Retirement: Transitioning To The Distribution Phase - Complete? 3-Year Update

|
Includes: ABBV, APU, BIP, CLX, CNP, CSCO, CVX, DLR, ETN, HAS, JNJ, KO, LMT, MAIN, MCD, MO, MSFT, O, OHI, OKE, PM, RY, SKT, SO, STOR, T, UTG, VTR, VZ, WEC, WPC, XOM
by: Earl Setser
Summary

Update to our plan for retirement with diverse and changing income sources.

Summary of results and observations for the first three years.

Key retirement considerations discussion - what we've learned.

Dividend Growth Investing portfolio summary.

Introduction

I graduated from work over three years ago now, WOW how time flies. This wonderful event occurred in late January of 2016! Yes, I know this is commonly referred to as "retired", but I like "graduated" better. I consider it more of a moving forward step than a stopping step. As an electrical engineer, I like to say "I hung up my slide rule." We did well in investing and saving, as I was able to leave shortly after turning 60, and my wife was only 54. This update is for three years later.

This article is my third article on how things have gone. The first two articles covered the first six months and the first year - available here and here. My plan was to do a two-year update, but I never seemed to have the time until now. This article presents our basic financial situation and discusses how we have approached and possibly completed 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 maybe some new ideas from your comments. I have also included a section that summarizes my Dividend Growth Investing (DGI) portfolio and provides a snapshot of holdings and sector diversification to fill in data for that portion of our incomes.

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, but you get the idea. I have included a good amount of the data from previous articles but not a full accounting. This article will present the framework, but the previous articles (linked above) give a more detailed description of some of the detailed plans. Please use them as a reference if you desire.

The article has been split into major sections as follows:

  • Introduction
  • Income Overview
  • Status of Plan
  • Plan Changes Ahead
  • Retirement - Other Observations and Considerations
  • DGI Portfolio Composition
  • Summary

And here is the next section.

Income Overview

My wife and I have several different sources of income. To keep things interesting, the various sources kick in at various times as we age over the next 10 years or so. Much of this is complete now, but taking Social Security is still in the future. That means we haven't had a constant income to this point or going forward for a while longer. I believe quite a few readers will have similar issues, and I discuss how we have approached the situation. Here is a list of our income sources, and they will be discussed in further detail below:

Pension: Yes, I guess I'm one of the lucky ones to have a pension, an endangered benefit these days. For the pension, we selected a payout alternative that had higher payments through 62. This gave us a temporary boost for the first 22 months or so of retirement. The lower payout is in effect now. The idea was to get that extra payout prior to Social Security to help fill our gap. That is one example of how our income flow has/will change. The pension is now constant for my lifetime going forward.

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 retirement cash flow plan very nicely. This gives us another steady/constant monthly payment for the rest of our lives. Note these are fixed annuities and avoid many of the concerns you may hear about.

Dividend Growth Investing, DGI: I started moving to DGI in 2013 and it has been a good approach for us to date. Our goal now is to withdraw only the distributions from these accounts going forward. Call that one Plan A. In addition, we can use principal withdrawals to provide a fallback plan in case of critical needs for extra income. However, there is no plan to do so at this point, so you could call that Plan B. Note that the DGI portion of our income is the largest of the four income sources, so it does draw the major part of my attention as compared to the other items.

Social Security: I'm about 3 years from Full Retirement Age (FRA) 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 to date. 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 reserved some cash in our deferred accounts to provide the funds needed to fill the gap in income until Social Security. We have been taking some of the cash, per the plan and it is on schedule to last to my FRA time with some margin.

Overall budget: We have a planned budget going forward that was originally based on our pre-retirement spending levels minus known reductions. Our goal was to maintain our lifestyle and enjoy the free time as much as possible in the near term. This has worked out great and, generally, we are under spending the budget to date.

Status of Plan

Wow, it's been a while since my last update. Let's look at how things have worked out to date.

Income sources: Everything is going to plan. We transitioned from dividend reinvestment to taking partial dividends soon after retirements, and now to taking all of the dividends. We are taking virtually all of the dividends in my accounts, while we are leaving my wife's smaller dividend flow untouched. We can't really take distributions from her IRA accounts without penalties for several years, so that will be an income bump when she gets to 59 ½.

Income tracking: It's been interesting changing from bi-weekly paychecks from one company to monthly or quarterly income payments from multiple sources. The issue was more about tracking/planning than a real income impact though. At this point, the monthly payments seem the norm. I generate a spreadsheet each year with the plan for each income source by month and I update the sheet for actual numbers once per month or so. Updates each year are generally needed due to various changes, like medical insurance cost. But there have become relatively quick to accomplish. I keep one section for before-tax income to track all of the income sources and total up the taxable income as we go. I also do a section for after-tax dollars to compare against our planned budget. I have a separate sheet where I update each of the tax withholding payments as we go. That keeps us on top of our tax payments as well as total income status, and aids in planning for tax withholding during the year.

Budget: Our first year of spending was below our initial budget, but we've spent much closer to the budget since then. I guess we are getting more used to distribution instead of accumulation! The extra funds the first year provided the opportunity for a TIRA to Roth IRA conversion, that I discussed here. After the tax changes for 2018, I completed another conversion for last year to take advantage of the lower tax brackets. This is covered in more detail later in the article.

Dividends: Due to the initial higher payout for my pension, and lower spending early on, we continued reinvesting a good portion of our dividends in 2016 and most of 2017. After the pension reduction, we began to take distributions for the majority of our dividends as they are received. Starting midway in 2018, we moved to the plan of withdrawing virtually all of the dividends on a monthly basis.

Cash withdrawals: We planned to fill our income gap to Social Security with distributions from our accounts where we set some cash aside for that purpose. We didn't need the cash in 2016, so those withdrawals started in 2017. These are now a regular part of our income flow each quarter. This distribution allows nice flexibility to adjust taxable income for the year as it progresses.

I think that covers the highlights to date. We have had a great start, and it just seems to be the usual approach now.

Plan Changes Ahead

Looking ahead to the next few years, here are the remaining items that we expect to change:

Pension: No changes

Cash withdrawals: We expect to continue to pull a portion of this cash for expenses through at least my Social Security FRA. Our initial withdrawals trailed our initial plan by quite a bit, but the withdrawals have picked up recently. We look good to have a small margin left when I reach FRA. We will see how it goes.

Social Security: After reaching 62, I did a quick review of taking SS at 62 vs. FRA and I decided to stick with our original plan to wait for FRA. We will take a detailed look again when we get closer.

Medical costs: As I covered in my previous article, we selected a medical insurance option offered by my company retirement organization. The premiums were similar to an Obamacare Gold or Platinum Plan. In other words, quite expensive. However, the coverage was comprehensive and provided some advantages that we liked including 50 state coverage and keeping our doctors. This has worked out as expected, and we plan to remain on this insurance through Medicare for both my wife and I.

Dividend growth: As a Dividend Growth Investor, a key goal is to have a growing dividend stream over time. Over the last two calendar years, our dividend income has increased an average of 7.7% each year. This is lower than previous years with dividend reinvestment, as expected. We are still showing great income growth for these accounts.

Reviewing the longer-term plan, our first few years met our plan very nicely. We felt we had some margin in our planning and the results support that. Next, we will continue to have planned income adjustments going forward, with Social Security starting for me, and later for my wife. In addition, our medical expenses are likely to vary quite a bit through Medicare and beyond. However, our overall plan still appears sound and we are executing the strategy. Oops, a little "work-speak" crept in there I guess.

Retirement - Other Observations and Considerations

This section will cover some of the items that we/you need to deal with - i.e. tax withholding. I think this section was the most commented/discussed in previous articles, I've spent much of my time and effort on updating information to this section. In no particular order, other than what the last article had, here are some observations and considerations.

Tax withholding: My goal has been to cover withholding for Fed and State for each income source as we go. The goal was to avoid estimated payments by using withholding like I always did at work. This worked out well for the most part, but I have ended up with estimated payments for last two years. Given my experiences, I did some further research and wrote a SA article to detail what I learned about withholding vs estimated tax payments here. With this approach, I covered all of our tax payments with withholding for 2018 just fine.

Tax estimates: I generate a detailed tax estimate each year right after I complete my taxes for the previous year. I use that tax estimate to determine an expected tax percentage for Federal and State purposes and then I use that percentage as the goal for each income source. For example, if my overall tax load for federal tax was 15% last year, then I aim for 15% withholding for each income source. More importantly, I shoot for 15% for the total of all accounts during and at the end of the year. This is a little more involved than with one income source that I've had in the past, but really is just a matter of adding up the sources. As part of my income planning spreadsheet, I track the payments for each income source as I go and total the amounts to see how the payments are going to see if adjustments are warranted. Of course, tax estimates were a larger challenge for 2018 with all of the moving parts of the tax changes. But we should be relatively stable going forward. Well, okay, maybe for a little while? Please?

Pension withholding: 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. I have needed to adjust it at times to adapt to changes, but again, just like what I did when employed. Of course, there was a big change for 2018 based on the new tax brackets.

Annuities withholding: This was also the W4 approach. However, with two different insurance companies to deal with, it was somewhat of an ordeal the first go around. My first try 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, etc. to accomplish this. After two or three tries with each company, I finally got these adjusted at a good level. With the new tax brackets, one of these adjusted nicely by itself, while I had to update the other one. But it's pretty much on autopilot now.

DGI investment distributions withholding: Our tax deferred accounts are with Fidelity and they are very flexible on withholding for your distributions. You can select Federal Tax Withholding from 10%-99% in 1% increments and any percentage (I think) for state withholding. I would assume most/all brokerages offer similar choices. I just go in, select transfer, and set the percentage for each distribution as I take it out - easy-peasy.

Adjustments during the year: Since we have dividend distributions during the year and optional cash withdrawals as well, I still need to track the numbers and do an updated tax/withholding estimate if things change significantly. Basically, this is "adjust as needed". I've pretty much settled on using the investment distributions as the "dial" for adjusting the overall tax levels. If we need to increase our tax load by say one percent, I could leave the others alone and ramp up our withholding enough the cover all of the income sources. I like this since it gives me "one dial" to worry about for the most part. Longer term, if, or maybe I should say when, tax law changes occur, we may want to reset the W4s for each income source to at least be close to the expected overall tax levels. It's nice for me to see that withholding percentage is pretty much constant across income sources.

Roth IRA deposits: We made a nice Roth deposit during my retirement year based on income from working in January. I recommend this strongly if it works out! Since then, we have not received any significant earned income, so we don't qualify for Roth contributions. However, we need to remember that any earned income that we may have going forward should be pushed into our Roth accounts if possible. That's something we will watch for going forward and I suggest you consider as well.

Medical coverage before Medicare: As detailed in my last article, we made a medical insurance decision/change. We used COBRA as long as possible, but that was good for only 18 months. After reviewing our options, we selected a medical insurance option offered by my company's retirement organization. The premiums are similar to an Obamacare Gold Plan, but the coverage provided some differences that we liked. We expect to remain on this plan through Medicare for both my wife and I.

Health Savings Account: We changed to a Health Savings Account (HSA) eligible medical plan a few years ago. My experience has pretty much met my expectations from a previous article: "… I went through the HSA in detail and decided this was a great deal for saving taxes on medical expenses." We are basically using last year's contribution to pay this year's expenses - repeat. Of course, we will have to make this year's contribution to have funds for next year. Anyway, it's been great for us. If you haven't investigated this, I suggest you look into it for future healthcare insurance options.

Inflation: One key thing I did not mention above was inflation. We plan to have a 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 two sets of income cover about 70% of our income based on the latest numbers. The remaining income is not inflation adjusted and is expected to decrease in value with time. That means we will likely have some level of reduction in real income as time goes on. However, it should be well below the overall inflation rate. Looking forward at spending needs, we feel our retirement will follow the "3 phases of retirement" discussed at retirehappy.ca, here (and others). These phases are the Go-Go, Slow-Go, and No-Go phases. As we move through these phases, we expect our expenses 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. Also, we do have a lot of flexibility in our spending levels at this point, so we should have the ability to make adjustments easier than many.

401K withdrawal rules: The next couple of paragraphs are from my previous articles, and then the update follows:

Prior to retirement, I had read about the rules involved with withdrawals from our 401K after retirement. I knew that I could go to a website and move funds to a Rollover easily online while employed. But the rules seemed to indicate much less flexibility after retirement. Based on that expectation, I did an IRA rollover from my 401K just before my last day to allow easier access for cash I planned to withdraw in the short term. For flexibility, it probably makes sense to just go ahead and move all the funds to your IRA. However, 401Ks can have investment alternatives that aren't available in an IRA, so you should consider what you want to do with the investments first. In my case, the money I kept in the 401K is cash reserved to fill our income gap through Social Security. I kept it in the 401K to take advantage of the income portfolio that our 401K includes. The return seems to be significantly larger than similar options in my IRA or bank money market.

Reviewing the (plan) rules more, it appears I could request a lump sum, installment payments, or a combination when I am ready. But the decision is only once. It seems to be structured to figuring out your withdrawal plans for retirement and hitting the "GO" button. After some discussions with the representatives, it seemed I could set up the payments and then adjust those as needed. I guessed there was some semi-hidden flexibility built into my plan. It also seemed that the "plan rules" are specific to the companies plan documents, not the finance company managing the plan. The real note here is check into the rules for your plan before retirement and plan ahead for your best withdrawal strategy given possible changing withdrawal rules after retirement.

That was the text from the previous article. Now for the update and warning! Late in 2017, I needed to start distributions from my account and called to set up the "periodic payments" mentioned above. The representative said it looked good, took my data, and submitted it. It was rejected. I called and dug into what had happened. As it turned out, I had some company match funds for make-up contributions that I made in the account. My company's plan document doesn't allow periodic payments for this source. But, the plan does require ALL funds to be used if you select periodic payments, so all sources. That was Catch 22 for me. There was no way to do periodic payments because I had these company match funds. The representative was baffled and had no explanation on why the plan would have that exception. In the end, a lump sum payout was my only option. I rolled the remaining funds in my account to my IRA and found a money market account with competitive rates, not too far below what the 401K fixed income (Stable Value) fund was paying. The message is "watch out for the plan rules", not just the summaries you are shown. The rules in question were not covered in any of the documents the employees get. YIKES!

Minimum Required Distribution (MRD) planning: Here is the text from my original article. I left the discussion here since it summarizes my thoughts well and I think it's worth repeating. Updates follow this paragraph below:

I've learned quite a lot from Seeking Alpha on RMD approaches, primarily from the comment streams! 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 time frame 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.

Again, that was the text from my original article. In the end, we had a higher than expected gap to the top of our federal marginal tax bracket for 2016. This allowed us to make a nice TIRA to Roth IRA Conversion. I detailed the steps in an article previously referenced above. There is an illuminating comment stream within the article if you are interested in getting information on conversions. For 2018, I decided to make a larger Roth IRA Conversion given the new lower tax brackets, and I made a rather large conversion (for us) split into two transactions (Spring and December 2018). The final impact to our portfolio of the Roth conversions to date is as follows:

  • Tax Deferred accounts - reduced from 95% of investments to 83%, a 13% reduction.
  • Taxable accounts - reduced from 4.6% of accounts to 2.4%. Note we used for some of the conversion tax
  • Tax free accounts (Roths) - increased from 0% to 14% of our accounts.

Overall, this appears to be a 14% reduction of our future taxable income, and that comes off the top tax bracket. It also gives us more flexibility in our distributions by reducing our RMD by the same amount due to the smaller account balance. Of course, the taxes were paid now rather than later, and that can be helpful or not, depending on future tax rates. But I like the idea of having some diversification in the tax situation of my investment accounts. Our plan is to continue to use Roth conversions to reduce future RMD amounts as much as makes sense until we both reach the RMD age.

DGI Portfolio Composition

During the previous article, I had done a pretty large reposition of our Dividend Growth Investing (DGI) accounts and summarized some of the portfolio changes and reasoning. Since then, I've been quite happy with the overall composition and performance. I still find I need to sell a stock due to concerns here and there, or maybe add a desired holding that finally reaches a buy price. In fact, I've added DLR and LMT recently for this reason. But most of my more recent changes are taking some profits from large positions, or moving our sector concentrations around a little. Here is a snapshot as of late-January of my DGI holdings and sector allocations.

Sym

Description

Size

Sector

Sub-Indus

Size

CLX

CLOROX CO

Full

Cons Staples

Household Prod

11%

KO

COCA COLA CO

Full

Cons Staples

Soft Drinks

MO

ALTRIA GROUP INC

Full

Cons Staples

Tobacco

PM

PHILIP MORRIS INTERNATIONAL

Full

Cons Staples

Tobacco

HAS

HASBRO INC

Full

Consum Discr

Leisure Products

7%

MCD

MCDONALDS CORP

Full

Consum Discr

Restaurants

CVX

CHEVRON CORP

Full

Energy

Integrated Oil & Gas

10%

XOM

EXXON MOBIL CORP

Full

Energy

Integrated Oil & Gas

OKE

ONEOK INC

Full

Energy

Oil & Gas Stor/Trans

MAIN

MAIN STREET CAPITAL CORP

Full

Financials

Asset Mgmt & Cust Bnks

7%

RY

ROYAL BANK OF CANADA

Full

Financials

Diversified Banks

ABBV

ABBVIE INC

Full

Healthcare

Biotechnology

6%

JNJ

JOHNSON &JOHNSON

Full

Healthcare

Pharmaceuticals

LMT

LOCKHEED MARTIN CORP

Full

Industrials

Aerospace & Defense

7%

ETN

EATON CORP PLC COM

Full

Industrials

Electronic Comp & Equip

CSCO

CISCO SYS INC COM

Full

Info Tech

Communications Equip

10%

MSFT

MICROSOFT CORP

Full

Info Tech

Systems Software

STOR

STORE CAP CORP COM

Full

REITs

Diversified REITs

21%

WPC

WP CAREY INC COM

Full

REITs

Diversified REITs

OHI

OMEGA HEALTHCARE INVS INC

60%

REITs

Health Care REITs

VTR

VENTAS INC

70%

REITs

Health Care REITs

O

REALTY INCOME CORP

Full

REITs

Retail REITs

SKT

TANGER FACTORY OUTLET CTRS

60%

REITs

Retail REITs

DLR

DIGITAL RLTY TR INC

Full

REITs

Specialized REITs

T

AT&T INC

Full

Telecom Svcs

Integrated Telecomm

6%

VZ

VERIZON COMMUNICATIONS

Full

Telecom Svcs

Integrated Telecomm

BIP

BROOKFIELD INFRAST PARTNERS LP

Full

Utilities

Electric Utilities

16%

SO

SOUTHERN CO

Full

Utilities

Electric Utilities

APU

AMERIGAS PARTNERS L P UNIT LP

15%

Utilities

Gas Utilities

CNP

CENTERPOINT ENERGY INC

Full

Utilities

Multi-Utilities

WEC

WEC ENERGY GROUP INC

Full

Utilities

Multi-Utilities

UTG

REAVES UTIL INCOME FD

Full

Utilities

N/A, CEF

A quick look at the table and I see that REITs have crept back up above my goals, so I may want to look at some reductions there to see if can get them nearer 15%. Overall, I want a focus on Utilities and REITs to give good cash flow and stability, and then good diversification between most of the other sectors. I believe I'm pretty close to that goal at this point!

Summary

That finishes up my content for this update. I hope you found this helpful. Things have now settled to the point that I don't believe further articles on this particular subject are warranted. But I'm looking forward to the comments and feedback as always! Thanks for reading, and please feel free to provide any suggestions for future articles. Good luck investing and graduating!

Disclosure: I am/we are long CLX, KO, MO, PM, HAS, MCD, CVX, XOM, OKE, MAIN, RY, ABBV, JNJ, LMT, ETN, CSCO, MSFT, STOR, WPC, OHI, VTR, O, SKT, DLR, T, VZ, BIP, SO, APU, CNP, WEC, UTG. 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.