How do I make an annual withdrawal from a retirement portfolio?

How do I make an annual withdrawal from a retirement portfolio?

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This article was first posted July 1, 2018.

A Retire Early reader suggested I explain how I make my annual withdrawal from my retirement portfolio.

In its simplest form, your annual portfolio withdrawal starts with any dividends and capital gains distributions you're received during the year. If they total to less than 4% (or whatever your withdrawal rate is), you'll need to supplement that by selling something in the portfolio. If they total to more than 4%, I'd use the excess to buy whichever asset class in the portfolio needs additional funding to return the portfolio to your desired asset allocation.

Let's say your desired asset allocation is 75% stock, 25% fixed income. If at the end of the year, your portfolio is 79% stock, 21% fixed income, I'd sell some stock to complete the 4% withdrawal. You may be able to match some winners and losers and get those additional funds without a tax liability. But I wouldn't worry about returning the portfolio to exactly 75%/25%. I don't do portfolio rebalancing if it requires a transaction that will incur a tax liability. Who knows, next year the ups and downs of the market may return my portfolio to balance "tax-free" (i.e., without incuring a taxable transaction.)

Should I withdraw from my IRA or taxable account

In general, most people seem to want to withdraw funds from their taxable account rather than their IRA, since everything in the IRA is taxed as ordinary income and you'll likely get a lower capital gains rate on a withdrawal from the taxable account. The one wrinkle on this is that if your IRA is a large percentage of your assets, you may want to start withdrawing from the IRA at a younger age to limit the size of your RMD at age 70. A 40-year-old with a multi-million dollar IRA is likely to see significant growth in the IRA by the time he's 70, resulting in an RMD that will likely vault him into the top tax bracket. It may make sense to start withdrawing from the IRA early and let the taxable account grow. (See link: Should I tap my IRA first in retirement?)

I started out my early retirement in 1994 with an IRA and taxable account of roughly equal size. But my two biggest stock market winners (DELL and PFE) happened to be in my IRA. After a few years of the late 1990's bull market my IRA was 80% of my networth and the taxable account only 20%. I started taking 72(t) SEPP penalty-free withdrawals from my IRA at age 40 to start whittling down the size of my RMD at age 70. I discontinued the SEPP at age 59-1/2 when another early retirement tax planning opportunity presented itself in the form of Obamacare.

If you manage your portfolio right, Obamacare may provide even a multi-millionaire retiree a "free" health insurance plan.

When I see all the misinformation you get from Fox News on Obamacare, I sometimes wonder if I'm the only one who actually "Read the Bill". I was surprised to find that Obamacare contains no asset test for getting a health insurance tax subsidy. You could own $100 million in Berkshire Hathaway stock and still qualify for a big tax subsidy if you reduce your dividend and capital gains income as much as possible. Funding your annual withdrawal with tax-free returns of capital (e.g., if you sell a $100,000 block of stock that you paid $80,000 for 2 years ago, you'll only realize a $20,000 capital gain (the other $80,000 is a tax-free return of capital). And if you have a $20,000/yr income, you get a huge Obamacare subsidy.)

When Obamacare was enacted in 2010, I started selling some of the dividend paying stocks I held in my taxable account and replacing them with investments like Berkshire Hathaway which doesn't pay a dividend. Over the course of three years I was able to get my taxable account "Obamacare ready" without incurring much in the way of capital gains taxes. When I ended my IRA SEPP withdrawals at age 59-1/2, I was positioned to get a sizable Obamacare tax subsidy. The rest, as they say is history, see link: Obamacare Repeal? My amazing story of drastically lower premiums.

Should I reduce spending in a stock market downturn (or complete economic collapse?)

While most retirement "experts" seem to advise that retirees reduce spending in market downturns, I actually doubled my spending in 2008 to 2012 when the World was in economic collapse and everything was on sale. I started doing 3 or 4 cruises per year and other international trips. Now that airline and cruise prices have returned to more normal levels, I find I have less appetite for travel.

I suggest retirees mentally earmark 5% to 10% of their portfolio for "strategic spending" when the opportunity presents itself. If you always wanted to go on a lengthy, luxury cruise, it makes more sense to do so when they're on sale.

What's my current annual withdrawal plan?

For the next 3 years until I turn age 65, I'll concentrate on minimizing income and maximizing my Obamacare tax credit. (My 2018 health insurance premium is $1.63/month. That's right, less than $20 per year.)

From age 65 to 70, I'm currently planning on Roth conversions to at least top off the 24% Federal tax bracket ($85,500/yr, single) or perhaps the 32% bracket ($157,500/yr, single) if stock market returns remain favorable through 2026. I'm delaying taking Social Security until age 70 assuming my health remains good.

That's what I've done over the past 24 years, and what I'm planning for the future. What's appropriate for you obviously depends on your individual circumstances.

Resources for additional information.

Cost sharing reduction weeds: “Silver loading” and the “silver switcheroo” explained -- Essential Facts About Health Reform Alternatives: Eliminating Cost-Sharing Reductions

Time Magazine -- Bitter Pill: Why Medical Bills Are Killing Us

How Millionaires Get Obamacare Subsidies Intended to Aid the Poor, by Dan Mangan,CNBC,January 26,2016

Why I'm Not Worried About Obamacare Premium Increases, Retire Early Home Page, November 2014

CBO estimate of health insurance premiums under Obamacare, Nov. 30, 2009

Health Care Reform in Indian Country
- Indexing Adjustments Related to Certain ACA Provisions , October 30, 2016

Health Insurance Premium Credits in the Patient Protection and Affordable Care Act (ACA)
- Congressional Research Service, June 13, 2012

Kaiser Family Foundation - Health Reform Subsidy Calculator

Federal Register - Health Insurance Premium Tax Credit

IRS - Affordable Care Act Tax Provisions

Actuarial Value and Cost-Sharing Reductions Bulletin

Plan Levels and Standardization of Coverage

Commonwealth Fund -- Choosing the Best Plan under Obamacare

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