I'm leaving my corporate job to be a brewmaster: What's the best way to tap into savings?
Q: I’m almost 60 years old and I need to get my financial affairs in order. I plan to leave my corporate job and start a fun new career as a self-employed brewmaster. I have a large 401(k) that I’ve been aggressively investing in equities. In the past, I’ve been able to ignore market fluctuations, but now I’ll need to tap it to create a paycheck. What should I consider doing now that my situation has changed?
A: Congratulations on your new career path and recognizing that this is a good time to modify your investment strategy. Equities have a long history of volatility and creating an income plan from another source may be very comforting should one of those testy downturns come along.
Recessions are unpredictable and have many different causes. As impossible as the COVID-19 recession was to predict, it also was the shortest on record. The Great Recession of 2007–2009 resulted in home prices declining about 30% and the S&P 500 fell 57% from peak to trough. This was not a good time to sell equities or real estate.
Adding fixed income as the foundation of your portfolio is a good diversifier and will likely provide some stability. Fixed income usually is not as volatile as equities or alternatives (such as gold, real estate, and cryptocurrency). Even so, 2022 showed that rare events do happen, as the intermediate-term bond market declined over 10%.
But after many years of low interest rates, we are finally seeing that trend reverse. Recently, five-year U.S. Treasuries and certificates of deposit (CDs) have been averaging about 4.3%. These investments mature on a defined date and provide income as regular payments.
Most 401(k) plans don’t offer individual bonds and CDs, but these plans usually allow a penalty-free in-service withdrawal at age 59 ½.
Be very careful when transferring out of a 401(k) plan and into a rollover IRA (individual retirement account). This must be done within 60 days to avoid income tax. Each employer’s plan is unique, and it’s best to call the third-party administrator for details and guidance.
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The rollover IRA is likely the better place to hold taxable laddered bonds to avoid generating 1099 income. While talking taxes, know that IRA withdrawals are going to generate ordinary income tax.
Currently, short-term interest rates are higher than long-term rates, which is known as an inverted yield curve. It’s counterintuitive to get paid a higher rate for committing to a shorter CD or Treasury, yet this is happening today.
When investing in fixed income, focus on credit risk and duration. These risks may be mitigated by choosing high-quality and short- to intermediate-term maturities. Review your marginal tax rate to focus on the best after-tax yield. This determines whether it makes sense to hold tax-free or taxable bonds. When in the 35% marginal tax rate, municipal bonds are usually more tax efficient than taxable CDs and Treasuries. Municipal bonds should not be held in IRAs.
Duration risk is minimized when bonds are held to maturity even though the value of the bond may fluctuate on the custodian’s statements. Bonds with lower interest rates show a lower value prior to maturity when the economy is in a rising interest-rate environment. That’s a function of supply and demand.
Bond-fund yields are often measured using the yield to maturity. Think of it as the internal rate of return considering the cash flow, purchase price, redemption value and coupon payments. When comparing different bonds, all these factors must be considered, especially as interest rates change and bond purchase prices fluctuate.
When making a career change and giving up the steady paycheck, high quality bonds and CDs add a level of certainty. Hopefully, this foundation of certainty can give you the confidence to move to your next chapter of life regardless of what happens in the economy.
Mary Baldwin, CFP®, is a fee-only financial planner at Buckingham Strategic Wealth in Indian Harbour Beach. Contact her at 321-428-4555 or mbaldwin@buckinghamgroup.com.
For informational and educational purposes only. Individuals should speak with a qualified financial professional based on their own circumstances to determine if the above is appropriate. The opinions expressed by featured authors are their own and may not accurately reflect those of Buckingham Strategic Wealth® R-23-6608
This article originally appeared on Florida Today: My new career as a brewmaster: How heavily should I tap into my 401k?
