That is a lot to go through, I didn't make it through everything. A couple of thoughts:
I do not follow the logic behind Roth conversions at very high tax rates and then ending up with many years with zero taxes. I don't believe that's actually profitable. Is that really the plan Pralana suggested? Note that if you need long term care, LTC would be tax deductible but by pre-paying those taxes with Roth Conversions, you would be out of luck.
Why not a more tax efficient portfolio where you put your bonds preferentially in tax deferred? See the bogleheads.org wiki on tax efficient fund placement. Holding bonds preferentially in tax deferred works better because it matches the taxation of tax deferred as ordinary income with the taxation of the investment. That leaves more stocks for taxable where their primary growth would be taxed as LTCGs. You can model that with Mode 2-Advanced Portfolio Modeling in Pralana, though you should understand that direct comparison to Mode 1 is not reliable as it requires an adjustment in the quantity of bonds in tax deferred to correct for the taxes due on them and that's a very hard to pin down number that Pralana doesn't adjust for. That's also explained in the bogleheads.org wiki if you want to read up on it. A tax efficient portfolio inherently slows the growth of tax deferred and so reduces the need for Roth Conversions.
While you have no legacy goal, you have a partner that may be your heir and she would rather not inherit HSA money as the balance would be immediately taxable. Your stored up receipts become useless, or as my CPA put it, they fly off to heaven with you. So once you have to choose between HSA money and Roth money to spend, spend HSA money up to the limit of your medical receipts (which includes Medicare B and D costs).
The attempt to spend down your bonds in bad markets is not readily modeled in Pralana. Karsten Jaske (retired Fed economist) at EarlyRetirementNow.com did a study using monthly historical data and found that whether it outperforms a constant allocation is more a matter of chance than anything else. For every plan, there is a market that makes it a bad plan and a market that makes it a good one, you just don't know which you will get. Holding a constant asset allocation tries to steer you down the middle, avoiding the worst cases by not trying so hard to optimize things.
Thank you @ricke, This is helpful feedback!
Below are a few comments about some of the topics you brought up
Paying for LTC with Pre-tax accounts - I think that you're right that holding some $$s in my pre-tax accounts might help avoid tax expenses on the portion of LTC costs that are qualified medical expenses (~100% in nursing homes, ~50% in assisted living, and ~75% in in-home care). I'm currently ear-marking HSA funds for that purpose, but I think you're right that holding some funds in my pre-tax accounts would also help.
Holding Bonds in Taxable Accounts v. Tax preferred 401k/Roth - Thank you for spotlighting this topic and providing useful suggestions and references regarding how this can be improved. I will need some time to follow up on your suggestions and perform my own analyses.
About a year ago I briefly worked with a professional financial planner and I asked him this same question, whether I should hold my TIPS ladder in my 401k or my Taxable account, and he gave me the default answer that "holding your income bolds in pre-tax is better" just like you and I intuited, but when I made him do the analysis for me and show me exactly how much better it would be he was surprised to discover that holding the bonds in the pre-tax account was actually better, resulting in a Chance of Success that is a couple of percent higher.
- Why my financial planner told me that holding bonds in Taxable accounts was better for me
- If the choice is to hold new, incremental bonds in Taxable or Pre-tax/Roth accounts, then the Pre-tax/Roth account will win every time due to Tax Efficiency, however, that's not really the choice I face.
- Because I have a fixed amount of dollars available in my Pre-tax/Roth accounts, every Pre-tax dollar that I hold in bonds imeans that I hold one less pr Pre-tax dollar in Stocks.
- Upon running the numbers, we discovered that it was better for me to pay the higher income taxes from holding the TIPS bond ladder in the taxable account for 7 years rather than give up 50 years of Tax-free growth from having more Pre-tax/Roth dollars allocated to stocks.
Spending the HSA - Thank you, this is good advice. I didn't realize that medical receipts from HSA's become useless if the the HSA is inherited by a non-spouse. Wade Pfau commented in passing once that he expected his HSA heir(s) to benefit from his meticulous record-keeping of his medical receipts, and I didn't realize that benefit didn't apply to a non-spouse. I had been toying with the idea of using HSA to pay for Medicare Premiums or medical-related Long-Term-Care expenses, but your insight put greater urgency on this question.
Modeling Bond Ladders in Pralana - Thank you, I've read a decent amount of Karsten's work, but probably not on this topic. I'll go dig into it!
It's really a tragedy that NO consumer retirement planning software, including Pralana, has a good way of modeling a bond held to maturity. This makes it hard to properly test our bond related risk-hedging strategies.
Wade Pfau and Michael Kitzes have published some research on the topic of Bond Ladders v. Rebalancing fixed-allocation portfios and they concluded that DEPLETING BOND LADDERS (which create rising equity glide-paths) perform better than FIXED ASSET ALLOCATION PORTFOLIOS WITH REBALANCING. If I recall correctly, after further research Wade concluded that DYNAMICALLY ROLLING BOND LADDERS perform even better than DEPLETING BOND LADDERS and he published some optimal guidelines regarding when to role v. deplete the bond ladder such as: "If total real assets in your plan are greater than what they were expected to be at this point, then re-fund/roll your bond ladder. But, if your real total portfolio value is less than what it was expected to be, then do not re-fund/role the ladder, deplete it by 1 year." Wade also identified an approximate rule of thumb guideline that worked almost as well: "If your nominal portfolio value is above/below what it was at retirement, then Do/Do not re-fund the ladder."
Here's my version of the logic supporting supporting DYNAMICALLY ROLLING BOND LADDERS:
- 100% Equity Portfolios - Historically the highest average lifetime spending outcomes have come from 100% equity portfolios
- However 100% equity have high year-to-year volatility and taking withdrawals during bear markets can deplete the portfolio too quickly, leading to SORR and creating Chance of Success failures
- Therefore, we may choose to start with 100% equity portfolio and determine what adjustments should be made to reduce year-to-year volatility and SORR
- Fixed Equity/Bond Allocation Portfolios - The traditional approach to mitigating bear-market risk is to hold a fixed allocation equity/bond portfolios and re-balance annually (e.g. 60/40)
- However, a fixed allocation equity/bond portfolios creates a lifetime drag on expected return due to the lower expected returns from bonds than from equities
- A Bond ladder $$s << the equivalent $s needed for a fixed allocation portfolio
- e.g., perhaps a 40 year retirement with a 60/40 portfolio -> bond allocation $$s equivalent to a ~16 Year bond ladder)
- Fixed Duration, Depleting Bond Ladders - A fixed duration, depleting bond ladder represents can mitigate the bear-market risk by holding a fixed duration bond ladder of X-years.
- Of all the Bear Markets in US history, 85% have recovered within 8 years. Longest was 14 years.
- A fixed duration bond ladder is an extreme case of the bucket approach where you never refill the bond bucket. This may be the type of bond ladder that Carsten was researching, but I'm not sure.
- If the bond ladder duration is "short enough" then a fixed duration, depleting bond ladder can create less lifetime return growth drag than a perpetual fixed equity/bond allocation while mitigate the risk of bear markets IF the recovery comes before the bond ladder fully depletes (Years_for_Recovery < Bond_Ladder_Duration).
- A Fixed Duration, Depleting Bond Ladder creates a rising equity glide path as the the bond ladder "rung" years deplete every year.
- Holding a fixed duration bond ladder for 5-10 years at the beginning of retirement can provide "good" protection against SORR when using a fixed withdrawal spending strategy, because IF a bear market occurs in the first 5-10 years after retirement, then the bond ladder protects against SORR and over-depleting the portfolio during those down years. However, IF no bear market occurs in that 5-10 year period then by the end of if the retiree's portfolio should have appreciated materially and provide additional buffer against bear markets.
- Dynamically Rolling Bond Ladders - A dynamically rolling bond ladder improves on the fixed duration bond ladder a bit in that you start with an X-year bond ladder and only deplete the ladder "rungs" during bear markets / not-yet-recovered years. Otherwise, you "roll forward" the ladder.
- A Dynamically Rolling Bond Ladder creates a rising equity glide path as the the bond ladder "rung" years deplete during during bear markets / not_yet_recovered years
- A dynamically rolling bond ladder can offer "similar" protection to fixed equity/bond asset allocations or long-term depleting bond ladders, but at a lower cost
- A dynamically rolling bond ladder allocates fewer dollars to bonds than a fixed duration bond ladder providing lifetime protection
- Bond ladder duration X (e.g., 8 years) << A fixed duration bond ladder covering the entire lifetime planning lifetime (e.g., 40 years)
- AND
- A dynamically rolling bond ladder allocates fewer dollars to bonds than a fixed allocation (higher equity allocation)
- Bond ladder $$s < the equivalent $s needed for a fixed allocation portfolio
- e.g., perhaps a 40 year retirement with a 60/40 portfolio -> bond allocation $$s equivalent to a ~16 Year bond ladder)
- Bond ladder $$s < the equivalent $s needed for a fixed allocation portfolio
- A dynamically rolling bond ladder allocates fewer dollars to bonds than a fixed duration bond ladder providing lifetime protection
- Therefore Dynamically Rolling Bond Ladders offer good, but not perfect, protection against bear markets / long recoveries at a reasonable cost.
