My spouse and I have 401(k)s and we are considering building a TIPS ladder in one 401(k) as a liability matching portfolio and an all equity portfolio risk portfolio in another 401(k). I need some help with how we can model this in Pralana where:
1. I can specify treasury ladder expected returns for one 401(k) and an equity index for another
2. Have Pralana prefer cash flow withdrawals from the 401(k) that has the TIPS ladder only (constrained by the overall withdrawal order with taxable, TD, and Roth)
3. Only consider the 401(k) with the risk portfolio when optimizing for Roth conversions
Is it possible to do this?
You are asking for something pretty complicated, so I'm going to give a complicated answer - the short version is Pralana is not really designed for that, but is powerful enough that you can approximate it with some work on your part. I doubt anything else you can buy will have enough power to even get you close.
When making projections based on fixed input values of returns and inflation, there is no difference between TIPS and other bonds. They will work out the same on a real basis (technically TIPS will trail by the amount the market demands for you to shift your inflation risk to someone else, so you could account for that by calling it a couple tenths of a percent of "management expenses" for your TIPS in your 401k on the Financial Assets -Asset Classes and Allocation tab). On the Home tab, stick with one value for inflation, adding another would cause a re-pricing of TIPS vs. nominal bonds that the program can't handle.
Since TIPS are just bonds in this "model world" of fixed returns and inflation, on the Financial Assets-Management tab, you select the account withdrawal order, tell the program to spend down your 401K before your spouse's. When you study Roth Conversions (Analysis-Roth Analysis tab), you select your spouse's account to convert.
Depending on what you are trying to do with your asset allocation over time, the program may still struggle to give you sensible answers. The program has two asset allocation modes - Mode 1, Asset allocation at the account level and Mode 2 - Asset allocation of the overall portfolio with selection of asset location. It sounds like you want a third way of holding different things in different accounts and a rising equity glide path as you spend down your TIPS.
If you try to model Roth Conversions while holding different allocations in different accounts using Asset Allocation Mode 1 (allocation at the account level), the program will see an advantage in doing Roth Conversions to quickly spend down the bonds in your 401K because that allows it to quickly switch to holding stocks - that effect can be much bigger than the one you are looking for of tax arbitrage, so the prediction of how much Roth Conversion to do can be wildly high. You can partially correct for this by looking at your portfolio allocation and re-setting the account allocations up to four times to try to bring it back in line. To make a fair comparison, at the start and at each of the four re-sets, you would set your asset allocation below the target portfolio allocation and then let it rise above target about the same amount and then re-set it back to below target again. In the Old Days of Pralana, before Asset Allocation Mode 2 came along, I used to do this, but it was very, very time intensive and required lots of fiddly work.
The alternative is Asset Allocation Mode 2, (User specifies Overall asset allocation and Target Asset Location). For this, you set a fixed overall portfolio allocation and as you spend bonds down in your 401K, the program will add bonds to your spouse's IRA to keep your portfolio allocation constant. This takes care of the program snooping for a way to get higher stock allocation, but wasn't really intended to have a changing allocation. It allows you to change allocation targets once, so you can approximate a glide path by having half the time at one extreme and half the time at the other. If, say, you want a rising equity path from 40% stocks to 60% stocks over your 30 years of retirement, you can approximate the glide path by setting the allocation for 40% stocks for 15 years and 60% stocks for 15 years.
Neither the Historic Sequence nor Monte Carlo analysis modes are built to handle TIPS or any individual bonds or changing maturities since the market of any given bond is heavily influenced by maturity and inflation expectations at the time. The program just uses summary information of two asset classes, not the level of granularity needed for spending down a ladder of TIPS in varying inflation and market environments. I'm not aware of anything you can buy that does that.
@ricke , thank you for the detailed reply. I will try out your suggestions and learn from it.
