally, I also like Twain's "There are lies, there are d@mned lies, and then there are statistics." Economists are also notorious for making simplifying assumptions that make for a nice theory bit do not necessarily reflect reality.

Regards, JAFO

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I have two comments.
SPY.
Vanguard S&P 500 Index would provide you better return.
QQQ.
PRSCX would be safer and acomplish investment strategy.
ok three comments
Bonds.
Balance mutual fund or
Tax Free zero.
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JAFO:
You did not save just a little money if you are risk of losing 50% to FET. For 2000, the first 675k would escape FET; although I do not know the brackets off the top of my head, they do not start at 50%.

You're right, I believe estate taxes start at 37% (property value > $675K) and max out at 55% (property value > $3 mil)


I wish I had better numbers, but I suspect that way more than 50% of all estates do not have FET issues (and I suspect that the number is north of 80%) and the benficiaries of all those estates do benefit from the step-up in basis.

I forget where I read it, but I think only 2-4% of US estates incur estate taxes. IOW, it's a pretty tiny percentage for the Republicans to get themsleves into such a lather about, especially since some prudent estate planning (trusts & gifting) can pretty much eliminate the tax.

Chris
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