Get With The Plan: August 22, 2010

82210Gabe, 59, and Sallie, 57, have raised a daughter and they’d like to retire when Gabe is 62. They’re considering whether or not to keep both their primary residence and their vacation home, and they also have to make some important choices about their pensions.

“We’re trying to decide the best alternative to develop a steady stream of income for my wife, given that she has very little pension. Should I take a joint/survivor pension at 50/50, 60/40 or no joint/survivor pension?” says Gabe.

The couple, whose names have been changed, has saved $656,000 in 401(k) plans, $164,000 in IRAs, $10,000 in mutual funds, $108,000 in Certificates of Deposit, $68,000 in a money market, $80,000 in savings and $50,000 in checking. They also have stock options worth $123,406.

And then, the pensions. At age 62, Gabe could take a smaller monthly pension, or wait until 65 or 70, when the monthly benefit would be higher. Also, Sallie would receive $350 a month for her pension, or a lump sum of $154,000 if she retired today, or $301,000 at age 62. Plus, the couple is eligible for employer medical care if they retired today.

The Star-Ledger asked Mike Maye, a certified financial planner and certified public accountant with MJM Financial Advisors in Berkeley Heights, to help Gabe and Sallie look at their options as they enter retirement.

“The couple is in good financial shape heading into retirement but need to make some critical decisions in terms of where to live and whether to downsize to one home,” Maye says.

A high percentage of the couple’s cash flow — 47 percent — is dedicated to home-related expenses. This will continue for the next 12 years until their vacation home mortgage is paid off, followed by their primary residence mortgage, which will be paid down three years later, he says.

If they plan on keeping each residence for more than a few years, Maye says they may want to refinance one or both of the mortgages. The current interest rate on both mortgages is 5.9 percent, substantially higher than the going rate of 4.25 percent for a 15-year loan.

With a lower interest rate on both loans, and even with the loans paid off, Maye says keeping both homes in retirement does not appear sustainable if the couple wants to maintain their current lifestyle for other expenses.

But selling one or both could change that.

“If the couple sold the primary home at Sallie’s retirement and netted $300,000, they are projected to be able to fund 100 percent of their current living expenses adjusted for the sale of the main home, or $98,626,” Maye says. “In addition, this expense amount will decline to $85,726 once the vacation mortgage is paid down in 2022.”

If the couple did sell their primary residence, Maye says they could probably afford another home, with the trade-off being fewer dollars available to spend on other living expenses. He recommends they work with a tax advisor when they are ready to sell their homes because of the tax complexities, including long-term capital gain exclusions and the implications of selling a home if it was used as rental property.

On to the pensions.

Gabe is eligible to begin receiving his pension at age 60, which is the year he plans to retire. At that time, he’ll would receive a higher monthly amount until he becomes eligible for Social Security at age 62. At that time, if he chooses to start receiving Social Security benefits, the pension payout could be lowered. If he waits until age 65 or 70 to start collecting the pension, the monthly benefit would be higher.

The other big consideration for this couple is not just when Gabe starts taking the pension, but whether he chooses a single life annuity, based only on his life, or a joint-survivor option, which would continue to pay something to Sallie even after Gabe dies.

Maye says the embedded cost of the single life annuity versus the survivor options can be easily calculated.

Take, for example, if Gabe begins collecting his pension at age 60 with a 50 percent survivor option. Once he is 62, his monthly pension would be $4,140 compared to a monthly check of $4,513 for the single life annuity. That’s $387 less per month, or $4,476 per year, pre-tax.

Maye says the actual benefit reduction will be less because of the income taxes that would have been owed on the $4,476.

He ran projections assuming Gabe chooses the 50 percent survivor option, with Gabe having an untimely death at age 63. In that case, Sallie would have approximately $90,000 for retiree living expenses, or approximately 10 percent below their combined projected retiree living expenses of $98,626 if Gabe had lived.

“Another alternative to selecting one of the survivor options is to take the single life annuity and purchase an insurance policy with the extra cash received,” Maye says.

“Whether this makes sense or not will depend on the type of policy used, net cash available to purchase the policy and other considerations.”