Creating Another Retirement Income Stream - Physician on FIRE (2024)

What if I told you that there’s an easy way to create a healthy retirement income stream from assets well above and beyond the sub-2% dividends offered by many Vanguard mutual funds?

You might say that I’m foolish and that one should “never touch capital.” Hold your assets tight and live off of the proceeds.

As someone who no longer receives a regular paycheck, I can appreciate the concepts of passive income streams and cash flow. However, I also feel that people get hung up on terminology and fail to appreciate the tax implications of certain retirement income streams. And is it really spending capital if your balance remains higher than your cost basis? That’s a question for another day.

Today, I’ll show you how to automatically shift money from mutual funds held in a taxable Vanguard mutual fund or brokerage account straight to your checking account. Other brokerages may have similar options, but this is the one I use and am most familiar with. Be sure to stick around to the end for a slew of other retirement income streams I plan to have.

Creating Another Retirement Income Stream

Late in 2020, I officially separated from my employer (I was available as a “per diem” employee until then). Although I lost my hospital privileges, I gained the ability to begin drawing down my 457(b) as one retirement income stream starting in April of 2021.

When I first outlined my retirement drawdown strategy several years ago, the plan was to bridge the gap to age 59 1/2 with both my non-governmental 457(b) and taxable account.

I have elected to deplete my 457(b) with monthly draws between $4,000 and $5,000 over 4 to 5 years. Invested completely in Vanguard’s total bond fund, I anticipate having the account drained by the time the Tax Cuts and Jobs Act (TCJA) sunsets at the end of 2025.

I also realize that the tax code will very likely be changed before 2025, i.e. by the end of 2021, but I made what I felt was the best choice at the time when I set up the automatic withdrawals.

This 457(b) money is deferred compensation, and as such, is not technically mine until it is withdrawn, so I don’t want to drag out the withdrawals over decades. That seems risky. I also don’t want to take a lump sum or all of it over two years, as that could push too much income into the higher tax brackets, screw up my QBI deduction, and even phase me out of the child tax credits I’m finally getting now that the phase out income threshold is much higher than it was prior to 2018.

Why Automate Withdrawals from a Taxable Account?

I’ll start by saying that I have not yet done this. I currently have online income, but that may cease at some point. I also have some other truly passive income streams that I’ll outline below.

From a behavioral finance standpoint, I think there’s a real benefit to “setting it and forgetting it.” You could manually sell lots whenever you want, but I imagine it would hurt just a little bit each time you hit that “sell” button.

Just like making a few large lump sum contributions to a donor advised fund allows me to make hundreds of grants throughout the years without feeling the sting of parting with money each time, automatic withdrawals from mutual funds can take away the second-guessing and market timing that is bound to come with frequently logging in to sell shares to provide that retirement income stream.

Essentially, what you’re doing when setting this up is reverse dollar cost averaging. You’ll sell when the market is high, low, and everywhere in between. If the market drops exceptionally low, you could always choose to pause or cancel the withdrawals until the market recovers, as long as you’re not completely reliant on the periodic distributions to support your desired lifestyle.

A Step by Step Guide to Automatic Withdrawals of Vanguard Mutual Funds

Note that this is only an option for mutual fund holders. If you own individual stocks or ETFs, you cannot automate the sale of those in a taxable brokerage account at Vanguard. Other brokerages may have different policies.

To get started, log in to Vanguard. Then, navigate to My Accounts -> Profile & account settings.

On the right hand side, under “Banking and money movement,” you’ll see “Automatic withdrawal.” That’s the link you want. Click it.

This next screen is where the magic happens. You’ll select the mutual fund account or brokerage account that holds the mutual funds you want to withdraw from.

You’ll also choose where you want the money to go. I chose my checking account.

You choose the frequency of withdrawals and when you’d like them to begin. You can let them run indefinitely (or until the money runs out) or choose a specific end date.
I chose to have them start on my birthday, ending when I’m 59 1/2 years old and able to more easily access my tax-deferred accounts penalty-free.

Further down the page, you’ll select the mutual funds you want to sell from and how much you’ll sell each month / quarter / year or whatever you’ve selected.

I went with a total of $5,000 a month, spread out over each of my stock funds.

Continue, confirm, submit, and you’re all set.

How Much Should One Sell?

The answer is a complex one, and it depends on a number of factors, including your retirement spending needs, other retirement income streams, time horizon, and tax implications.

Obviously, you don’t want to deplete your funds prematurely. One way to do this is to conservatively assume that the funds won’t increase in value at all and sell no more than a percentage that will last your desired time horizon even with no capital appreciation.

For example, if you need 10 years of retirement income, withdraw no more than 10% annually. To stretch it out over 20 years, assuming no growth, take no more than 5% annually. 40 years gets you 2.5% withdrawals.

In my example above, I wanted the money to last 13.5 years from my 46th birthday to age 59.5. Since 100/13.5 = 7.4, I could withdraw 7.4% if the funds gained nothing over that timeframe. The account balance to sustain $5,000 monthly draws under the no-return scenario is $60,000 x 13.5 = $810,000.00.

A terrible sequence of returns could sink even that conservative plan, but it’s far more likely that there will be money left in the account at the end of your time horizon.

Tax Considerations

There are a few tax considerations for early retirees and “normal” retirees later in life.

Capital Gains Taxes

You won’t owe taxes on the entire withdrawal of appreciated mutual funds from your taxable account. You’ll only owe taxes on the gains you’ve had. Your cost basis (what you paid) is subtracted before calculating the capital gains taxes due when you sell.

Also, assuming you’ve owned the mutual fund for at least a year when sold, you’ll pay favorable long-term capital gains rates, which are 15% (plus state income tax where applicable) for most retirees, and could be as high as 23.8% for retirees with high taxable income.

This is a good reminder to also turn off any automatic dividend reinvestment plan (DRIP) on these funds. Since you want cash from them, you might as well collect the cash distribution that is fully taxed. This will also help you avoid any short-term capital gains, which would be taxed at ordinary income tax rates, that could result from using Average Cost as your cost basis.

You may also choose to change your cost basis from Specific ID (which is what you want when choosing to sell individual lots for tax loss harvesting and other purposes).

The ideal setup would be to double-check that all dividends are set to NOT be reinvested, but to be transferred to the settlement (money market) fund. Then, I’d set up the cost basis on all funds being sold automatically to Highest in First Out (HIFO). That way, you’ll leave the lowest cost basis lots to be sold last, deferring the tax as long as possible. If those low cost basis lots are never sold, they could receive a step in cost basis when inherited by heirs, and they would also be good lots to donate if you’re charitably inclined, as no capital gains taxes would be realized in that situation.

The 0% Capital Gains Tax Bracket

If your total taxable income is $80,800 or less, congratulations! Your capital gains (and qualified dividends) will be tax-free in 2021, assuming you’re married and filing jointly. Divide that taxable income by 2 if single.

There is a 0% capital gains tax bracket and it lines up pretty closely to the jump from the 12% federal income tax bracket to 22%. It actually lined up perfectly (with the cutoff for the old 15% federal income tax bracket) prior to the TCJA. In 2021, that jump in your marginal tax bracket happens with taxable income of over $81,050. Again, the number for single filers is half that amount at $40,525.

If, when all other taxable income sources are taken into account, you would be close to this mark with your automated withdrawals, you may want to do your best to stay under these marks.

If you do go over, it’s not an all-or-none scenario. Only your realized capital gains that exceed the cutoff will be taxed. Similarly, only the taxable income above $81,050 (or $40,525) will be subject to the 22% income tax rate.

You can view all of the tax brackets for 2021 here.

Affordable Care Act Subsidies

The Affordable Care Act (ACA), also known as “Obamacare” provides a subsidy in the form of a tax credit to help cover the cost of eligible health insurance premiums.

If your modified adjusted gross income (MAGI) exceeds 400% of the federal poverty line for your household size, you will not qualify. Earn less, and you can qualify for a subsidy that increases as your MAGI decreases.

The math is beyond the scope of this article, and Justin from Root of Good explains it better than I could. If you’re not in the 0% capital gains bracket or in the 12% marginal federal income tax bracket, you’re probably not going to qualify for much of an ACA subsidy unless you’ve got a bunch of kids living at home.

IRMAA

This one only affects Medicare recipients with a good amount of taxable income. Nevertheless, if you’re bridging the gap between Medicare eligibility at 65 and the maximum Social Security benefit at age 70, or you’re already receiving Social Security benefits, it’s worth considering.

As we’ve discussed before, Medicare comes with a number of fees.

One of them is your Medicare Part B premium. It covers things like medically necessary and preventive physician services, outpatient therapy, and durable medical equipment.

Married couples with a MAGI under $176,000 (and singles with a MAGI under $88,000) will pay a monthly Part B premium of $148.50.

Earn more than those figures, and your Medicare Part B premium increased by an Income Related Monthly Adjustment Amount (IRMAA).

As you can see, the monthly premium can more than triple as your income rises. If you’re close to one of these cliffs, you’ll want to pay attention to how your MAGI is impacted by any automatic withdrawals or any other taxable or partially-taxable retirement income streams.

Do-It-Yourself Tax Planning

When I was doing some end-of-year tax planning, I constantly updated the set of spreadsheets that helps me pinpoint the optimal tax strategy for me and my income sources. I did so right up until the afternoon of 12/31 when I received my last bit of online income and made one final donation of appreciated mutual funds to our donor advised fund.

It just so happens that this amazing tax planning tool is 15% off in the New Year for the month of January 2021, and the discount will be applied automatically when using our referral link. I don’t know of a better way to see how all of your income sources, deductions, and credits interact.

The Personal Finance Bundle from Kathryn Hanna, CPA actually does a whole lot more, but to me, it’s well worth it for the tax prognostication alone.

Additional Retirement Income Streams

I’ve got the 457(b) money coming from 2021 to 2025. I also have the option of setting up the automatic withdrawals from my Vanguard mutual funds as outlined above. Here are a few more sources of passive income to support my early retirement.

Social Security

In the distant future, I’ll presumably have some form of Social Security benefit, but at the moment, I’m 25 years shy of 70, which is when I’ll likely start collecting if the rules remain roughly the same. As I approach the second bend point in the Social Security benefit calculation, we should have something close to $50,000 a year in today’s dollars if I wait to collect until I’m 70. Of course, the rules and benefits will likely be different by the year 2045.

Real Estate Equity Deals

I am currently invested in a handful of real estate investments that give me equity and/or preferred equity.

I’ve invested in two ground-up equity builds in Texas viaCrowdstreet. Both are projected to generate returns of over 20% annually and be completed in 2023.

Another is a multifamily housing value-add deals via EquityMultiple. I recently had a similar investment via Alpha Investing go full circle after 20 months with an IRR of 45%.

I’ve also got shares in a luxury condominium via Republic Real Estate (formerly Compound). This will pay an annual dividend and, like the others, a return of capital plus upside when sold.

Finally, I have shares in Origin Investment’s IncomePlus Fund, which contains a mix of equity and preferred equity with the goal of 6% tax-neutral distributions and modest appreciation. I’m considering investing in DLP’s evergreen housing fund REIT, which has a very similar fund structure and goals.

Real Estate Access Fund

I invested in a fix-and-flip lending fund from DLP via Cityvest. This investment pays quarterly dividends of 10% or more, and I can expect a return of capital a few years down the line.

eREITs

All of the above (with the exception ofRepublic Real Estate) are reserved for accredited investors — those with a high net worth and/or high income. eREITs are available to any investor and the risks are reduced by pooling numerous investments like those above into one fund.

I have invested in funds fromDiversyFund,RealtyMogul, andFundrise. These provide quarterly dividends, and there may be capital appreciation from the projects in the funds, as well. Diversyfund has outperformed the other two by a significant margin (IRR just over 10%) in the 18 to 24 months I’ve been invested in these funds.

Farmland

Just like everyone needs a place to live, everyone’s got to eat. I’ve got my two acres of crop-producing farmland acquired viaAcreTrader(see myAcreTrader Review).

The farm I’m invested in is rented to a local farmer and I receive dividends from the proceeds. Like many of the other real estate investments, the plan is to eventually sell the property at a higher price than it was acquired, and I expect to turn a profit when the farm is sold.

Roth IRA

While it’s the last money I would touch, since it benefits from both tax-free growth and withdrawals, I could create a nice income stream from the investments in my Roth IRA.

The contributions can be withdrawn penalty-free since I’ve had a Roth IRA for more than 5 years, and the earnings will also be available to be withdrawn without penalty when I’m 59 1/2 years old.

401(k) / Rollover IRA

I’ve got a 401(k) from my past employer and an individual 401(k) at Etrade. I can leave the money where it is or some day move the balances to a rollover IRA. Either way, the tax-deferred dollars will be subject to required minimum distributions at age 72 based on current law. At that point, these accounts become the source of a government-mandated retirement income stream.

There’s a decent chance I’ll reduce the size of these account balances with Roth conversions over the years. That, however, is a topic for another day.

I’m looking at quite a few different retirement income streams, and it’s good to know I can easily set up my Vanguard mutual funds to be yet another stream of automated passive income on top of the dividends the funds spin off.

What retirement income streams do you have? Would you consider automated withdrawals from your taxable account. Why or why not?