Get With The Plan: August 25, 2013

82513Chris, 62, was laid off from his job in June. He and his wife MaryBeth, 54, weren’t planning on the income loss, so now they wonder if an earlier-than-expected retirement is a possibility.

“Are we in any financial position for him to retire early, or will he need to find another position to ensure a comfortable retirement?” MaryBeth asks. “I have to work nine more years to be eligible for my full pension.”

When they retire, they plan to downsize to a smaller home, and they wanted to do $40,000 of upgrades to their current home, hoping to increase its resale value.

Chris will receive 12 weeks of severance pay, but after that, the couple will deal with the loss of his $55,000 a year salary.

Both will receive pensions upon retirement. Chris will get $428 a month if he starts benefits this year, or the monthly amount would increase to $510 a month if he waits until age 65. MaryBeth’s pension would be $1,220 per month at age 62, or $1,928 per month at age 65.

The couple, whose names have been changed, have also been saving. They have $62,700 in a 402(b), $463,000 in IRAs, $10,200 in a brokerage account, $33,000 in a money market, $6,000 in savings and $18,600 in checking.

The Star-Ledger asked Howard Hook, a certified financial planner and certified public accountant with EKS Associates in Princeton, to help the couple assess their options.

To calculate cash flow and retirement projections, Hook made several assumptions. First, MaryBeth would continue working for nine more years, and Chris would retire today.

He assumed they’d finance $20,000 of home renovations and pay $20,000 in cash for the rest. When they sell their home, Hook assumed they’d get $430,000, and they’d buy a smaller one for $375,000. He also assumed Chris would start receiving Social Security benefits next year, while MaryBeth would wait until 2023.

Taking a look at their investments, Hook says there doesn’t appear to be any kind of plan.

“It seems like each account is looked at individually with no consideration given to assets held in other accounts,” he says. “This is very common.”

Instead, Hook recommends investors look at all of their assets together — as one portfolio — regardless of what accounts the assets are in. He says this should be done because the goal for all those accounts is the same — at least for this couple.

Today, they have 42 percent in stocks, 22 percent in cash and 36 perfect in fixed income. Twenty-two percent of their holdings are invested in only one stock, and they have a very high allocation to large-caps stocks in general. That means they have zero in small-caps and other important asset classes.

This allocation means the couple is taking on many risks they could avoid.

First, Hook says they’re underweighted in stocks in general, and they should bring their allocation up to 55 percent of the total portfolio.

“The portfolio will need to be allocated more towards stocks than bonds than it currently is to have a better chance of reaching an asset base that can support a $43,000 annual withdrawal, adjusted each year for inflation,” he says.

And, they should reduce their position in the one stock that represents 22 percent of their total assets. There won’t be tax consequences because the position is held in an IRA account.

Next, they should reallocate, lowering their allocation to large-caps while increasing small-caps.

“A lack of diversification can lead to higher volatility,” he says.

They should also change their international investments, which focus on single country or regional exposure, and move towards a wider variety of international stocks.

They also have too much cash in their retirement accounts, he says, so those funds should be invested. They should also invest the cash in their non-retirement accounts to provide better yields to hedge against future inflation.

“It is important that the recommendations be done in conjunction with one another so that all the assets in the portfolio now have a purpose or reason for being in the account,” he says. “They should be able to look at each investment they own and be able to answer the following question: Why do I own Investment X in my portfolio.”

If they can’t answer that question, Hook says they need to re-examine that particular asset.

Hook also looked at their pension options.

“They should choose pension options that allow for the survivor to receive a portion or all of the pension after the pensioner dies,” he says. “This protects their assets against a premature death, which, if the pension went away, the survivor would need to withdraw more money from their investment accounts.”

Ideally, he says the 100 percent joint and survivor payment option for their pensions would be best even though their pension benefits can be significantly less than they would be if they chose an option that paid less or nothing to the survivor.

Putting aside the home renovations for a moment, Hook examined the couple’s cash flow if Chris didn’t return to work.

He found the couple would still have a positive cash flow, however small, and they wouldn’t need to withdraw money from retirement accounts (except for a Required Minimum Distribution MaryBeth is required to take from an inherited IRA) for their regular expenses.

Looking at their home renovation plans, Hook suggests they pay cash for half the costs, and use their home equity line of credit for the other half. This would allow them to maintain an adequate cash reserve for emergencies. Plus, borrowing rates are still low, and even lower on an after-tax basis, he says.

But the whole idea of the renovations is one Hook says they need to examine closely to see if it will add enough value on the resale of their home.

“Our projections assume they will sell the house in 2022,” he says. “However, if they ultimately want to sell it sooner, they should make sure that $40,000 of home renovations will increase the value of their home by at least $40,000. If not, they may want to think twice about doing those renovations.”