Get With The Plan: January 13, 2013

11313Tony and Bea are in their mid-50s. Their financial responsibilities for their one child are almost done — as much as they ever are for any child — and they’re wondering how many more years they need to work.

“I’d like to retire at 62, or 60, if possible,” says Tony, 56. “Bea would like to work until 65. We’d stay in New Jersey but travel.”

The couple, whose names have been changed, have saved $203,500 in 401(k) plans, $413,400 in IRAs, $27,200 in an annuity, $78,900 in a brokerage account, $45,900 in a money market and $1,000 in checking. Upon retirement, they both expect small pensions totaling about $7,000 a year, or Tony can take a $100,000 lump payout instead.

The Star-Ledger asked Jeffrey Boyer, a certified financial planner with RegentAtlantic Capital in Morristown, to help the couple determine when they will be ready for retirement.

“The couple has a high probability of making this plan work assuming Tony is comfortable working until age 62,” Boyer says. “Results of the plan when Tony retires at age 60 look significantly worse due to the lost income and needing to begin withdrawing from the portfolio sooner.”

Tony and Bea have a moderately aggressive portfolio with 70 percent allocated to growth or equity-like investments, and 30 percent invested in fixed income. Boyer says the majority of equity investments are concentrated in developed large-cap companies, so some changes could be beneficial.

“Investors could benefit from the diversification benefits of adding additional weightings to small-cap stocks — both domestic and foreign — emerging market stocks, and infrastructure or Master Limited Partnership investments,” he said.

Master Limited Partnerships, or MLPs, are publicly traded partnerships that generally invest in natural resources, similar to how real estate investment trusts, or REITs, invest in real estate.

Another investment Boyer says the couple should consider is a floating rate fund.

“Floating rate funds focus on a segment of the bond market where issuers are of relatively low quality,” he says. “Although the floating securities do tend to have some kind of collateral, the issuers themselves are typically not high quality issuers, so you are exposing yourself to credit risk.”

Boyer says this asset class sold off almost as much as high yield bonds in 2008 and should be considered, together with equities, as one of the riskier assets in a portfolio.
Today, he says, spreads on floating rate loans are not attractively valued because of a lack of investor interest.

“Most importantly, you do have duration risk with floating rate bonds, which is contrary to the reason one might be investing in this asset class,” he says. “Most of the bonds will have a floor, the minimum they will yield when interest rates are low. That floor won’t change if current interest rates are already low and below this floor amount.”

He says if rates rise, this would cause the floating rate bonds to have duration and lose value up until the floor amount threshold — but a risk he says is worth evaluating with today’s current interest rate environment.

Boyer took a look at the couple’s tax situation.

Bea is self-employed, and while her income will vary, Boyer assumed it will average about $40,000 a year.

But he pointed out that last year, she earned nearly $100,000, so the couple’s tax bill was nearly $30,000.

“Earning higher income and paying more in taxes isn’t necessarily a bad problem to have, however we would recommend that strategies be considered to reduce this tax liability,” he says.

For example, she would be able to contribute more to an individual 401(k), therefore lowering her taxable income.

Boyer also looked at Social Security because the couple considered collecting benefits as soon as they retired. He says there’s a better strategy.

“If Tony were to begin collecting his benefit at age 62, he would only receive 75 percent of it, as there is a 25 percent reduction for commencing benefits at age 62,” Boyer says. “If Bea were to begin collecting her benefit at age 65, her benefit would be reduced by 6.67 percent.”

Alternatively, Boyer recommends a “file and suspend” strategy. Tony, at his Full Retirement Age (FRA) of 66, would file and suspend his benefit. He would suspend receiving his benefit until age 70, which would allow his benefit to earn Delayed Retirement Credits (DRC).

“DRC would increase his benefit by 8 percent each year,” Boyer says. “Bea, at her FRA, would begin to claim a spousal benefit — 50 percent of Tony’s benefit — on Tony’s work record until age 70.”

During that time, Bea’s benefit would also earn DRC by suspending it until age 70. Then at age 70, both of them would start collecting benefits on their own work records, Boyer says, significantly increasing both of their monthly benefits.

Boyer says at age 70, after cost-of-living-adjustments (COLAs — historically 2.8 percent) and Delayed Retirement Credits, Tony’s benefit would grow to $4,187, compared with $2,379 under his age 62 election. Bea’s benefit would grow to $3,773, compared with $2,668 under her age 65 election.

“While they would wait longer to collect benefits, they would begin to benefit on a cumulative dollar basis beginning at Bea’s age 76,” he says. “This is often referred to as their break even age — the age they would both need to live to for them to better off delaying receipt of benefits until age 70.”

Boyer says over time, their higher monthly benefits result in an additional $700,000 in cumulative benefits received by the time Bea is age 90.