maximum Indebtedness--simple questions

I'm sure this has been answered plenty, but my search function keeps sending me back to the Home page. Here's the question, then:
How to comprehend "maximum indebtedness" in the Assumptions section?
I realize that it is just a means for showing how to smooth the projections. But is it only theoretical-- how might it work in reality?
Let's say it takes $500,000 of maximum indebtedness to smooth discretionary spending/ consumption over the next 25 years, with the next 10 years requiring more money to reach that smoothing goal. Could the smoothing, then, be accomplished by borrowing from savings accounts, for example?
This is the hardest thing for me to picture-- to move it from the theoretical to the practical.
Let me know some ways to think about this. Thank you. Charlie

Comments

dan royer's picture

I think I follow you, so let me give it a shot. If you tell the program you are willing to go into debit, it will allow the Reg Assets to go negative and you'll be assumed to repay that amount at the rate of interest equal to the assumed nominal interest rate on your regular assets. In practice, it means that in those years where you see negative regular assets that you are going to the bank and getting a loan to cover that amount.

Dan,,, that helps, but just to clarify further-- why go to the bank? since there are funds stored in my savings, stocks, and SEP IRAs (and since I am over 65 and can withdraw money without penalty), can I not deplete funds from those accounts to cover those years of negative regular assets? Charlie

dan royer's picture

Yes, you can model "special withdrawals" from retirement accounts and this may cause the need to go into debt to go away. The default is "smooth withdrawals" from retirement assets, so if there are expenses that make a smooth living standard not possible, then an alternative to raising max indebetedness might well be to take some special withdrawals from retirement assets in a year or series of years--basically overriding the smooth withdrawals.

thank you Dan.

Charlie, be aware that special withdrawals are in lieu of smooth withdrawals, not in addition to. Whatever you enter will be the total amount withdrawn from that account in that year. That's not a problem. You just need to consider that in your plans.

Also, when you make special withdrawals, subsequent years in which smooth withdrawals resume will have lower smooth withdrawal amounts because the balance in your retirement accounts has changed. Again, not an issue, but it may have downstream ramifications if your regular asset balances are borderline. If you were already close to 0 in some future years, the lower smooth withdrawal may put you over that edge.

My goal when forecasting special withdrawals is to take only enough to keep the regular assets above 0. Any more than that and you're triggering premature income taxes, at least from regular IRAs. It's better to defer those income taxes and let your retirement accounts grow, unless you're forecasting higher income tax rates in later years.

Chris
A user

thank you Chris. I am closer to understanding this than ever.... an actual hands-on demonstration would seal the deal.... maybe a local user group, if such exist.

As a user I found paying for Dan's one-to-one personal service very cost-effective. I waited until I had some experience with the system and had gotten some questions answered online, as you're doing here. That way I already had my data stored in a mostly accurate manner and Dan could use it for illustration of concepts.

$175 per hour ain't cheap but it's a modest one-time expense that dramatically improved my understanding and use of the program. Dan is informative, patient and very flexible with his time.

I hope you find this useful.

What you are saying is clear... and I'm trying to use your way of modeling. But here's what I just wrote Dan:
I put the Borrowing amount to zero, thenI looked at the Regular Assets report and found two places where there were zeros (in addition to the last year). I made special withdrawals in each of those two years, but no matter how much I specially withdrew, the numbers did not budge from zero (nor did new zeros arise).
Two questions: 1) theoretically, if I have enough money in retirement/savings, shouldn't I be able to plug up those zeros with special withdrawals?
2) does the program allow for special withdrawals beyond the amount we actually have in our savings/retirement accounts? It seemed to do so.

Charlie

dan royer's picture

When there is "borrowing constraint" you see this in the model by looking at the Regular Assets report and noting that the balance goes to zero one or more times before your final year. This will show up on the Annual Suggestions report by as a kind of stair step pattern: one level of discretionary spending, then another higher level after that. One response is to allow the program to let you go into debt in those early years by borrowing money. But there are other ways to deal with it: take extra money out of your retirement accounts in those early years or reduce special expenditures, or stop contributing so much to retirement if you are doing that, or downsize a home so that the mortgage is a lower amount, or take SS sooner, or in some imaginative way get money out of the future and into the present. Some would just accept the constraint if it's not too bad and view it as a cushion in the future.

You didn't mention it, but bank robbery might be another alternative.

Dan, seriously your post is very helpful. So here's what I did. I put the Borrowing amount to zero, thenI looked at the Regular Assets report and found two places where there were zeros (in addition to the last year). I made special withdrawals in each of those two years, but no matter how much I specially withdrew, the numbers did not budge from zero.
Two questions: 1) theoretically, if I have enough money in retirement/savings, shouldn't I be able to plug up those zeros with special withdrawals?
2) does the program allow for special withdrawals beyond the amount we actually have in our savings/retirement accounts? It seemed to do so.

thank you. Charlie

Charlie, considering giving yourself a very generous borrowing capability, run the report, then look at where your borrowing kicks in. Those are the years in which you need to make special withdrawals.

The amount of the borrowing will approximate the amount of the needed special withdrawals. Add special withdrawals in those years until borrowing goes to zero.

Depending on the balances in your different account types (regular IRA, Roth, employer account, etc.) the amount of your special withdrawals may be constrained. Unfortunately ESP does not indicate to you that you don't have money available to withdraw, except by seeing that your withdrawals are less than you recorded that they should be. It also isn't smart enough to shift special withdrawals from one account type to the other, in the order indicated for smooth withdrawals, like it does for smooth withdrawals. (Some day, maybe. One can hope.)

That happened to me. I didn't realize ESP wasn't actually w/d'ing money when I told it to because previous w/d's had already exhausted the account balance. I had to shift my specified withdrawals from my regular retirement account to Roth IRA, after which ESP withdrew the entire specified amount and life was happy again.

Chris

dan royer's picture

Yes, I like Chris's answer above. Seeing the pattern with max debt cranked up can help you understand what the program "would like to do if it had unlimited resources."

But I also think that the problem you ran into may be that you created a special withdrawal in the same year you went to $0 in regular assets. I suspect an issue where the money is coming at the end of the year maybe when it's too late to help! There are beginning-of-year and end-of-year issues that crop up in different contexts in the program. So give yourself the money the year before you need it. Or here's what I typically do--not sure exactly how or why I find this makes sense to me, but this is what I often do:

Say I have constraint at age 70, the year SS kicks in--in that year, or the year before say, my regular assets drop to $0. Let's say too that my smooth withdraws from the husband and wife's retirement accounts have been 20K per year--beginning at age 65--and by coincidence they are the same amount, 20K.

So I might choose the husbands account and roll that up an extra 10K for five years so that I enter special withdraws of $30K from age 65-70. I run a report and see if that helps. If not I might do the same for the wife--or bump it to $35K etc. Of course I'll see the smooth withdraws that ensue after the "special period" be smaller than they were before.

This way I'm feeding my economy a little money each year for 5 years instead of all at once. This seems to me to cooperate better with the program's effort to smooth consumption.

Another thing I look at is taking one of the two accounts, say the wife's account, and start those withdrawals sooner than I would have. Say I start those at age 62 and then STOP them at age 72. This will compress those withdrawals into a shorter time span and thus raise the amount, thus helping to deal with the borrowing constraint.

I'm not saying what's tax efficient here or anything, I'm just pointing to strategies to experiment. But taxes this, taxes that: the bottom line is not only which discretionary spending pattern is highest (or most agreeable in the case where constraint comes into play) but also which pattern you are most comfortable with--which may not always be the highest. Taxes are often a big factor when you are fine tuning, but all of this is judged by which discretionary spending pattern is highest and most agreeable involving strategies you are comfortable with.

Chris and Dan, you guys are great. I'll be playing around with this more, based on your help and strategies. And given my advanced age of 65, and the fact that I still have teenage daughters who are quick to point out any lack of mental acuity on my part, I'll probably ask you these same questions in, say, one or two more years. For now, all is good (and one of my teenage daughters is off to college in the Fall--- let's see, that's $72,000 a year.... I better lower the age of my demise on ESPlanner.) Charlie

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