Q. I have around $1.2 million, mostly in equities. My house is paid for. There will be around $300,000 in company profit sharing when I retire, and that has been my ace in the hole for the conservative portion of my investments. If I were to retire soon, what would you advise doing with the $300,000? - J.C., by email from North Arlington, TX
A. With a $1.5 million nest egg, your starting withdrawal rate should be between 4 percent and 5 percent, preferably 4 percent if you are retiring under age 65. That’s $60,000 a year.
One way to prepare for retirement at any time is to build a ladder of fixed-income securities that will mature in 1,2,3,4,and 5 years. As each security matures, replace it with a new 5-year security.
The ladder approach, by the way, is also a good defense against uncertain interest rates. Yields are now so low that making long-term commitments is dangerous. But with a 5-year ladder you’ll have an average maturity of about 2.5 years.
As I write this, Bloomberg.com indicates that the yield on a 5-year Treasury is 2.87 percent, while the yield on a 2-year Treasury is 2.04 percent and the yield on a 6-month T bill is only 1.53 percent. Basically, you’ll earn twice as much as a money market fund with very little increase in risk, particularly since you are never more than 12 months away from a maturity.
Although building a ladder involves some effort (first creating it, and then replacing the maturing security each year), it allows you to distinguish between market risk and what might be called “life risk”--- the risk of bad events in your life.
If you own a short-term, fixed-income mutual fund, you’ll always be subject to market risk--- the possibility that interest rates will increase and reduce the market value of the mutual fund portfolio. If you create a fixed-income ladder, on the other hand, you may never need to sell an individual security at a depressed value because a security is always about to mature at par value. Even if you have an extreme need for cash, your risk is reduced because you can sell the shortest maturity, the next shortest security, etc. If you find yourself in a situation that requires liquidating the entire ladder, the threat that you are facing will dwarf any issue of financial loss.
Q. I have a variable annuity with Vanguard valued at $370,000 with a cost basis of $110,000. It is in my living trust. At my death I have instructed that it be gifted to my charitable remainder trust, which will be used as a foundation for qualified Native American education.
Could I make partial gifts each year now (less my cost basis) and avoid taxes by balancing the yearly gift level to my annual income taxes? My 2007 1040 tax bill was about $3,500. ---B. K., by email from Dallas, TX
A. Sorry, that won’t reduce your current tax bill. When you withdraw money from a variable annuity, it is taken out on a last-in/first-out basis. That means you’ll take out $260,000 of taxable income before you get to take out non-taxable original principal. So if you withdrew, say, $30,000 for charitable gifts, that amount would be added to your taxable income.
You can avoid paying any taxes on the withdrawn amount by making a $30,000 contribution in the same year. Basically it will be a wash.
There are two important caveats here. First, your itemized deductions need to exceed the standard deduction BEFORE you make the charitable contribution. Otherwise, some portion of the charitable contribution won’t benefit from an offsetting tax deduction. Second, depending on how much other income you are spending, your charitable gift is likely to trigger the taxation of some Social Security benefits.
This is the kind of move you make AFTER you spend some time with a tax accountant.