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Investing Blog Roundup: Evaluating Variable Spending Strategies

A quick housekeeping note, with regard to my new book:

  • Please feel free to submit any follow-up questions that you think might be useful as future articles.
  • If you liked the book, I’d be super appreciative of a review on Amazon given that the book is very new still.
  • If you didn’t like the book for any reason, please let me know. As with any of my books, I’m happy to provide a refund.

When it comes to retirement spending, the most famous strategy is the “4% rule” in which you do not actually spend 4% of your portfolio balance per year, but rather spend 4% in the first year and then increase that dollar amount with inflation every year, regardless of portfolio performance.

And then there’s a multitude of variable spending strategies, in which you allow your spending to fluctuate in some way based on your portfolio’s performance.

Retirement researcher Wade Pfau recently wrote a two-part series about such variable spending strategies. In Part 1 he describes a framework for how to evaluate such strategies, and in Part 2 he takes a look at how a handful of the most popular such strategies measure up.

Other Recommended Reading

Thanks for reading!

New Book: More Than Enough

More Than Enough book coverAs of today, my latest book is available: More Than Enough: A Brief Guide to the Questions That Arise After Realizing You Have More Than You Need.

Among people who read personal finance books, many save a high percentage of their income through most of their careers. One thing that eventually happens for some such people is that they reach a point at which they realize they have not only saved Enough, they have saved More Than Enough. Their desired standard of living in retirement is well secured, and it’s likely that a significant part of the portfolio is eventually going to be left to loved ones and/or charity.

A similar thing can also happen for people simply as a result of the way that spending in retirement usually works. That is, early in retirement, you have to spend at a very low rate — because you don’t know what investment returns you’ll get, you don’t know how long you’ll live, and you don’t know whether you’ll have massive medical expenses later in life. Said differently, it often makes sense to plan for an outcome in which you get poor investment returns and live to age 105 in a nursing home. But most likely, that’s not what’s going to happen. As a result, Enough ultimately turns out to be More Than Enough, most of the time.

And that realization — that you have (or are at some point likely to have) more than enough — raises a whole list of new questions and concerns. Some of those are financial (e.g., how much can I afford to give away to charity during my lifetime?), and some are non-financial (e.g., how should I communicate my estate plan to my intended heirs?).

This book’s goal is to help you answer those questions.

For reference, this book was written largely simultaneously with my previous book (After the Death of Your Spouse), and it actually shares some of the same material (specifically, some of the material about trusts, working with attorneys, and working with financial planners).

The book’s table of contents is as follows:

Part One: Non-Financial Considerations (What’s the goal? And why?)

1. Do You Have More Than Enough?
2. Who Gets the Money?
3. Talking with Your Kids or Other Heirs

Part Two: Financial Considerations

4. Giving and Spending During Your Lifetime
5. Learning to Spend and Give More
6. Impactful Charitable Giving
7. Impactful Investing
8. Reassess Your Asset Allocation
9. Trusts
10. Asset Protection

Part Three: Tax Strategies

11. Qualified Charitable Distributions
12. Donating Appreciated Taxable Assets
13. Deduction Bunching
14. Donor-Advised Funds
15. The Roth Question(s)
16. (State) Estate Taxes
17. Developing a Workable Plan

Part Four: Finding Professional Assistance

18. Working with an Attorney
19. Working with a Financial Planner

Conclusion: Mission Accomplished. Now What?

Afterword: Our Most Limited Resource

If you think the book would be helpful to you or to a loved one, I would encourage you to pick up a copy. (Print version here, Kindle version here.)

What Comes After Financial Independence?

Among people who read personal finance books, many save a high percentage of their income through most of their careers. One thing that eventually happens for some such people is that they reach a point at which they realize they have not only saved "enough," they have saved "more than enough." Their desired standard of living in retirement is well secured, and it’s likely that a major part of the portfolio is eventually going to be left to loved ones and/or charity. And that realization raises a whole list of new questions and concerns.

This book’s goal is to help you answer those questions.

More than Enough: A Brief Guide to the Questions That Arise After Realizing You Have More Than You Need

Topics Covered in the Book:
  • Impactful charitable giving
  • Talking with your kids or other heirs
  • Qualified charitable distributions
  • Deduction bunching
  • Donor-advised funds
  • Trusts
  • Click here to see the full list.

Investing Blog Roundup: Retirement Spending Flexibility

Much of retirement spending research — as well as many financial planning programs — assume that a retiree household will keep spending the same (inflation-adjusted) amount each year throughout retirement. But common sense tells us that retirees probably would not keep spending the same amount, regardless of whether the portfolio is growing quickly, shrinking quickly, or holding steady.

David Blanchett highlights a recent survey of 1,500 defined contribution (DC) retirement plan participants between the ages of 50 and 70, which found that respondents were much more capable of cutting back on different expenditures in retirement than the conventional models suggest. Blanchett writes, “For example, only 15% said a 20% spending drop would create ‘substantial changes’ or be ‘devastating’ to their retirement lifestyle, while 40% said it would have ‘little or no effect’ or necessitate ‘few changes.'”

And when you account for that flexibility, an assortment of financial decisions surrounding retirement need to be adjusted. The decisions that make sense for a household that intends to never adjust their spending (other than to match inflation) are different than the decisions that make sense for a household that has spending flexibility.

Other Recommended Reading

Thanks for reading!

HSA Contributions: Effect on FICA Tax and Social Security Benefits

A reader writes in, asking:

“On the subject of social security, extremely belatedly I realized my ‘catchup’ strategy of max deferral to traditional 401(k), HSA, and sometimes traditional IRA impacts my social security benefits.

Have you looked at this at all, is there a strategy for deferrals that would take impact on social security into account? By this point the ship has sailed for us (I think), but maybe it’d be beneficial to others to keep this in mind or understand the trade offs.”

To back up a step, the effect this reader is asking about (i.e., contributions reducing your FICA tax and therefore potentially reducing your ultimate Social Security benefit) is specific to HSAs — and it only applies when contributing as a payroll deduction.

That is, contributions to a tax-deferred 401(k), contributions to a traditional IRA, and contributions made from a checking account to an HSA will all reduce your adjusted gross income (and therefore taxable income), but they do not reduce the amount that shows up in Box 3 of Form W-2 (“Social Security wages”). And they will not, therefore, reduce your ultimate Social Security benefit.

For contributions that you make to an HSA on a pre-FICA-tax basis (i.e., contributions made as payroll deductions, rather than money going from your checking account into an HSA), yes, they do reduce your Social Security wages for the year. And they will therefore reduce your ultimate Social Security benefit, unless a) the reduced amount of Social Security wages for the year is still above the limit ($160,200 for 2023) or b) you still have 35 other years of maximum taxable earnings.

Many people though (in particular, people with higher earnings histories) will actually find the net result to be positive. That is, the taxes saved are likely to be more valuable than the reduction in ultimate benefit. Specifically, that’s most likely to be true for anybody whose 35 highest years of (wage-inflation-adjusted) earnings will ultimately put them above the second “bend point” in the PIA formula. (In today’s dollars, that would require about $2.8 million in wage-inflation-adjusted earnings during those 35 years — an average of about $81,000 of earnings per year over 35 years, in today’s dollars.)

There is a bit more to it than that just earnings history though. For example, the greater the number of people who will receive a benefit on your work record, the more detrimental a smaller benefit would be. So, for example, somebody whose spouse did not work for pay and who has one or more adult disabled children would be more likely to find it advantageous to pay the additional Social Security tax, relative to another person with the same earnings history.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security cover Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Investing Blog Roundup: Treasury Interest from Mutual Funds and ETFs (Avoiding Unnecessary State Income Tax)

Interest from Treasury bonds is exempt from state income tax, and that’s just as true for interest from Treasury bonds held by mutual funds that you own. But as Harry Sit points out this week, the 1099-DIV the brokerage firm sends you doesn’t tell you how much of the dividend distribution from a fund is from Treasury bond interest. If you don’t go look it up yourself, you can end up paying unnecessary state income tax.

Other Recommended Reading

Thanks for reading!

Social Security and Safe Spending Rates

A reader writes in, asking

“I’m a big fan of Morningstar and the stuff they’ve released recently on ‘safe withdrawal rates.’ My question is how I should be thinking about future Social Security payments, when I calculate my ‘safe withdrawal rate.’

To me, it makes sense to add the NPV (calculated conservatively) of the future Social Security payments that I expect my wife and I to receive to our current portfolio, before I do the math on what our starting annual withdrawal number looks like.

Have you published anything on how to think about that question?”

That’s a great question, and it gets directly to the limitations of safe spending rate research. That is, such research is very helpful for determining approximately how much a person should have saved before retiring, but when trying to use it as an actual spending plan, it comes up somewhat short.

The biggest issue isn’t that the strategy of spending a fixed (inflation-adjusted) amount from the portfolio every year is necessarily a bad strategy (though it does have some drawbacks). Rather, the issue is that such an idea is simply not applicable for most real-life households.

That is, in most households, it’s rare that (inflation-adjusted) spending from the portfolio will be kept constant from one year to the next, because the amount of non-portfolio income changes meaningfully over time — for example as the person semi-retires, then fully retires, then Social Security begins. And for a couple, there are even more distinct phases, because there are twice as many retirement dates and twice as many Social Security start dates.

As far as considering the expected present value of your lifetime Social Security benefit to be a part of the portfolio, and then calculating an initial spending amount accordingly, the issue I see with that is that it depends significantly on what real interest rates are at the time of the calculation. And the higher that real interest rates are (i.e., the higher the discount rate used in the PV calculation), the lower the PV will be, which would indicate spending a lower dollar amount. And that’s rather backwards (i.e., higher real interest rates should indicate that you can spend at a higher rate).

My preferred way to incorporate Social Security into the analysis is to consider it a reduction in spending, for the years in question.

You can do this manually. Calculate what your non-portfolio income will be, year-by-year (including Social Security, earned income, and anything else). Then you can carve out a piece of the portfolio to “replace” that income in the years in which it won’t exist. And then you can spend at a fixed (inflation-adjusted) rate from the rest of the portfolio. (In the context of Social Security, this is often referred to as creating a “Social Security bridge.”)

Very basic example: Bob is single. He’s 65, just retired. He plans to file for Social Security at age 70, at which point he’ll get $36,000 per year. He could allocate 5 x $36,000 = $180,000 to something safe (e.g., a short-term bond fund or a 5-year CD ladder). And he could spend from that chunk of money at a rate of $36,000 per year. And he would spend from the rest of his portfolio at a fixed (inflation-adjusted) rate, which would lead to a fixed (inflation-adjusted) total spending rate also.

As mentioned above though, a real implementation of this idea is likely to be more complicated than this simple example, because there may be a phased retirement — or perhaps a pension or annuity that starts on some particular future date. And there may be two people involved, which would mean even more dates at which the level of non-portfolio income will shift.

Also, ideally, the above calculation would be done on an after-tax basis.

And, admittedly, all of that can get rather cumbersome when taking a DIY approach.

If you want, you can use financial planning software for this, because it can do all of this math (including the taxes) very quickly. The software I use for retirement spending analysis is RightCapital. It’s great, but it’s priced for advisors. The only reason I mention it is that, because I’m happy with the software that I’m using, I’m not also spending time test-driving a whole bunch of other software packages. So I can’t confidently recommend one software package or another for individual users. I have heard good things about the following, but I have not tested them myself.

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."
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My Social Security calculator: Open Social Security