Motorhome Retirement May Update: 72(T) Explained
Summary
- We had positive cash flow in May.
- The 72(T) is an IRS-allowed method to withdraw from an IRA before 59-1/2 without the 10% early withdrawal tax.
- The portfolio is performing slightly better than the S&P 500 in 2020 through May.
Introduction
Followers of my articles are aware that we planned to retire in July of this year at the age of 54. Our original intent was to not use any of our tax-deferred retirement accounts until we were 59-1/2. However, we had to change the plan due to uncertainty of the future of the Affordable Care Act. A federal judge ruled the law unconstitutional in December 2018. To plan for the potential disappearance of the healthcare exchange and associated benefits, we need to get access to some of our IRA funds. We created a 72(T) withdrawal plan from one of our IRAs in January of this year. An additional benefit of this was that it allowed us to retire in March of this year instead of July.
With this series of monthly update articles, I hope to inform readers about aspects of early retirement as we live ours. These articles will include:
- Monthly cash flow summary
- Status update of the IRA account from which we are withdrawing funds via a 72(T) SEPP exception
- My stock watch list with target prices
- Dividends received
- Dividend increases announced by any holdings
- A brief overview of what we have been doing
We retired on a Friday to start our “Motorhome Retirement” and the United States went into social distancing and all the related COVID-19 stay-at-home and business closures the following Monday. We had great timing (sarcasm) - instead of heading out across the country, we did our “shelter-in-place” or “stay-at-home” or whatever else you want to call it at a lake campground near Dallas, TX. Like most others, our activities were limited to daily walks, weekly trips for groceries and TV watching.
What we’re doing now
States began opening in early May, so after two months at the same campground in Texas, we finally hit the road. For the most part, national parks were still closed and developing plans for re-opening, so we did not head to Mt. Rushmore and Yellowstone in May. Instead, we went to visit family in Kansas and Missouri. We stayed 10 days at a State Park in Kansas and another 10 days in the driveway of family. We did a lot of grilling and BBQing. We had 3 family events and grilled up hamburgers, hot dogs, brats and sweet corn cobs to go with them. We put on my dad’s favorite music app and broadcast it on our Bose portable speaker and were able to visit more than we have been able in years. We also went out to eat a few times. We went to Minsky’s Pizza on our 30th anniversary, and our daughter took us out to eat at her favorite Mexican restaurant for an early Father’s Day celebration. Now we are back in Texas and will head north to Mt. Rushmore and Yellowstone in mid-June. I managed to snap the photo below at the State Park campground in Kansas.
Sources of Income
We fund our Motorhome Retirement in four ways. In addition to the 72(T) account, we have standard (non-IRA) brokerage account invested similarly that generates income. There is also minimal income from blogging, under the heading of “other.” Finally, we plan to spend down some of our cash savings. To summarize the income streams:
Motorhome Retirement funding sources
- 72(T) Account distributions
- Dividends and interest from brokerage account
- Minimal “other” income
- Savings spend down
The table below shows our cash flow for the month of May.
Cash Flow | |
Income | May |
Income from Investments | $ 4,370 |
Other | $ 2,231 |
Total Income | $ 6,601 |
Expenses | $ 3,047 |
Net increase (decrease) in cash | $ 3,554 |
Some of the May expenses are prepaid campground fees for June and July. To keep it simple with campgrounds, I log it in the month it is paid. There is one 10-night stay and a deposit for another 10-night stay in those expenses. Even so, our costs are lower than anticipated because we could not really do much except hang out. We project our ongoing income to average around $4,000-4,500. It has been higher because Mrs. GrayBeard is providing support to her previous employer until her replacement is hired and trained. While it has been nice having the extra income, we have always expected that we will draw our cash savings down until we get to either 59-1/2 or 62.
What is a 72(T)?
Rule 72(T) is a way to make distributions from an IRA account using “Substantially Equal Periodic Payments,” or SEPP, without incurring the 10% penalty for early withdrawal. Investopedia says the following:
Understanding Rule 72(T): Rule 72(T) actually refers to code 72(T), section 2, which specifies exceptions to the early-withdraw tax that allow IRA owners to withdraw funds from their retirement account before age 59½, as long as the SEPP regulation is met. These payments must occur over the span of five years or until the owner reaches 59½, whichever period is longer."
So, under this exception, one can withdraw money from an IRA before the age of 59-1/2 without paying the 10% early withdrawal penalty. To qualify for the exception, the distributions have to continue for at least five years and they must be "substantially" equal. There are three calculation methods the IRS has approved to calculate the amount of the withdrawals. These are amortization, annuitization and RMD (required minimum distribution). I chose amortization, mostly because it is the least complicated of the three. The factors that go into this calculation are account balance, interest rate and life expectancy. The interest rate is based on the Federal Mid-Term rate. The life expectancy is a look-up in an IRS table.
There are some drawbacks. Making the calculation of the distribution requires factors determined IRS tables, and it is not always clear which table is appropriate for a given situation, so it can be confusing. If an error is made or if the withdrawals do not go the required length of time, the 10% penalty is due on all of the withdrawals. Many avoid using this exception due to these rules. In fact, many financial planners and most brokerage firms will not calculate this for you for fear of backlash if done incorrectly. Indeed, we were going to avoid it as well if possible, but we have decided to go ahead with it due to the uncertain healthcare environment. Better that than to delay retirement.
The 72(T) IRA Portfolio
I am not just going to load the portfolio up with higher-yielding dividend growth stocks. I will implement a portfolio strategy that will meet our needs while maintaining a reasonable asset allocation. Given the recent activity of the Federal Reserve Bank and the multi-trillion dollar stimulus package from the US government, I have added gold to the allocation for protection in the event of inflation. The target allocation now looks like this:
- 65% common stocks and preferred stocks
- 10% gold
- 25% bonds
Having bonds and gold will depress the total yield of the portfolio and make obtaining a 4.5% overall yield unlikely without taking more risk than we can tolerate. To plan for this, the bond allocation will be split into 6.25% long-term, 6.25% intermediate-term and 12.5% short-term. The heavy weight of short-term bonds is to have something to sell because the portfolio income will not enough to make the required distribution to fund the distributions.
Current Allocation
The portfolio has been under construction and is a work in progress. The current allocation is shown below.
(Source: Author)
Motorhome Retirement 72(T) account 2020 progress
January | February | March | April | May | |
Beginning Balance | $100,000 | $99,364 | $94,448 | $87,320 | $92,521 |
Dividends | $181 | $143 | $328 | $198 | $135 |
Gains & (Losses) | -$817 | -$5,059 | -$7,103 | $5,356 | $2,414 |
72(T) Distribution | $0 | $0 | -$353 | -$353 | -$353 |
End of Month | $99,364 | $94,448 | $87,320 | $92,521 | $94,717 |
The 72(T) distribution was calculated using the January 1 balance. Distributions began in March. Note that the values have been prorated so that the account balance on January 1, 2020 equals $100,000. The amounts are not the actual amounts, but they do represent the exact performance, on a percentage basis, of the account. So far this year, we have taken 1.06% of the beginning account balance in distributions, and the account value is 94.72% of the beginning balance, or down 5.28%. When considering distributions, the portfolio performance is down 4.22%. For reference, the S&P 500 was down 4.97% for the year as of May 31, 2020. The sequence of return risk is a real one right now for us.
We need to be careful to manage allocation to combat it. The rules of the 72(T) will require only 5 years of the constant withdrawals. After 5 years, they may be different depending upon multiple factors, including healthcare law changes and other income needs. We will also be old enough at that point to draw from our other IRAs without penalties. I conducted a Monte-Carlo Simulation of this allocation on Portfolio Visualizer and it showed a 96% chance of lasting 30 years with this allocation and draw rate. I am satisfied with this, as I have flexibility on the withdrawal rate after five years.
During the month, I added Johnson & Johnson (JNJ) and Kimberly-Clark Corporation (KMB). I had sold some shares earlier in the year at higher prices and bought back the same dollar amount in June. I had a net add of 5 shares of JNJ and 1 share of KMB in the exercise. While both were purchased at lower prices than I recently sold them, they are still above my fair value estimates. I also added shares of AT&T (T) at $28.86, which is below my fair value estimate and target price. I also sold shares of the iShares Core Total USD Bond Market ETF (IUSB) to raise cash.
Obtaining the target allocation will take some time. The allocation is not set in stone either - if the market continues higher, the equity allocation may be reduced, and if the market goes significantly lower, it may be increased.
What’s in the portfolio now?
During the rally from the March lows, some equities were sold and allocated to cash and gold. I anticipate that the market will drop again, as I believe the market has now bounced too high for current and forward economic realities. The cash position will be invested if valuations become attractive.
The following table details the account holdings in terms of value percent and income percent.
Motorhome Retirement 72(T) Account Holdings
Ticker | Credit rating | % Value | % Income | Type |
KMB | A | 6.9% | 8.6% | Stock |
JNJ | AAA | 5.2% | 5.8% | Stock |
A+ | 4.8% | 4.0% | Stock | |
AA- | 4.6% | 5.6% | Stock | |
BBB | 3.9% | 5.0% | Stock | |
A- | 3.4% | 6.7% | Stock | |
A+ | 3.6% | 5.1% | Stock | |
NR | 3.7% | 5.0% | Stock | |
BBB | 3.1% | 4.8% | Stock | |
A | 3.0% | 4.1% | Stock | |
BBB+ | 2.4% | 1.9% | Stock | |
A | 1.7% | 1.3% | Stock | |
BBB+ | 1.7% | 4.6% | Stock | |
BBB+ | 1.5% | 2.5% | Stock | |
A+ | 1.4% | 1.8% | Stock | |
A | 1.7% | 2.0% | Stock | |
AA | 1.5% | 3.8% | Stock | |
T | BBB | 1.0% | 2.6% | Stock |
BBB- | 0.6% | 0.9% | Stock | |
BBB+ | 0.4% | 1.3% | Stock | |
BBB+ | 0.2% | 0.3% | Stock | |
BBB | 0.1% | 0.4% | Stock | |
BBB | 0.1% | 0.2% | Stock | |
BBB | 0.6% | 1.3% | Preferred Stock | |
9.5% | 7.7% | Bond - Short | ||
2.5% | 2.2% | Bond - Short | ||
1.2% | 1.3% | Bond - Intermediate | ||
1.1% | 1.1% | Bond - Intermediate | ||
IUSB | 1.2% | 1.4% | Bond - Intermediate | |
4.7% | 3.8% | Bond - Long | ||
4.0% | 2.9% | Bond - Long | ||
6.3% | 0.0% | Gold | ||
4.3% | 0.0% | Gold | ||
Cash | 8.3% | Cash |
The average credit rating of the stocks is "A". The average equity yield is 3.5% and the total portfolio yield is 2.5%. Overall, I am satisfied with this portfolio. I know it will not supply the needed income, but I can add to the income with strategic purchases and I can withdraw cash or sell the short-term bond component when needed to cover distribution.
Dividends
Dividends were received from the following companies in May:
72(T) IRA Account | Non-Qualified Account |
SBUX | |
HRL | |
ABBV | ETPRE |
EPD | ETPRC |
IUSB | EPD |
NEAR | |
SCHZ | SPTL |
SPTL | MINT |
SPAB | VZ |
TLT | T |
MINT | |
VZ | |
T |
Dividend Increases
The following dividend increases were announced in May:
Dividend Increases | |||
Ticker | New | Previous | % increase |
CAH | $ 0.49 | $ 0.48 | 1.00% |
The only announced increase in May was Cardinal Health (CAH) with a small increase. Exxon Mobile normally increases the dividend in the second quarter, however this year the company maintained its dividend. XOM has not lost its Dividend Aristocrat status and should have until 2021 Q4 to increase the dividend before losing the status.
Watchlist
The table below is a portion of my watchlist spreadsheet.
Motorhome Retirement Watchlist
Ticker | Price | S&P Rating | Price Target |
JNJ | $ 146.10 | AAA | $ 134.00 |
$ 187.73 | AAA | $ 120.00 | |
CSCO | $ 47.73 | AA- | $ 36.00 |
$ 118.16 | AA- | $ 95.00 | |
RY | $ 71.96 | AA- | $ 53.34 |
$ 49.09 | AA- | $ 38.70 | |
$ 199.03 | AA- | $ 120.00 | |
$ 160.05 | AA | $ 116.00 | |
$ 36.58 | NR | $ 26.00 | |
MMM | $ 166.14 | A+ | $ 120.00 |
$ 45.51 | A+ | $ 34.00 | |
KO | $ 49.71 | A+ | $ 43.00 |
$ 166.93 | A+ | $ 125.71 | |
$ 308.88 | A+ | $ 183.00 | |
$ 90.98 | A+ | $ 62.00 | |
$ 131.44 | A+ | $ 108.00 | |
$ 92.03 | A- | $ 75.00 | |
$ 41.95 | A- | $ 37.00 | |
$ 37.59 | A- | $ 30.00 | |
$ 60.27 | A- | $ 51.20 | |
ADM | $ 42.78 | A | $ 28.80 |
$ 90.95 | A | $ 65.00 | |
$ 139.19 | A | $ 90.00 | |
EMR | $ 68.89 | A | $ 40.00 |
HRL | $ 48.01 | A | $ 30.00 |
$ 135.04 | A | $ 118.55 | |
KMB | $ 137.95 | A | $ 115.00 |
$ 100.89 | A | $ 84.00 | |
$ 121.78 | A | $ 70.00 | |
$ 110.00 | A | $ 84.00 | |
$ 126.37 | A | $ 88.00 | |
T | $ 33.01 | BBB | $ 29.00 |
BEP | $ 49.37 | BBB+ | $ 36.00 |
$ 85.80 | BBB+ | $ 66.00 |
I am not in a big hurry to bring the stock allocation up to target. A stock trading below the price target does not mean I will automatically buy it. As discussed previously, I think there is a considerable probability the market drops from current levels of around $3222 for the S&P 500 as of the time of writing. I may make small buys but will wait till the market drops or the COVID-19-related health and economic issues are resolved before I become aggressive.
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Comments (89)
As always, there are rules to this such as 1) It can only be from the 401k from the employer you separated from at 55, and 2) it cannot be used to roll into an IRA [2]. But it does not require the SEPP calculations and risks stemming from that.I am intentionally waiting until the year I turn 55 to separate and retire so that I could have access to these funds, even though I do not plan to use them.
UP[1] This rule comes from Internal Revenue Code 72(t)(2)(A)(v), which states that the 10% additional tax for early distributions does not apply to any distributions that are “made to an employee after separation from service after attainment of age 55.”
investingtothrive.com/...
financialducksinarow.com/...
[2] Reference: IRS Code §72(t)(2)(A)(v)
I went back for a look and see that I commented on that article too. Thanks so much for allowing us a little peek under your retirement planning tent. Good luck in your RV adventures.
UP
PS. I enjoy the vicarious travel by reading your posts and look forward to doing some when I retire
Best of luck and happy travels.
GBR
- We didn't skimp in any way, but only ended up spending $33k for the year we took off (not including capital cost like buying the RV). This included a cruise, a long weekend at a Spa, going to the movies, a couple flights back to Silicon Valley for things like Christmas, etc. Surprisingly it actually cost us less to live in an RV traveling around the country than it did to live at home.
- Don't ignore the rare county RV parks and other out of the way places to camp. For example the small RV Park on Puget Sound near Joyce, Washington had a 180 degree view of the Sound from your RV. Another one somewhere in Oregon near where they make Tillamook cheese was basically a flat grass area on a beautiful estuary you paid like $10 a day to park on. Since we were fully self contained, it didn't matter that there were no hookups and the place was both empty and gorgeous.
- Chamber of Commerce supported visitor stations are a fantastic resource for what to do and check out in the area. The first thing we would typically due after parking the RV in a new area is to take the tow car to a chamber of commerce visitors center. They are usually staffed by a local retiree who can tell you, this is a great microbrewery where you can hang out at the bar and meet people, here's a nice hike or bike ride you might like, you got to check out.....
- Don't make anything more than a rough schedule of where you want to go and what you want to see. We used a large Atlas marking a dot on each place we wanted to go, then started to connect the dots. No timeline at each dot. We'd see anything within about an hour drive using the tow car, or fun mobile as we called it. Then when we felt we'd done everything there was to do and see in an area, we'd move on to the next dot. Sometimes it was a couple days, sometimes 4 weeks+, we never really knew or cared how long we were going to stay. No timeline is a huge advantage, enjoy it.
- I'm not sure we ever made a campfire. Instead we walked around saying hi to others who had. Invariably someone invited us to join them. We met some great people this way, and enjoyed some wonderful conversations.