Frugal Couple Plots Their In-Retirement Portfolio Withdrawals
On the to-do list: getting ready for RMDs and taking steps to deploy a huge cash stake.
Investing Specialists
Glenn and his wife, Toni, are a great example of the peace of mind that can come along with a frugal lifestyle. At 70 and 65, respectively, the couple lives on their combined Social Security and pension income, which supplies them with $4,800 a month. They haven't yet had to touch their $500,000 nest egg, which Glenn has been assiduously building up with income from consulting jobs since he was, as he put it, "forced into retirement" 12 years ago.
The pair have no debt and own their own home, which they downsized into several years ago, and their two daughters are grown and living on their own. Glenn notes that they'll soon need to replace their 11-year-old car, which has 140,000 miles on it; he intends to pay cash for that purchase, but there are no other major expenditures on the horizon. His and Toni's retirement goals? Travel, volunteering, and staying physically fit. "Basically, we try to be productive and still enjoy what life has to offer."
That's not to say that Glenn doesn't have concerns, however. Although he doesn't worry too much about outliving his assets, he notes that his and Toni's health-care-related costs have been on the rise, and health insurance premiums now consume 8% of their combined pension and Social Security income. Should those costs drift higher, they'll have to begin tapping their investment portfolio.
Glenn also concedes that their portfolio probably includes too much cash, but he likes the security blanket, noting, "I am concerned about the ability to recover from unexpected financial disasters like the 2008 crash." He also hasn't been particularly enthused about the performance of his invested assets, writing, "I feel like my invested money needs to work harder." Finally, Glenn regrets that he hasn't paid sufficient attention to matters of tax efficiency and asset location: With required minimum distributions on the horizon, he'd like to reduce the drag of taxes on his take-home return.
The Before Portfolio
This couple's portfolio is split into several different components. They each have traditional IRAs as well as 401(k)s from former employers. They also have a taxable portfolio, consisting of a huge slug of cash as well as several Vanguard funds and a smattering of individual dividend-paying stocks and exchange-traded funds.
Glenn's largest IRA holding is an equity-indexed annuity, a product that provides a fixed rate of return plus a return that's linked to a market index. These are often costly, always complicated products, as discussed in this article. In addition, he holds a range of mutual funds within the IRA, including more Vanguard holdings. Toni's 401(k) includes several index-based offerings from TIAA-CREF; her IRA holds Vanguard STAR (VGSTX). From an asset-allocation standpoint, the annuity has both stocklike and bondlike characteristics, so the total portfolio isn't nearly as light on fixed-income exposure as it might first appear. (In contrast with a variable annuity, this type of annuity won't experience equitylike losses, but its returns will be more muted than pure equity holdings.)
The After Portfolio
Job one for the portfolio makeover is to consolidate their 401(k) holdings into their IRAs. Their 401(k)s have decent holdings, but rolling over those assets to their Vanguard IRAs will allow them to streamline while also keeping costs nice and low. In addition, 401(k) plans often carry fees that IRAs do not have.
Glenn will soon be required to take minimum distributions from his IRAs, so the next job is to figure out from where those distributions will come. Given that he would like to defer distributions from the annuity for as long as possible, he'll need to carve out a pool of more liquid assets with the rest of his IRA. Vanguard Short-Term Bond Index (VBISX),
Vanguard Total Bond Market Index (VBMFX), and
Vanguard Inflation-Protected Securities (VIPSX) provide core fixed-income exposure. The short-term fund can be first in the queue for RMDs, and Glenn can periodically refill the short-term bucket as he takes his RMDs. Meanwhile, Vanguard High Dividend Yield Index , the ETF version of which they hold in the taxable portion of the "before" portfolio, provides high-quality equity exposure for distributions that are further into the future. Because Toni won't have to take RMDs for another five years, Vanguard STAR, which holds 60% in stocks and the rest in cash and bonds, is a fine no-fuss holding.
The "after" portfolio calls for enlarging their fixed-income exposure, but with the Total Bond Market and TIPS funds, in particular, I would recommend doing so over a period of months to avoid adding to bonds at what in hindsight was an inopportune time. (This article discusses strategies for those enlarging their bond stakes right now.) Because they'll face a substantial surrender fee to unload the equity-indexed annuity, which they purchased in 2008, I've left that position intact; Glenn notes that their goal is for their granddaughter to inherit the annuity.
Holding Market Value ($) Weight (%) Star Rating Glenn IRA: Vanguard Total Bond Market Index (VBMFX) 37,000 7.03
Within their taxable account, deploying their sizable cash hoard should be a priority because once inflation is factored in, all that cash is a losing proposition right now. (The health-care costs that Glenn is concerned about have historically run even higher than the general inflation rate.) Moreover, any cash needs above and beyond what their pension and Social Security income will provide will largely be covered by Glenn's RMDs from his IRA; thus, the couple doesn't need much liquidity in their taxable account, save for a fund to cover planned expenditures, such as their new car, as well as unplanned ones.
Rather, they should think of their taxable assets as the growth engine of their portfolio. Glenn notes that he's "a conservative to moderate value investor," and the current market volatility should supply some opportunities to put the cash to work in stocks at reduced prices. That said, Glenn says he doesn't relish overseeing individual stock holdings, so I think it's preferable to use funds to do the heavy lifting for him. Vanguard Dividend Growth (VDIGX) makes a superb core equity holding for an in-retirement portfolio: Manager Donald Kilbride aims to buy high-quality companies at reduced prices, a strategy that syncs up well with Glenn's own. And the fact that the fund focuses on companies that have increased their dividends, rather than ones with dividends that are high in absolute terms, means the fund hasn't been much less tax-efficient than a total market index fund.
Vanguard Selected Value (VASVX) provides exposure to companies further down the capitalization ladder to augment the mega-cap-dominated Dividend Growth. Because those two core domestic-equity funds lean toward the value side of the Morningstar Style Box, I included a small stake in Vanguard Total Stock Market Index (VTSMX) to provide a modicum of exposure to growth equities. Finally,
Vanguard Total International Stock Index (VGTSX) provides a dash of overseas exposure; Glenn and Toni's portfolio was light on foreign stocks before.
Data as of May 14.
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