Juan, 55, and Maria, 52, want to know how anyone can retire without a pension. This is the couple’s challenge as they plan for retirement. At the same time, they want to foot the entire higher education bill for their college freshman and their high school junior.
“I would like to retire by the time I am 62 or so, possibly keeping our house in New Jersey and also having our townhouse in Florida and going back and forth between the two,” Juan says.
The couple, whose names have been changed, have saved $622,700 in 401(k) plans, $58,000 in IRAs, $388,800 in mutual funds, $20,000 in savings in $1,000 in checking. They’ve also set aside $92,000 for college.
The Star-Ledger asked Jerry Lynch, a certified financial planner with JFL Total Wealth Management in Fairfield, to help the couple balance their two major goals.
Lynch says he generally tells people that age 70 should be their target for several reasons.
First, if you retire at age 62, he says there is a 61 percent chance that one spouse will still be alive in 30 years, and that takes a lot of money to fund.
Next, for someone who is retired for 30 years, there will be several market swings that could seriously impact someone’s ability to maintain a consistent income.
And finally, Social Security.
For Juan, taking benefits at age 62 instead of age 70 would mean $1,280 less per month, or $15,360 less per year — for life.
Lynch says retirement is very difficult and it really requires some difficult planning and choices.
“A dollar saved is not a dollar earned, but it is a dollar compounded at a reasonable rate for the rest of your life,” he says.
That’s why your spending makes a big difference.
For example, cars. These are depreciating assets that lose money every day that you own them.
“Currently their cars are worth $80,000 and they are planning on buying two more in the next two years,” he says. “If they cut this back to $50,000, at age 80, they will have an additional $162,000 — 25 years at 7 percent — and this is only cutting (the expense) once. If they buy cars every three to five years, the numbers would be staggering.”
Then there are education expenses. Lynch says he’s a fan of education, but not the cost of private colleges.
“The difference between Rutgers and a private college over four years can be about $140,000 less,” he says. “If that savings is invested for 20 years at 7 percent, you have $541,755.”
Lynch says when he talks to people about cutting expenses, they cut the little things such as going out with their friends, but they still have the big expenses such as cars and private college. He says if retiring early is really their priority, they need to make some tough choices on what they are willing to cut.
“Twenty years from now, will anyone ever bring up that you went to a state school or drove a Ford Explorer versus a Range Rover? The only thing they will know is that you are retired, comfortable and having a really good time.”
Looking at the couple’s savings, a lack of diversification is a big problem, which translates into risk that’s larger than necessary.
For example, they have $452,000 in only one mutual fund, a mid-cap fund that has reasonable expenses and good management.
“I still have to say: are you nuts?” he says. “Generally, mid-size and smaller size stocks are more volatile in nature. You have greater potential for returns but you have the ability to lose half your money. Diversify!”
The diversification problem continues into the couple’s taxable portfolio because the bulk of the savings is in concentrated positions in just two mutual funds.
Both Juan and Maria also have old 401(k) plans from the same company, and their money is all invested 100 percent in company stock. They need to diversify this, too, but given that they haven’t yet, Lynch says they may have a great tax planning opportunity for those who have highly appreciated company stock in a 401(k) plan.
It’s called Net Unrealized Appreciation (NUA), which allows you to take company stock out of a retirement plan, put that stock in a taxable account and only pay tax on what it was worth when each share went into his 401(k) account.
“When the stock is then sold at a later date, the gain is treated as a capital gain, which can be either tax free, 15 percent or possibly at 20 percent, which can be less than half, or more, of what they would normally pay,” he says.
To make retirement income a bit more predictable, Lynch says Juan and Maria might be good candidates for an annuity.
Annuities have a bad rap because of high commissions for salespeople, but Lynch says that doesn’t mean annuities are a bad product. It’s more a situation of annuities being sold when they’re inappropriate for the buyer but, he says, they can be great products for the right buyers in certain circumstances.
“Annuities can provide a guaranteed income for the life of the couple, backed by an insurance company and with additional protection through the state reinsurance programs,” he says. “In a world with fewer and fewer pensions and where people are living longer and longer, it is not a bad thing to have some form of guaranteed income for life.”