transitioning from tax-managed saving to living on passive income

[Hamhock]

Certainly tax-deferred retirement options should be maximized first (although once one has >500K in retirement accounts, I don't see why it's time to focus on taxable accounts since one can't get to retirement money without significant penalty until they are at "traditional retirement age").

However, once tax-deferred retirement options have been maximized, my understanding is that taxable accounts should be filled with "tax-managed" and index funds to allow continued growth.

However, eventually the taxable accounts should be able to produce enough dividends to cover all living expenses.

When this happens, how does on transition form "tax managed" or index funds to income-producing/high dividend funds? Are you just supposed to sell your "tax managed" funds, pay the capital gains taxes, and then buy funds that give more dividends?

Thanks, HH

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[sazerac]

You can do that, either all at once, or bit by bit each year. One possibility is to put all interest / dividends / capital gains into the desired category, while always selling the undesirable category for living expenses.

If you are asking what we personally do, I found that one of the Vanguard Target Retirement funds matches my risk tolerance and asset allocation desires over decades of time, so I just put all of my taxable assets in one fund.

I reinvest all returns, and sell 1% of principal every quarter. It's a machine that will maintain a given lifestyle in perpetuity, even after I am dead.

It's such a turnkey system that I only read financial news or check stock prices every other year. Gives me time to focus on more important stuff like family and medical school.

 

[krl7044]

When you invest after-tax, even if you try very hard to implement a tax-managed strategy, you will still be paying taxes on your S&P dividends (15% rate), which historically are at around 2.5%, and income taxes on any bond mutual fund income if you use bonds to balance your after-tax portfolio. Also, if you diversify globally (as you should if you invest in stocks) as much as 50% of the emerging markets fund dividends might be taxed at your income tax rates. You will also pay capital gains if/when you sell, and rebalancing this portfolio can only be done using incoming contributions (because of capital gains taxes). So you might want to see if you can up your pre-tax contribution even more (using Cash Balance plan for example or having a cross-tested 401k plan with a maximum of $52k contribution), because for those in the high tax bracket, using tax advantaged accounts is probably going to win over using after-tax accounts.

If you really maxed out all of your pre-tax accounts (and depending on the size of your asset allocation inside your retirement plans) it might be a good idea to allocate a portion of after-tax portfolio to income-producing municipal bonds so that your transition from growth to income is seamless. In fact, municipal bonds might be a great idea because you pay neither income nor capital gains taxes (unless you sell early), and depending on which state you live (and your tax bracket), they might provide a better bang for the buck than having an after-tax portfolio. The problem with a target retirement fund is that it is balanced with bonds that are taxable, so they might not be the best choice for a portfolio while you are in a high tax bracket, and neither are they good for income, because you don't want to invest in an aggregate bond fund whose value (and income) fluctuates wildly. Using individual municipal bonds (and possibly CDs/treasuries, depending on your tax bracket and interest rates) will allow you a predictable stream of tax-free income (combined with some shorter-maturity taxable income from CDs/treasuries).