yes wrong use of words. I think I meant it more in ‘it feels like that doesn’t work…’ but of course it does when you look at the numbers. If one put money in sound investments and does not capitulate, value would tend to accumulate and compound.
Thanks Gene.
In your other post you said: “When I was doing the planning to retire, I knew our portfolio would need to cover about 90% of our expenses with a small pension to cover the rest.”
So that 90% includes the cash you would generate from the stocks dividends and the sales of stocks, right?
You maintain a 3 years cash cushion so the dividends and proceeds from stock sale goes in that buffer and your current expenses comes out. I get that during times of highs in the market, you would take out more to replenish your cushion and/or to cover your extra expenses like this house.
But when you take out a large sum, you would be paying more taxes? In the FIRE or other retirement guidelines, they are talking about taking <4% of the portfolio/year. How do you decide to part from that guideline? I guess end of 2020 and 2021 were great times to take more money out from the stock market but I guess you didn’t see the market goes up and decide then that you have your funds to build a new house. If the market did not rise to its extent, would you have hold off on building your house?
In more ‘normal times’, how do you decide to sell when and what to replenish your cushion?
For example, do you tend more to sell some at the end of the fiscal year or at the beginning or are those time spread evenly over the year?
Thanks,
tj
Hi thejusticier,
"In your other post you said: “When I was doing the planning to retire, I knew our portfolio would need to cover about 90% of our expenses with a small pension to cover the rest.”
So that 90% includes the cash you would generate from the stocks dividends and the sales of stocks, right?"
My pension covered about 10% of our expenses and the portfolio was to supply the other 90%.
“You maintain a 3 years cash cushion so the dividends and proceeds from stock sale goes in that buffer and your current expenses comes out. I get that during times of highs in the market, you would take out more to replenish your cushion and/or to cover your extra expenses like this house.”
I will say no, not exactly. Everything stays in our portfolio until I decide to flow some cash to our cash cushion.
Here is something I just used in another post:
I think of our cash cushion as a water balloon. The balloon is connected to a “T” with 2 hoses on the “T”. One hose goes to a supply reservoir (portfolio) and the other connects to a usage point (our check book).
The supply side has a valve that is normally turned off. The usage side has a regulator (timer) that allows a steady flow of drops (dollars) to drip into the usage container (check book) over set periods of time. Normally, the balloon (cash cushion) provides the source of water (dollars).
When the reservoir (our portfolio) is full, I open the valve a little, allowing water (dollars) to flow into the balloon (cash cushion), expanding it. When it is full, I close the valve.
I may open the valve all the way or just let it trickle for a longer period. It is driven by the situation. If things are going well, I may top-off the balloon every month. At times like the present, the valve stays closed and the balloon shrinks a little every month.
When the balloon (cash cushion) is full, I close the valve. I only open it when the reservoir is full.
If push comes to shove, I can let the dividends flow through since they are not dependent on selling shares.
“But when you take out a large sum, you would be paying more taxes?”
From tonight’s update to my profile page:
Portfolio Makeup: _Indiv. Stock: 78.71% _Bond ETF: 0.81% _Bond Annuity: 6.98% __ Stock: 78.71% Bonds: 7.79% Cash: 12.93% _Options/Short: 0.57% __By Acct Type: Taxable: 2.65% _Trad IRA: 0.00% _Roth IRA: 97.35%
I do not pay tax on withdrawals. I started converting our trad IRA’s to Roth in 2010. I did annual conversions every year since. In January 2022, I took my first and only RMD then converted the remainder of my IRA. I finished DW’s IRA a few years ago.
My first draw to fund part of the land purchase and initial expenses was $480K. Coming out of a trad IRA would have been a big tax hit.
Doing annual conversion kept the numbers lower and in a lower tax bracket.
“In the FIRE or other retirement guidelines, they are talking about taking <4% of the portfolio/year.”
The 4% guideline is a planning guideline. That is it. Nothing more.
You can plan to take out 4% but if 3% is all that you need, just take 3%. Right now, our living expense shortfall, what the portfolio needs to provide, is about 1.4% of our portfolio. In 2005, it was about 4%.
I use 6% annual appreciation for planning. Yes, 6%!
But our XIRR from 2005 is just over 20%. You could say that is 14% additional growth each year, over plan.
“I guess end of 2020 and 2021 were great times to take more money out from the stock market but I guess you didn’t see the market goes up and decide then that you have your funds to build a new house. If the market did not rise to its extent, would you have hold off on building your house?”
Actually, the 2020 gains allowed us to decide on our change of plans. In November and December, I sold off stock to fully fund this build. The cash was in our portfolio and our expense cash cushion since. The funds still in our portfolio will stay there until needed (in Roth IRA’s). If I don’t need it, the money will just stay in the portfolio for use there.
"In more ‘normal times’, how do you decide to sell when and what to replenish your cushion?
For example, do you tend more to sell some at the end of the fiscal year or at the beginning or are those time spread evenly over the year?"
I don’t manage based on a calendar. I decided a long time ago that it is stupid for me to even try. The stock market does not follow a calendar.
Our portfolio has never set an all time high on Dec 31 of any year. For 2020, it was close at Dec 22. For 2021 it was Nov 9. For 2019 it was Aug 1! For 2018, it was Sep 13. Going back farther shows the same.
Using a Dec 31 number is arbitrary at best.
When our portfolio hits a new high, I know, in dollars, how much higher it is than the previous. I can decide right then on a plan of action which may be selling something, just taking cash or doing nothing.
Usually, I wait for a few day where I hit a series of new highs. Here are the last few from 2021 with the percentage higher than the previous:
281. 10/13/2021 2.39%
282. 10/14/2021 2.20%
283. 10/15/2021 0.53%
284. 10/18/2021 2.01%
285. 10/19/2021 0.58%
286. 10/21/2021 0.04%
287. 10/25/2021 0.52%
288. 10/26/2021 0.33%
289. 10/27/2021 0.58%
290. 10/29/2021 0.66%
291. 11/01/2021 0.36%
292. 11/02/2021 0.06%
293. 11/04/2021 0.10%
294. 11/05/2021 1.52%
295. 11/08/2021 1.64%
296. 11/09/2021 0.85%
(296 is the count of highs starting with 12/1/2012 and covers a 400+% rise in our portfolio.)
Usually there will be 3 to 5 or 6 in a row then a week or a few months to the next series.
In order to set a new high, any withdrawals need to be recouped. Example:
Our portfolio sets a high at $1,000. The next day I withdraw $100, leaving $900. It has to grow to $1,001 to set a new high.
So, the timing of withdrawals is at the whim of the markets. Our longest dry spell was July 2007 through Oct 2010 without selling stock and doing a full replenishment of our cash cushion.
That “water balloon” is a very nice thing …
Does that help you?
Gene
All holdings and some statistics on my Fool profile page
http://my.fool.com/profile/gdett2/info.aspx
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Hi Gene:
in your hydraulic analogy, the balloon has to have enough pressure to push out some money to your passbook.
When do you decide your reservoir (portfolio) is full to open the valve? is that mainly on a need basis or you consider certain conditions when you would open more or less the valve? and do you ever pass money from your cash cushion to your portfolio?
On converting IRA to Roth, wouldn’t you have to pay taxes on your capital gains incurred when in the IRA, right?
when you left on this journey in 2005, did you use as you portfolio target to reach min 25X the revenue you thought you needed each year? and you left your job when you reached it?
tj
On converting IRA to Roth, wouldn’t you have to pay taxes on your capital gains incurred when in the IRA, right?
No, that’s not correct. Traditional IRAs are not taxed based on capital gains - they are taxed at ordinary income rates on the amount distributed, whether it’s distributed to a taxable account or converted to a Roth IRA. That’s because most, if not all, of the money in a Traditional IRA typically has not ever been taxed as income. (Note: if you have any after-tax contributions in your IRA, the percent of the distribution that is taxed will be adjusted. But since most IRA owners do not have after-tax contributions in their IRAs, in most cases, the entire distribution will be taxable.)
On the other hand, under current law, tax rates are supposed to revert to the previous (higher) rates in 2026. So converting now could save money compared to waiting to take distributions later.
AJ
2 Likes
Hi thejusticier,
“in your hydraulic analogy, the balloon has to have enough pressure to push out some money to your passbook.”
It is a magic balloon (not like the one in the 1956 short film “The Red Balloon”). This balloon puts out a steady 45 psi from full to empty. So 5 gallons or 1 ounce in the balloon, 45 psi.
“When do you decide your reservoir (portfolio) is full to open the valve?”
Purely mechanical. If our last all time high was $563,701 and our close today is $571,332, a new high was set by $7,631 and I look through:
-
Condition of cash cushion, percent of target amount.
-
Available cash in the portfolio, percent of target amount.
If I believe I want to top off the cushion and I have cash available, I transfer cash to our savings account and log it as a withdrawal.
If I don’t have enough cash, I look at sale candidates for possible trimming.
It still boils down to a judgement call. I may not top it off. I might just send $20,000 instead of the $50,000 it is down and wait for the next all time high.
I balance the value of cash in the portfolio vs the need for the cash in the cushion.
If the cushion is low, like below 50%, I place more emphasis on getting more into it. If the cushion is at 90%, I might let it ride for a bit.
“do you ever pass money from your cash cushion to your portfolio?”
No.
When I get money, I usually use it to top off the cushion first. Depending on how much money remains after that, I may just add the remainder to the cushion, particularly if I have larger payments approaching like property taxes since it would be used shortly.
IIRC, over the last 10 years, our only larger cash income was 3 pipeline easements and 4 drilling/production 3 year leases and some 2 year extensions. In those cases, I topped off our cushion and put the remainder into our portfolio, logged as deposits.
“On converting IRA to Roth, wouldn’t you have to pay taxes on your capital gains incurred when in the IRA, right?”
There is no such thing as capital gains inside of a retirement account for taxes.
From traditional retirement accounts, all withdrawals are taxed as ordinary income. If the “account” has basis, tax paid contributions, then the withdrawals are partly tax free.
I say “account” above since each 401K/403B account is a separate entity, while every IRA account in your name is actually grouped as a single IRA. That is whole different discussion.
Retirement accounts are “black boxes” for taxes. Only one taxable event can occur inside a retirement account, UBIT, and it is rare since most people do not have sufficient assets to trigger it past the $1,000 threshold.
“when you left on this journey in 2005, did you use as you portfolio target to reach min 25X the revenue you thought you needed each year? and you left your job when you reached it?”
Kind of …
Using Quicken planner and a few online planners, I knew I had enough about 2 years before. I chose to wait a bit to pass the 55 threshold and get my little pension. And in 2004, DW had an all-expenses paid vacation to the garden spot of southern Iraq. When she got home, I was ready to leave …
Does that help you?
Gene
All holdings and some statistics on my Fool profile page
http://my.fool.com/profile/gdett2/info.aspx
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Retirement accounts are “black boxes” for taxes. Only one taxable event can occur inside a retirement account, UBIT, and it is rare since most people do not have sufficient assets to trigger it past the $1,000 threshold.
When holding MLPs (the most common trigger for UBTI) inside an IRA, that’s no longer correct. While UBTI generated annually may not pass the $1k limit for UBTI, the act of selling the MLP will often generate UBTI in excess of $1000. As long as the IRA could avoid selling the MLP, or moving it in-kind, generating that UBTI could be avoided. Now that IRAs must be fully disbursed, generally no later than 10 years after they pass to a non-spouse beneficiary, it’s no longer going to be possible to avoid that UBTI. So any IRA holding an MLP is likely to end up with a UBTI bill for the IRA at some point.
AJ
I have put already taxed money in the IRA. So I shouldn’t be taxed again on the principal, right?
I believe that’s correct… but there are caveats.
Ask your question on the Tax Strategies Board.
https://discussion.fool.com/tax-strategies-100155.aspx?mid=35108…
You’ll get superb answers there…
ralph
Hi thejusticier,
“I have put already taxed money in the IRA. So I shouldn’t be taxed again on the principal, right?”
This is correct as long as you filed IRS Form 8606 with your fed tax filing every year that you made the non-deductible contributions.
If you didn’t file the forms, you will probably have problems if you try to claim the basis on your IRA when you withdraw funds.
Does that help you?
Gene
All holdings and some statistics on my Fool profile page
http://my.fool.com/profile/gdett2/info.aspx
1 Like
I have put already taxed money in the IRA. So I shouldn’t be taxed again on the principal, right?
If you made after-tax contributions to a Traditional IRA, those form a basis in your IRA. Your distributions will be taxed on a pro-rata basis, with the percentage of the distribution representing the basis being tax-free, and the rest of the distribution being taxed at ordinary income rates, not capital gains rates.
Note: This assumes that you properly filed Form 8606 each year that you made the after-tax contributions. If you did not file Form 8606 for the contributions, then you need to dig up your records and file a Form 8606 for each year that you made after-tax contributions.
AJ
2 Likes
Hi Gene:
I have not done that and I think I have made some IRA contributions (in addition to my fully funded 401K) over the past several years.
Over that time period, I have used H&R Block’s TaxCut and it asks if I want to make after tax IRA contributions. I answer in the affirmative and put the max I can put according to the software. But I don’t recall seeing anything about filling 8606. Can this be done retroactively?
I don’t want to be taxed twice obviously.
tj
Over that time period, I have used H&R Block’s TaxCut and it asks if I want to make after tax IRA contributions. I answer in the affirmative and put the max I can put according to the software. But I don’t recall seeing anything about filling 8606.
Check your tax returns. If the tax software asked you about making after-tax contributions to your IRA, and you answered yes, it should have included Form 8606 in your tax return.
AJ
Check your tax returns. If the tax software asked you about making after-tax contributions to your IRA, and you answered yes, it should have included Form 8606 in your tax return.
And always print your tax returns - the whole works - and keep them around for a few years. Print-to-PDF counts if you have a designated place to put it and keep good backups including both an external-device backup and an off-site backup.
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you are both right.
I do have it.
Thanks,
tj
I do have it.
Be sure to keep a copy of the last Form 8606 you filed, even if you don’t do any more after-tax contributions. You will need it when you start taking withdrawals and/or doing conversions from your Traditional IRA.
AJ
Note: This assumes that you properly filed Form 8606 each year that you made the after-tax contributions. If you did not file Form 8606 for the contributions, then you need to dig up your records and file a Form 8606 for each year that you made after-tax contributions.
Does that necessitate filing an amended return, or just sending the form 8606?
I’ll have to check if we filed the form in the years we did after-tax contributions. Probably did, but I don’t want to assume anything. I relied on Turbo Tax, not an accountant. Which relies on me not inputting garbage (i.e. GIGO).
1poorguy
Does that necessitate filing an amended return, or just sending the form 8606?
You can just file the Form 8606, but you should probably include an explanation of why you are filing it. Note: The IRS can charge penalties for filing the form late.
AJ
Penalties on monies I’ve already been taxed for? That’s odd.
Probably just being paranoid, but I do want to be sure an 8606 is present every year we did this (which has been the past three or four years, at least).
1poorguy
Penalties on monies I’ve already been taxed for? That’s odd.
No, penalties for filing late.
Probably just being paranoid, but I do want to be sure an 8606 is present every year we did this (which has been the past three or four years, at least).
Yes, in order for the IRS to recognize the basis (i.e. already taxed contributions) in your IRA, there needs to be a Form 8606 filed for each year that you made those after-tax contributions.
AJ
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