Retirement: Here We Go, Transitioning To The Distribution Phase - First Six Months

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Includes: APU, BIP, CLDT, CLX, CNP, CSCO, CVX, ETN, HAS, JNJ, KMB, KO, MAIN, MCD, MO, MSFT, O, OHI, OKE, PM, RY, SBRA, SO, T, UTG, VTR, VZ, WEC, WPC, XOM
by: Earl Setser

Summary

My plan for retirement with diverse and changing income sources.

DGI approach and our portfolio summary.

Summary of results and observations for the first six months.

Key retirement considerations discussion.

Introduction

I graduated from working last year. Yes, I know this is commonly referred to as "retired", but I like "graduated" better. As an electrical engineer, I like to say "I hung up my slide rule." I graduated shortly after turning 60, and my wife is 54.

This article will present our basic financial situation and discuss how we're approaching our transition from Accumulation to Distribution. My goal is to share some of my thoughts and observations to help those working towards this milestone. I also hope to get some good feedback on my thoughts and some new ideas from your comments.In addition, I've included a section that describes my general Dividend Growth Investing approach and summarizes our holdings and industry diversification at this point.

Note that I manage our investments, so I have attempted to use "I" for decisions on steps that I generally make and "we" for the overall portfolio and performance.

Income

My wife and I have several diverse sources of income. To keep things interesting, they kick in at various times as we age over the next 12 years or so. So it's not a constant income starting now and you will be able to see how this has impacted our plans. Here is a summary of our income sources:

  • Pension from work - We selected a payout alternative that has higher payments through 62. That is about the first two years for us. The payment will be reduced to a slightly lower, stable amount after that.
  • Annuities - We purchased a couple of immediate annuities to provide additional steady income throughout our lifespans. We used some non-DGI investment assets for this purchase and it filled in our cash flow very nicely. This gives us another steady/constant monthly payment for the rest of our lives.
  • Dividend Growth Investing - Our goal here is to withdraw only the distributions, at least near term. Longer term, we will have to see how things work out. I feel that principal withdrawals can provide a fallback plan in case of critical needs for extra income, but there is no plan to use that at this point. Further detail on the DGI portfolio is also included below.
  • Social Security - I'm almost 6 years from Full Retirement Age, and our present plan is to wait until FRA to take my benefits. We will likely wait the extra time for my wife to get to FRA before taking hers as well. That is the working plan anyway. Of course, we have almost two years until we need to really decide anything. We will be watching how things change/pan out in the meantime for our situation, our health and possible changes to SS rules.
  • Cash - We kept a cash sum in our deferred accounts that is our estimate of the funds needed to fill the gap between the incomes listed above and our needs until my Social Security kicks in.
  • Overall Budget - We have a planned budget going forward that is based on our recent budget minus known reductions. Our goal is to maintain our lifestyle and enjoy the free time as much as possible in the near term. We have been fortunate to this point, and the planned income supports the budget with some margin, so this looks good as a plan.

Immediate Approach/Plan

Wow, it's already been almost 6 months since I pulled the plug. Here is some more detail on our income sources for the first 2 years:

  • Pension from work - This one started right away after I left work.
  • Annuities - These started payments soon after retirement, so they are a normal part of our monthly income flow now.
  • Dividend Growth Investing - Given the larger pension payments we have for 2016 and 2017, our added income needs are a little smaller for these 2 years. We decided to stop DRIPing on about half of our DGI holdings for this timeframe. This was based on continued reinvestment for those holdings whose valuations are lowest in that timeframe. We withdraw the non-reinvested dividends on a quarterly basis so far.
  • Cash - We have cash in my TIRA/401K to cover our remaining budget shortfall for the time period through my SS. We designated an adequate cash amount to fill the gap assuming our budgeted spending, and SS starting at my FRA. The planned cash amount also bumps up in year 3. This along with taking full income on our DGI account will offset the Pension reduction that occurs after about 2 years.
  • Social Security - Not Yet

Dividend Growth Investing Details

Since this is the area where we are common to many Seeking Alpha readers, here is more detail on how I am using DGI. For background, I started my first DGI investment in March 2013. I have an "investing buddy" that was following Seeking Alpha closely and he recommended I look into it. I took a relatively small amount of my investment assets and tip-toed into DGI to see how it would work out for me. To get a good understanding, and develop my own process, I read a ton of articles, and really focused in on the names my friend recommended. In the end, I used David Van Knapp's ebook as a template for my approach selecting stocks and general approach. In addition, Bob Wells, Bob Johnson, Chowder and Chuck Carnevale as key sources of information, although I read quite a few more authors these days. I was quite pleased the with approach and my results, and moved a larger portion of my investments to DGI later in 2013 - catching a nice dip in the fall that was a great time to increase positions in several of my positions. Last year, in preparation for retirement, I increased our DGI investments again, and now DGI is our approach for our investments going forward. I have learned quite a lot since 2013, but I still consider myself a relative newbie compared to many of the Seeking Alpha contributors. However, I have written several articles to date and feel pretty comfortable with the basics going forward.

For stock selection, I use a numeric method based on David Van Knapp's approach to rate the various candidates. I covered the details in several articles with selections in early 2015. I break the rating into industry groups to make stock to stock comparisons. I think this is more meaningful since business approaches vary much between different sectors. I use the numeric rating to determine which candidates deserve a closer look. Then a do a deep dive into the stock, the prospects, the history, the business, etc. to determine which of the initial candidates go onto my watch list. I use F.A.S.T Graphs, Morningstar and S&P Capital IQ to determine fair value ranges, and go from there.

As I've added investment funds, my positions have grown. I decided that using about 30 positions seemed right for me, with the notes from Benjamin Graham in The Intelligent Investor having a strong influence. Looking back, I had about 10 positions after my initial purchases. As I added funds, this grew to about 24 larger positions by the end of 2013, and further to 28-ish positions that I now have. Here is a table of my present positions along with the sector and sub-industry.

Sym

Stock

Type

Sector

Sub-Industry Class

Size

Sector Portion

KO

COCA COLA CO

Stock

Cons Staples

Soft Drinks

Full

15.3%

PM

PHILIP MORRIS INTL INC

Stock

Cons Staples

Tobacco

Full

CLX

CLOROX CO DEL

Stock

Cons Staples

Household Products

Full

KMB

KIMBERLY CLARK CORP

Stock

Cons Staples

Household Products

30%

MO

ALTRIA GROUP INC

Stock

Cons Staples

Tobacco

Full

HAS

HASBRO INC

Stock

Consum Discr

Leisure Products

Full

7.1%

MCD

MCDONALDS CORP

Stock

Consum Discr

Restaurants

Full

OKE

ONEOK INC

Stock

Energy

Oil & Gas Stor/Trans

50%

10.7%

OKS

ONEOK PARTNERS LP

MLP

Energy

Oil & Gas Stor/Trans

50%

CVX

CHEVRON CORP

Stock

Energy

Integrated Oil & Gas

Full

XOM

EXXON MOBIL CORP

Stock

Energy

Integrated Oil & Gas

Full

O

REALTY INCOME CORP

REIT

Financials

Retail REITs

Full

17.1%

OHI

OMEGA HEALTHCARE INVS INC

REIT

Financials

Specialized REITs

Full

CCP

CARE CAP PPTYS INC COM

REIT

Financials

Healthcare REITs

10%

VTR

VENTAS INC

REIT

Financials

Healthcare REITs

Full

CLDT

CHATHAM LODGING TRUST

REIT

Financials

Hotel & Resort REITs

70%

WPC

WP CAREY INC COM

REIT

Financials

Diversified REITS

Full

RY

ROYAL BANK OF CANADA

Stock

Financials

Diversified Banks

Full

3.6%

MAIN

MAIN STREET CAPITAL CORP

BDC

Financials

Asset Management & Custody Banks

Full

3.6%

JNJ

JOHNSON & JOHNSON

Stock

Healthcare

Pharmaceuticals

Full

3.6%

ETN

EATON CORP PLC

Stock

Industrials

Electronic Components & Equipment

Full

3.6%

CSCO

CISCO SYS INC

Stock

Info Tech

Communications Equipment

Full

7.1%

MSFT

MICROSOFT CORP

Stock

Info Tech

Systems Software

Full

T

AT&T INC

Utility

Utilities

Integrated Telecomm

Full

7.1%

VZ

VERIZON COMMUNICATIONS

Utility

Utilities

Integrated Telecomm

Full

SO

SOUTHERN CO

Utility

Utilities

Electric Utilities

Full

21.4%

CNP

CENTERPOINT ENERGY INC

Utility

Utilities

Multi-Utilities

Full

WEC

WEC ENERGY GROUP INC

Utility

Utilities

Multi-Utilities

Full

BIP

BROOKFIELD INFRASTRUCTURE PARTNERS LP

LP

Utilities

Electric Utilities

Full

APU

AMERIGAS PARTNERS LP

MLP

Utilities

Gas Utilities

Full

UTG

REAVES UTIL INCOME FD

CEF

Utilities

CEF

Full

So that's where we stand as of the end of June. Looking forward, here are some further discussions.

Future Cash Flow Approach/Plan

As we move forward, we expect these changes in income:

Future Approach/Plan

As we move forward, we expect these changes in income:

  • Pension from work - A planned cut will occur near the end of 2017, and it will be steady after that for my lifetime.
  • Dividend Growth Investing - We will cease, reinvesting dividends, probably starting the first of 2018. We plan to take all of the income as distributions at that point forward.
  • Cash - Our cash accounts will fill the gap until I hit Social Security age. At that point, we would expect the cash total to be fully exhausted - at least that's the plan.
  • My Social Security - Start at my FRA.
  • Wife's Social Security - Start at my wife's FRA, about 5.5 years after mine.

So that's the income approach at a high level. Next, how is it going so far?

Status on the Approach/Plan

We have been plugging along for about 6 months now. There was a nice transition where we had a couple of paychecks coming in after my last day of work. Since our annuity checks started about a month later, these paychecks filled that gap very nicely. It's been interesting transitioning from bi-weekly paychecks to monthly or less income payments. Mostly, it's really been more about tracking/planning than a real impact though.

After a couple of months, we noticed the checking account balance trending lower and took our first distribution of dividends to catch our balances back up. I decided to try quarterly distributions to see how that would go. Our 2 nd quarter showed a similar reduction, especially after a vacation to Seattle, but the 2 nd distribution returned the accounts back to a good level. As noted above, we have some cash set aside for this year as well, but we haven't seen a need to pull any of that cash so far. That's a really nice surprise, and may allow for some Roth IRA rollovers later in the year. Anyway, we seem to be hitting our budget, and have not needed our planned margin to date. That's a very nice surprise. Maybe it's time for a new computer? So far, so good.

Other Considerations

This section will cover some of the items that we/you have to deal with - i.e. tax withholding. So in no particular order, here are some observations and considerations.

DGI Portfolio Composition- I have modified our portfolio holding more than usual in the last 6 months. There were a couple of tough business situations and a couple of dividend cuts that I wanted to deal with. I feel better with the portfolio now that these changes are made. Going forward, I expect I will look primarily to reduce risk, especially for the present income level, while watching for adequate growth. Our financial situation may have some impact as well, but income seems good to date .

Tax Withholding - My goal has been to cover withholding for Fed and State for each income source as we go. The plan is to avoid estimated payments by using withholding like I always did at work. This is working out fine, but is has been a little more challenging for some income than others - at least at the start.

  • DGI Investment Distributions - Our tax deferred accounts are with Fidelity and they are very flexible on withholding for your distributions. You can select Fed Tax Withholding from 10%-99% and any percentage (I think) for state withholding. I would assume most/all brokerages offer similar choices. I just go in, select transfer, and sets the percentage for each distribution as I take it out - easy peasy.
  • Pension Funds - This was much like at work where you set up a W4 form that gets you in the ballpark, and then adjust as needed to hit your numbers. Overall, it worked out pretty easy.
  • Annuities - This was also the W4 approach. However, with 2 different insurance companies to deal with, I ended up researching online, calling, emailing and mailing various forms and updates back and forth. It was interesting how each company had a totally different set of steps, forms, rules to accomplish this. After two or three tries each, I finally have these adjusted at a good level going forward.
  • Adjustments during the year - since we have dividend distributions during the year and another withdrawal of cash later in the year, I will need to do an updated tax/withholding estimate and adjust these later payments to get to the total withholding we want for the year - basically, adjust as needed. It seems I've been doing this at work forever, so again, just doing the normal monitoring and adjust as needed. I have been updating a spreadsheet each month with the totals since I do have withholding from at least 4 different income streams to total up.

Roth IRA Deposit - As it turns out, with a partial year of earnings, we can make Roth IRA deposits for both my wife and I for this year. I'm still trying to figure out where the cash for that is going to come from. Going forward, we are not expecting earned income of any significance. But, we are thinking any income that we may have going forward should be pushed it into our Roth accounts each year. This is a great idea to get a bit more in there, assuming any extra income isn't needed for expenses. So that's something we will watch for going forward and I suggest you consider as well.

Medical Coverage before Medicare - Oh boy, this one is tough. So far, we are using COBRA coverage to maintain our present medical plan/coverages, albeit at a relatively high cost. With two different states where we spend time and big changes year to year in our plans, our approach for Healthcare after COBRA is not clear. We plan to spend a lot of time near the end of 2016 to look at options and determine whether to pull the trigger on new coverage for 2017, or continue COBRA to the absolute last day (mid-2017). Either way, we need to come to grips with our options once the plan details for 2016 are available late this year. I have observed a lot of changes in the plans in our state year-to-year and I hope that things settle down a lot going forward. The one provider that seemed to have all of our present doctors in 2015 went out of business late last year and is gone. This one is really not settled by any means yet.

Inflation - One thing I did not mention above was inflation. We plan to have growing dividend income that exceeds inflation for the DGI account. So far so good for our DGI portfolio. For Social Security, we will be getting some level of inflation adjustments. Those 2 sets of income cover about 60% of our income, and they should be moving up at a fair level. The remaining income is not inflation adjusted, and is expected to decrease in value with time. That means we will likely have a reduction in real income as time goes on. Looking forward at spending needs, we feel our futures will follow the "phases of retirement" discussed at retirehappy.ca (and others). These phases are the Go-Go, Slow-Go, and No-Go phases. As we move through these phases, our expenses are expected to go down with time. In other words, given a gradual transition between these phases, we are expecting a moderate reduction in discretionary spending as we age. That will reduce our overall income needs (constant dollars) at some level. We believe the reduction in expenses will reduce the impact of inflation, and believe it will cover most/all of it. However, in the end we have a lot of flexibility in our spending, so we have to make adjustments as needed.

Minimum Required Distribution Planning - I've learned quite a lot from Seeking Alpha on RMD approaches, primarily from the comment streams! Bob Wells and I had a little back and forth on RMDs a few days ago! Since almost all of my investments are in tax deferred accounts, we plan to transition some of those funds to a Roth IRA prior to reaching RMD age. I've done analysis on various approaches and generally I can't make a good case for doing a rollover early assuming the same tax brackets and paying the taxes from the IRA accounts. However, I really like the idea of splitting my assets between tax deferred and Roth accounts for more flexibility and diversity. If nothing else, it should reduce the dollar amount of the RMD while our annual expenses are the same. The thought is this will help delay the timeframe where the RMDs start to exceed our income needs. I also feel it's a good idea to withdraw deferred income to reach a specific income level each year - probably to the top of my present tax bracket. The goal is to balance taxes year to year through the start of RMDs and not have a low tax year followed by a high tax year. If the selected income level supports some rollovers to a Roth without driving our marginal tax rate too high, then it makes good sense to me to take advantage of that. This could help reduce or delay the risk of RMDs driving higher tax brackets in the future. So it's really a matter of "hedging our bets" to some extent - probably small. I'll be working through the numbers near the end of the year to determine our approach for 2016.

Summary

Well, it seems like there were other key items that often come up, but they are escaping me at this point. Maybe I keep a list for future discussions. I'll have to consider whether another update is warranted early next year. To date, this has been a wonderful six months and we are very pleased with our decision to date. Income-wise, everything is running to plan and it's all very comfortable.

As for the article, let me know what you think. Thanks for reading, and please feel free to comment and provide any feedback/suggestions for this or future articles. And good luck investing!

Disclosure: I am/we are long ALL STOCKS MENTIONED.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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