Get With The Plan: December 16, 2012

GWTP-121612-01Chris, 56, and Carly, 53, have a big income, but they also have big bills.

For their three children, 22, 20 and 16, they’ll have a total of seven years of tuition payments remaining. And while Chris earns a large income with job security, it’s not exactly regular.

His job has a mandatory retirement age and income drops as one approaches the retirement/phase-out age, he says.

“My concern is being able to develop a sufficient nest egg for retirement to maintain our lifestyle,” he said. “This concern is heightened because not only does compensation vary from year to year, but compensation typically drops after age 62 until mandatory retirement.”

The couple has used creative financing to account for this variable compensation.

They borrow against their home equity line of credit regularly to pay for tuition, quarterly tax payments and other major expenses, but they always pay it down in the last quarter of the year, which is when Chris receives most of his compensation.

And that’s when he decides how much he can add to his 401(k).

Chris and Carly, whose names have been changed, have saved $1.3 million in 401(k) plans, $380,000 in IRAs, $96,000 in mutual funds and $23,000 in checking. They also have $92,000 set aside for college funding.

The Star-Ledger asked Douglas Buchan, a certified financial planner with Main Street Financial Solutions in Pennington, to come up with a plan for success while weaving through the challenges of irregular income.

“Chris is in no hurry to retire,” Buchan says. “However, his employer requires full retirement at age 68 and further, requires a draw-down in hours/pay beginning at age 62.”

Before addressing the income issue, Buchan took a look at all the protections the couple has for “ifs.”

Rather than paying for college with this money, one option would be to add the money to savings accounts earmarked for retirement

Chris and Carly both have term insurance policies: $1.5 million for Chris and $500,000 for Carly. These both expire in eight years.

“This is excellent coverage for their particular situation,” Buchan said. “The eight-year time frame is perfect, as this coincides with the youngest graduating college as well as the beginning of when Chris begins his walk into income phase-out at work.”

Buchan says Chris has also done a great job in protecting his family against an unforeseen disability. He has a long-term disability policy that will pay out $10,000 per month to age 65.

“Bravo. I can’t tell you how many times I have seen high-income earners that have ample life insurance — or often more than they need — but they have no disability insurance,” Buchan says.

Chris and Carly have budgeted about $50,000 per year out of his salary to cover existing college costs, and there’s another $92,000 in a 529 plan.

“Although his salary varies from year to year, he is confident his income will stay in the high 300s to the low 400s,” Buchan says. “Even if their youngest heads off to a Northeast private school at $55,000 a pop, I don’t see them having any issues funding it.”

But, Buchan says, funding college with cash creates an opportunity cost.

Rather than paying for college with this money, one option would be to add the money to savings accounts earmarked for retirement.

The question then becomes whether or not they’ve saved enough, and are they saving enough going forward, to fund the retirement lifestyle they want. Depending on how the year goes, Chris is able to put away between $45,000 and $75,000 per year for retirement.

Buchan assumed a conservative estimate of $45,000 per year until Chris begins his employment phase-out.

“Assuming a nice, long life of 100, Chris and Carly can be confident they will have enough money/income to support their lifestyle, if — and it’s a big if — they are able to stay disciplined in an appropriate investment plan,” Buchan says.
Buchan says the days of retiring and living off of income from certificates of deposit are over.

“That may have worked for your parents’ generation — although I’ve seen too many 90-year-olds realizing it wasn’t the right choice for them either — but, it’s not going to work for you,” he says. “The amount of years that Baby Boomers will be retired for are two, three, even four times that of their parents. Solely investing in CDs and T-bills will assure you that your income will not keep pace with the inevitable and constant rise in living costs.”

That means investors need to find growth in their portfolios.

Chris and Carly are heavily tilted toward equities, but they describe their risk tolerance as moderate to conservative, and that’s bad — for two reasons, Buchan says. First, there is a disconnect with the makeup of their investment portfolio and their self-perceived risk tolerance. This disconnect, he says, very often results in making wrong decisions at wrong times, namely panic selling when the “fear du jour” hits.

“Proper investing is simple, but it’s not easy,” Buchan says. “The key is to build an asset allocation based on your need to take on market volatility. You do this by building out a retirement plan.”

Given the plan for Chris and Carly, a 60 percent stock and 40 percent bond portfolio will give them the greatest probability of success, he says.

“Chris and Carly’s investment assets are more tilted towards equities than they need to be,” he says. “That, coupled with the fact that they describe themselves as moderate to conservative regarding risk tolerance, I advise they lower the stock allocation — for the long term — to 60 percent.”