Get With The Plan: April 19, 2009

Mac and Sue have seen a lot of economic change in their more than 70 years.

Markets that have gone up. Markets that have gone down.

But now that they’re retired and need income from their savings, they’re not sure what to do in the current economy.

“Our main goal is retirement income,” says Mac, 74.

Mac and Sue, whose names have been changed, have set aside all of their savings in liquid assets: $420,000 in Treasurys, $150,000 in money markets, $90,000 in Certificates of Deposit and $109,154 in an IRA (with an underlying investment of a money market).

The Star-Ledger asked Vince Pallitto, a certified financial planner and certified public accountant with Summit Asset Management in Florham Park, to help the couple create an income strategy.

“They consider themselves conservative investors and rightfully so, when two-thirds of your retirement income and lifestyle is depending on your nest egg,” Pallitto says.

The couple’s problem is they are too conservative, and their portfolio after taxes is yielding less than half the annual inflation rate. That means, like many retirees, they are losing purchasing power every year.

Pallitto says Mac and Sue need about $40,000 a year from their portfolio to maintain their current lifestyle. To reach that income level, their investments would have to earn an average 5.25 percent to avoid tapping into their principal.

He says most money markets, CDs and Treasurys yield less than two percent, so the couple will need to add some risk to their portfolio.

“Most income with capital preservation asset allocations have 15 to 20 percent invested in equities, with the balance spread over various bond classes and durations,” he says.

Mac and Sue say they’re not enthused about annuities, but Pallitto says that kind of investment could be the best way for them to increase income without increasing risk exposure. Rather than a fixed annuity, Pallitto says they might be better-served with a variable annuity with a guaranteed income or guaranteed withdrawal rider.

The other challenge they face is tax efficiency. Pallitto says they’re paying about $5,000 a year in federal and New Jersey taxes.

“If you think about it this way, they are receiving about $20,000 a year from Social Security and paying $5,000 back,” he says.

The key to a successful plan, he says, is to understand your opponents or obstacles. Taxes and inflation are obstacles to retirees. He suggests setting up a cash flow strategy for the next five years, then investing the balance of their assets in a variable annuity with a guaranteed income rider. This would reduce or eliminate their tax liability and help them keep up with inflation.

First, their other assets: Pallitto recommends shifting most their $100,000 IRA from money market funds to a combination of high-quality corporate bonds funds, preferred stock funds and REIT funds. An additional $200,000, or five years of their living expenses, could go into a laddered CD strategy: invest $5,000 per month in one-year CDs and $5,000 per month in two-year CDs, so that in one year a CD will be maturing every month, and that could be rolled into a two-year CD at that time. By the time the second year rolls, they’d have two-year CDs maturing every month.

“If interest rates increase, this strategy will allow them to keep up with rising yields,” he says.

Pallitto would then split the remaining $80,000 between money market funds and short-term municipal bond funds.

Finally, the big egg: $460,000 in a variable annuity with a guaranteed income rider. The funds could be invested in various mutual funds or exchange-traded funds inside the annuity to increase their potential yield, but they’d retain the comfort of a guaranteed minimum rider, so they’d receive at least a 5 percent or 6 percent return, depending on the product they buy.