Get With The Plan: February 2, 2014

2214Gene and Shannon are both 65, and they’ve been retired for more than three years. They’re concerned that they don’t have enough monthly income to cover their living expenses.

They recently pulled out $25,000 from a 401(k) plan to buy a car, and they have other big-ticket bills coming. Plus, they want to travel and rent in Florida for a month or two, and they’re worried they can’t afford it.

“We both started taking Social Security at age 62 because expenses were not being covered by the interest and dividends our investments were generating,” Gene said.

The couple, whose names have changed, have saved $380,000 in 401(k) plans, $262,000 in IRAs, $70,000 in a brokerage account, $90,000 in mutual funds, $90,000 in bonds, $10,000 in a money market and $2,000 in checking.

The Star-Ledger asked Jody D’Agostini, a certified financial planner with AXA Advisors/the Falcon Financial Group in Morristown, to help the couple plan for a long retirement.

“They are feeling some cash flow pressures,” D’Agostini says. “They are starting to feel the effects of inflation, as prices for goods and services are rising, and they now are relying on their savings to provide.”

In order to make their budget work, D’Agostini says they have to take a critical look at their monthly expenses.

She said it appears the couple are spending close to $5,400 per month. Their collective Social Security benefit gives them $3,190 a month, and starting in May, $104 will be deducted for Medicare for each of them on a monthly basis. This all adds up to $2,210 month of unmet expenses, post-tax.

D’Agostini took a look at their expenses, starting with the fixed ones, which are expenses they must pay each month: basic food, clothing, shelter and transportation. These totaled about $3,700 per month, leaving only roughly a $500 per month to be covered.

D’Agostini recommends they try to meet their fixed expenses with fixed sources, which would include Social Security, pensions or annuities.

“Since neither Gene nor Shannon have a pension, then I would recommend that they purchase an annuity for this gap,” she said. “This will assure that their fixed costs will be met.”

All the other expenses are discretionary, and can be reduced or cut when the need arises, she said.

In retirement, if you are able to be disciplined in your spending, you stand the best chance of a financially healthy retirement, she said.

“By this I mean, in the years when your investments are performing well, and returns are greater, then you can spend more, and conversely, in the years when your investment returns are lower or negative, then you should curtail the discretionary spending,” she said. “Having your fixed costs already met, then you will not be dependent upon market performance to pay your basic bills.”

She said most retirees do not have enough saved to generate income for a potential 30-year retirement, so they will need to stay fully invested during their entire retirement. This means taking on some equity exposure.

One of the ways to accomplish this is having your investments in different buckets, she said. The fixed bucket is there to meet all of your fixed expenses. There could then be a second bucket for the discretionary expenses going out for the next 18 months to two years.

“In a 30-year retirement, if history is an indicator, there will be two to three market corrections,” she said. “These often last less than two years, and if you do not need to draw on your investments during this period, and rather continue to stay fully invested, then you have a better chance of being able to afford a long retirement.”

That means the third bucket would be invested in a diversified portfolio with a goal of growth. This would theoretically outpace inflation and provide the future cash flow that can pour into the short-term bucket, D’Agostini says.

“Using the ‘Rule of 72’ as a basic calculator, if inflation averages 3 percent, then prices would double in 24 years,” she says. “The greatest risk in retirement is longevity. You can outlive your resources.”

D’Agostini had Gene and Shannon take a risk tolerance quiz, which found them to be moderate investors, which would be a roughly 40 percent stock and 60 percent bond mix. But right now, they only have about 13 percent in stocks, which limits the upside of their portfolio.

“It looks like their rate of return should be around 4 percent, which over time will hurt their ability to stay ahead of inflation,” D’Agostini says.

She instead proposes a new allocation with a rate of return of over 5.5 percent. They can sell off some of their bonds, remember to rebalance annually and replenish the short-term bucket. The new mix proposed also has them moving from five asset classes to nine asset classes, which means spreading the eggs over more baskets, she says.

One area to watch is the couple’s old Series EE Bonds, now worth $90,000 with a cost basis of $30,000. Selling these will lead to a $9,000 tax on capital gains, but she recommends these be sold and invested in stocks for appreciation.

Currently, they are living off approximately $64,000 per year, and they would like to generate enough from their investments for travel and winter vacations in Florida. D’Agostini says they need their investments to offer a safe withdrawal rate of $32,000 a year.

“Assuming that they carve off $64,000 for their short-term or cash bucket, they would have close to $800,000 for the growth bucket,” she says. “If they were to generate an average of 4 percent from this investment, that should provide them with approximately $32,000 of income per year and would allow them the ability to take the month in Florida and perhaps travel.”

The one caveat would be that in years when their investments are not performing, they should curtail their travel, and in years when the investment returns are positive, they can join the snowbirds down South.