Depletion Bucket

This post will revisit an idea we have touched on a few time before. The textbook order from which retirees "should" draw from is taxable accounts until depleted, then traditional IRAs until depleted and finally Roth IRAs. Frequently, they never get to the Roth and that can be part of the estate. This has to do with taxes and RMDs but it is very generic. There are countless circumstances where someone should take a different path.

The idea today focuses on the circumstance where the retiree is willing to deplete their taxable account because they want to let their Social Security payout grow or maybe want to wait until they have to withdraw from their IRA or maybe have to wait for their pension to kick in. This sort of circumstance probably wouldn't be too many years unless someone in their mid-50's had their hand forced with their work (layoff or health issue). 

We'll work with what starts as $250,000 in a taxable account that will take $25,000 out annually where the retiree in question is willing to deplete the account. Let's say this person is 61, just retired, prefers to delay starting Social Security until age 70 and will take RMDs at 73 but could take IRA withdrawals earlier if the taxable account depletes. 

I chose Global X S&P 500 Covered Call ETF (XYLD) and Global X NASDAQ 100 Covered Call ETF (QYLD) so that we could get a full ten year backtest. Putting it all in the SPDR T-Bill ETF (BIL) depleted after 9 1/2 years. If it matters, I actually built the withdrawal to be $6250 per calendar quarter. 

Portfolio 1 includes an S&P 500 index fund to provide a little, regular equity market growth. XYLD and QYLD haven't come anywhere close to keeping with with plain vanilla market cap weighted indexes. With dividends reinvested, they have captured half the S&P 500 for the last ten years and without reinvesting they have compounded negatively. 

After ten years you can see how much is still in each portfolio. Even Portfolio 2 which compounded negatively and with a 10% withdrawal rate might still have four more years of life in it. Even VBAIX is in very good shape for a bucket that only needed to last for nine years. 

The portfolios were very successful versus needing to last nine years but of course they benefitted from a strong stock market. It was up nine out of eleven full and partial years, there was a third year where it was barely up which is all pretty close to the rule of thumb about the stock market having an up year 72% of the time. It compounded a little higher than average in that time at 11.32%.

The risk I am getting to in the above paragraph is that stocks don't do as well as they did in the previous ten years. That's tough to model in Portfoliovisualizer, please leave a comment if you know of a way, so to stress test the idea, we can increase the income from $25,000 up to $35,000. When we do that, Portfolio 2 depletes after eight and a half years, VBAIX depletes after nine years and two months and Portfolio 1 depletes at nine and half years. If this depletion strategy had been implemented with putting it all into the S&P, with the $25,000 withdrawals, the balance would have grown to $296,000 and with $35,000 withdrawals would still have $65,000. 

When I had the idea for this post, it didn't occur to me to just put it all in an index fund. I figured that some version of the portfolios we build with the covered call funds would work. Putting it all into an S&P 500 index fund would run into trouble if the period in question included a 2008 when the index cut in half. Also the capital gain potential isn't that much better than one of the depletion portfolios we build because the derivative income funds often include returns of capital which of course are not taxable on the front end but they do lower your cost basis. There are now so many different types of derivative income funds that it would be possible to diversify strategies to take a little less risk. 

It is worth pointing out that all of the dialog about 4% withdrawal rates is built around sustainability over a normal retirement duration which most people peg at around 30 years, at least that is the typical timeline for planning purposes. Talking generically, for someone for whom a depletion bucket makes sense, they are leaving their IRA alone for some number of years to keep growing. In our example, if the depletion bucket lasts for nine years, that could reasonably be enough time for the equity allocation to increase 50-100%. Since 2014, the S&P 500 has almost tripled so 50-100% for the equity portion of a diversified portfolio is not insanely unrealistic. Yes, there is absolutely the possibility that the period that someone needs to do this looks like the 2000's or maybe David Kostin of Goldman Sachs will turn out to be right about 3% annualized growth over the next 10 years. But what retirement plan doesn't need some level of resilience in the face of some sort of adverse market sequence? 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.