Get With The Plan: February 24, 2013

22413Harris, 62, has enjoyed a very healthy income, and now he wants to see how his long-term savings plan will translate into retirement income.

“I want to retire at age 65 with a similar lifestyle,” says Harris, who is divorced. “I plan to retire to my Florida home.”

Harris, whose name has been changed, has saved $495,000 in 401(k) plans, $72,300 in IRAs, $60,000 in a brokerage account, $250,000 in money markets and $15,000 in checking. At age 65, he will also receive a pension estimated to be worth $120,000 a year.

The Star-Ledger asked Vince Pallitto, a certified financial planner and certified public accountant with Summit Asset Management in Florham Park, to help Harris determine if he’s ready for retirement.

Pallitto has good news for Harris.

“The primary reason Harris can retire immediately is due to the fact that his employer’s pension would pay him 60 percent of his base salary, or about $120,000 a year, for the rest of his life, which is well more than his monthly expenditures,” Pallitto says.

Pallitto says there are only two minor obstacles in Harris’ retirement plan. The first is that he is obligated to pay $3,000 a month in alimony until he dies. Even with a pension income, he can still afford those payments without dipping into his savings.

The second issue is that he currently owns a residence in New Jersey and one in Florida, however, the value of the house in New Jersey is less than the current mortgage balance.

“The reason these are minor obstacles is that, even with the alimony and two mortgages, Harris is spending about $9,000 a month,” he says. “Therefore, under the worst case scenario, if Harris keeps both residences and cannot rent the New Jersey residence when he moves to Florida, his pension income still exceeds his expenses without considering his Social Security income.”

Looking more closely at the idea that Harris will have to carry two mortgages with the alimony payment after he retires, his pension and Social Security will add up to more than $12,000 a month in gross income.

“From a tax standpoint, the alimony is an immediate deduction from gross income, which means, of his estimated $12,000 of monthly income, only $9,000 would be taxable to cover the remaining living expenses of $6,000 a month after the alimony,” he says.

But that’s not the likely or more realistic scenario, Pallitto says. He expects Harris would be able to rent his New Jersey home for a conservative $2,000 per month — conservative because such homes are currently renting for $2,100 to $2,200 per month. This would cover the cost of the New Jersey home, still leaving him with $9,000 of monthly gross income after alimony to cover $4,000 of expenses that are left, no longer counting the New Jersey home as an expense.

All that said, Harris can retire very comfortably whenever he wants without even considering his other assets.

But of course, those assets shouldn’t be ignored. Pallitto says Harris’ 401(k) and brokerage account are not invested appropriately for a 62-year-old pre-retiree. But because Harris has retirement income to count on for the future, there’s no real rush to make changes — as long as he’s willing to take some chances and stick it out should there be a substantial market decline.

Pallitto says Harris’ aggregate portfolio of retirement accounts and investment accounts has 53 percent in equities, but when you add in his cash balances, it reduces his overall equity exposure to 38 percent. That means 38 percent of his total portfolio is exposed to volatile investments that have a great deal of downside exposure, while 28 percent is in cash, earning nothing.

Pallitto says a more diversified mix can achieve a better yield with downside protection.

“I would strongly recommend that he sell most of the stocks and stock funds in his portfolio as the market is near all-time highs,” he says. “The stock market has been artificially inflated by Federal Reserve stimulus, like economic steroids.”

Pallitto says the economy is not nearly as strong as it was in 2007 when the markets were at these levels, so he feels the downside risk to retirees and pre-retirees is far greater than the upside potential.

Pallitto recommends Harris keep $100,000 in his cash account, and invest the remaining in shorter-term bond funds.

Moving to Florida could be a big plus for his estate planning situation.

There is a current federal estate tax exclusion of $5 million, which is something that New Jersey doesn’t follow. The state estate tax kicks in at $675,000, but that’s something Florida residents don’t need to worry about.

But estate planning is still something for Harris to think about, Pallitto says, and he should start thinking of a wealth transfer strategy for his daughter and grandchild.

“He has no intention of remaining a New Jersey resident, but no one knows when they will die, therefore I would recommend that he update his will and address the New Jersey issues,” Pallitto says.

It may make sense to meet with an estate planning attorney, but Pallitto says one alternative could be to transfer the New Jersey property to an irrevocable trust with his daughter as the beneficiary. Harris would rent it from the trust, and eventually it would be rented to others when he moves to Florida, but that would get the value of the New Jersey home out of his estate, he says.

Lastly, Pallitto recommends Harris look into a low coverage long-term care insurance policy to protect his assets in the event of a long-term illness.

“The estimated cost of a nursing home is about $300 a day,” he says. “I would suggest looking into a policy that would cover about $100 to 150 a day to supplement his other income without depleting his assets for his heirs.”