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Bogleheads Speaker Series “Experts Panel” (Saturday 2/13)

It has come to my attention that last Monday’s article did not go out via email to many subscribers. I think the issue has been resolved going forward, but here’s the link for those of you who missed it:

On a separate note, this upcoming Saturday, I’ll be participating in a Bogleheads Speaker Series panel discussion, with Christine Benz, Allan Roth, and Bill Bernstein. The discussion will be moderated by Karen Damato. Here’s the link with more information:

The link above is also where you would register for the event and submit a question for the panel if you are interested in doing so.

Investing Blog Roundup: It’s OK to Build Wealth Slowly

I recently came across an excellent piece by Ben Carlson, discussing the concept of building wealth slowly. One thing that struck me is the publication date of the article: January 10 (i.e., immediately before the GameStop hullabaloo began in earnest).

In our household, we’re very much on the “build wealth slowly” train as well. We have a boring, diversified, low-cost portfolio. Changes to the allocation or the plan are rare. We’re never going to live in a $17-million penthouse mansion or fly around the world in a private jet. But I’m very confident that we’re on track to meet our goals without having to take undue risk to get there.

Recommended Reading

Thanks for reading!

Long-Term Tax Planning Requires Guessing. Focus on the Near-Term.

There’s a common idea that tax planning is a very precise mathematical procedure.

Some parts of it are.

But there’s also a fair bit of guessing going on.

For instance, with retirement tax planning, the process each year is usually to:

  1. Identify the various income thresholds at which your marginal tax rate would increase (i.e., points at which the next dollar of income would be taxed at a higher rate than the prior dollar of income),
  2. Select one of those thresholds, and
  3. Manage your income in such a way to keep your income below that threshold.

Step #1 is a precise mathematical procedure. And step #3 is reasonably precise as well. (It’s not to-the-dollar precise, because in some cases you’ll want to leave a bit of “fudge factor” space before the identified threshold, in case there’s some income that you forgot about. You wouldn’t want that $13 of dividends from those AT&T shares you never bothered to sell to put you just over a Medicare IRMAA threshold, thereby increasing your Medicare premiums by several hundred dollars.)

But step #2 involves a lot of guessing. Generally, the process each year is to keep taking dollars out of tax-deferred accounts (either spending those dollars or doing a Roth conversion of those dollars) if your marginal tax rate on those dollars would be lower this year than it would be if you took them out of the account at some date in the future.

So you have to estimate what your marginal tax rate will be later in retirement. But how do you do that?

At a minimum you have to come up with assumptions regarding:

  • Whether tax rates themselves will change (i.e., due to legislative changes or due to temporary tax legislation being allowed to expire);
  • Your future work income, if any;
  • How your portfolio will perform (because, for example, RMDs from a larger account result in a greater level of income than RMDs from a smaller account); and
  • If you’re married, how long it will be until either you or your spouse has passed away (because the marginal tax rate for the survivor is often higher than when both spouses were alive).

When you consider all of those things together, you’re left with quite a bit of overall uncertainty.

That doesn’t mean that retirement tax planning has no value. But the value is primarily in the near-term calculations (i.e., this year’s calculation and possibly the next few years). For those calculations, the analysis is actually reasonably precise, because we aren’t trying to make guesses so far into the future.

That is, in our three-step process from above, the value is primarily in steps #1 and #3 (i.e., identifying all the various “gotcha” provisions this year which would cause your tax rate to be greater than your tax bracket as your income crosses various thresholds, and then managing your income to avoid those “gotchas”) rather than in trying to precisely determine what your tax rate will be 10 or more years from now.

Many people put their focus in the wrong place. They spend considerable time and effort in an attempt to calculate exactly what their tax bracket will be 20 years from now. And they compare that bracket to their current bracket. And then, without realizing what they’re doing, they make a big mistake with this year’s tax planning. For example: a big enough Roth conversion to blow right through the Social Security tax hump, cross an IRMAA threshold, or lose eligibility for the premium tax credit. They end up paying tax right now at a considerably higher rate than they’d realized — and in a way that could have been avoided with precise calculations and little to no guesswork.

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Investing Blog Roundup: Beating TIPS Yields with I Bonds

While I Bonds aren’t exactly a secret, they don’t get the amount of coverage they deserve — especially in an interest rate environment such as today’s in which yields on the other type of inflation-adjusted bonds (TIPS) are negative, even all the way out to 30-year maturities.

Presumably, that lack of discussion is for a combination of reasons. Nobody makes any money promoting I Bonds. There are no mutual funds that own them. There’s an annual purchase limit. And a lot of people don’t really like dealing with TreasuryDirect.

But as Harry Sit points out, there’s one easy way to buy some I Bonds each year:

Recommended Reading

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Spending More Than 4% Per Year Can Be Safe

If you’ve read much about retirement planning, you’ve probably encountered the “4% rule” — the idea that, if you spend 4% of your portfolio balance in the first year of retirement, then adjust that level of spending upward each year in keeping with inflation, your portfolio will probably last through a 30-year retirement.

An unfortunate side effect of the proliferation of this concept is that people sometimes think that it’s automatically dangerous to spend more than 4% of your portfolio per year. In reality, there are plenty of cases in which spending more than 4% per year isn’t particularly risky — and even some cases where that’s the safest thing to do!

The “4% Rule” Often Involves Spending More than 4%

The idea of the 4% rule isn’t to spend 4% of the portfolio balance each year. Rather, the idea is to spend 4% in the first year of retirement, then adjust the dollar amount based on inflation going forward, regardless of how the portfolio performs.

As a result, even with the original 4% rule strategy, there are plenty of scenarios in which a person ends up spending more than 4% of the portfolio balance in a given year. (For example, any scenario in which the portfolio declines at all in Year One will result in spending more than 4% in Year Two.) Scenarios of that nature are already accounted for in the research that found that a 4% initial spending rate was reasonably safe.

Age Matters

Depending on your age, spending more than 4% per year can make perfect sense. As an obvious example, consider a 85-year-old widower. He doesn’t need his portfolio to last another 30 years. He might want to spend at a low rate, if his goal is to leave most of his savings to heirs, but he doesn’t have to.

Conversely, if you sell a business at age 35 and plan to be retired as of that point, living primarily off the portfolio, I would not suggest spending 4% per year. Given the super long time span that’s likely to be involved, it would probably be prudent to start with something more like 3% — or possibly even less.

Intending to Deplete the Portfolio

One long-time reader of this blog is unmarried, in her 60s, retired after a career with the federal government. Her home is paid off. And, in her own words, her savings are “modest, compared to what I would have tried to accumulate if I did not have a pension.”

Her plan is to spend about 10% of the portfolio balance per year, and I think that’s entirely reasonable. She plans to deplete the portfolio — that’s the goal. Spend the portfolio down while her health is still such that she can get the most enjoyment from the additional spending, and then live on the (not-at-all-trivial) pension for her remaining years.

Delaying Social Security

Finally, as we’ve discussed about a zillion times, delaying Social Security is typically advantageous for most unmarried people, for the higher earners in married couples, and in some cases even for the lower earner in married couples.

But delaying Social Security means spending down the portfolio at a faster rate in the meantime — often a rate in excess of 4%. And that scares some people.

But in reality, this is typically the safest thing to do.

You can carve out a separate chunk of your portfolio to satisfy the higher level of spending in early retirement, and put that money in something low-risk. (For example, build an 8-year CD ladder to satisfy the 8 years of higher spending until your Social Security kicks in.) In such a case, yes, you’re likely spending more than 4% in those years. But that chunk in question has almost no risk. And the result is a lower long-term spending rate once your Social Security does kick in. (Plus, in the event that you were to deplete your portfolio, you’d be left with a higher level of income than if you had not delayed Social Security.)

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Can I Retire Cover

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Investing Blog Roundup: What’s Next?

It’s been one heck of a week, to follow what was, by any measure, one heck of a year.

In finance, one thing you eventually have to accept is that it’s impossible to predict what’s going to happen next. Lots of events look obvious, in hindsight. But lots of potential events that didn’t happen would have looked obvious in hindsight as well.

That feeling — unsure what’s about to happen, recognizing that some of the potential outcomes are dramatically different than other potential outcomes — feels particularly acute right now.

As always, thank you for reading, and I wish you well.

Recommended Reading

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