Sunday, November 19

Week 333 - $175/wk For An IRA That Uses DRIPs Backed By Savings Bonds

Situation: If you don’t have a workplace retirement plan, then you most likely have concerns that you won’t have enough savings to support retirement. You should be able to replace at least 85% of your final year’s salary by withdrawing 4%/yr from your retirement savings, which amount is increased in subsequent years to allow for inflation. But the median Social Security payout only replaces 46% of median household income. If you don’t have a workplace retirement plan, you’ll have to set savings goals, eliminate non-mortgage debt, and start cutting costs long before retiring. For example, move to an apartment after your children finish high school.

Most of us don’t think about allocating money to Savings Bonds and an IRA until we’re 50. So, let’s be realistic. How much could you augment your retirement income by contributing the maximum $6500/yr starting at age 50 to an IRA consisting of Dividend ReInvestment Plans (DRIPs) for stocks, and backing that up by contributing $2600/yr to tax-deferred Inflation-protected Savings Bonds (ISBs). You’d be saving $175/wk ($9100/yr), which is 15% of median household income for 2016 ($59,039). This plan is approximately one part Treasury Bonds and 2 parts stocks. Over the past 20 years, the lowest-cost S&P 500 Index fund has returned 7.0%/yr. The lowest-cost intermediate-term investment-grade bond index fund (composed mainly of the same 7-10 year US Treasury Bonds used for ISBs) has returned 5.4%/yr. Overall return for the 2:1 private retirement plan would have been 6.5%/yr, but 2.1%/yr of that would have been lost to inflation. 

Starting at age 50, IRA contributions of $6500/yr to stocks in a DRIP IRA, and ISB contributions of $2600/yr, would have built up a private retirement account worth $314,101 by the time you retire at age 67. Spending 4% of that in your first year of retirement would add $1047/mo to the $2260/mo provided by Social Security, if you and your spouse have a the 2016 median household income of $59,039. A complicated formula will determine your exact benefit, so start learning the basics. 

Mission: Develop our standard spreadsheet for 6 DRIPs using stocks issued by companies in the FTSE High Dividend Yield Index, specifically those that grow dividends 8% or more per year. In other words, pick stocks from the Extended Version of “The 2 and 8 Club” (see Week 327 and Week 329).

Execution: (see Table). 

Administration: To augment your Social Security income by using a private retirement account, you’ll need to build an IRA for stocks that is backed by Inflation-protected Savings Bonds (ISBs). Make sure your accountant declares to the Internal Revenue Service that 6 DRIPs above represent your IRA, noting that annual contributions to those will not exceed $6500/yr unless the US Treasury raises the contribution limit. 

We have used high-quality stocks instead of index funds in our example above, given that index funds are now thought to carry the same risks as other derivatives. 

Bottom Line: It is practically impossible for you to fund your retirement without contributing at least 15%/yr to a workplace retirement plan for 25+ years. The private retirement plan outlined above envisions contributing the maximum amount allowed for an IRA, supplemented by Savings Bonds, to channel 15% of your income into tax-deferred savings for the 17 years after you turn 50, which is when you can start making the largest annual contributions to your IRA. But if you’d started that plan 17 years ago (when you were 50), you’d now receive ~$1050/mo in your first year of retirement, which is less than half your Social Security check.

Risk Rating: 5 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold = 10).

Full Disclosure: I dollar-average into all 6 stocks, as well as ISBs.

"The 2 and 8 Club" (CR) 2017 Invest Tune

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