Get With The Plan: January 19, 2014

11914Todd and Karen are edging closer to retirement, but they still have two children in college and they’re not sure they’ve saved enough.

“My concern and challenge is determining when my wife and I can retire and ensuring that we have sufficient funds to support us,” says Todd, 59.

He and Karen, 52, plan some part-time work in retirement, and they hope to take one vacation a year and stay in their current home.

The couple, whose names have been changed, have saved $140,000 in 401(k) plans, $361,500 in IRAs, $160,000 in mutual funds, $7,000 in a brokerage account, $88,500 in a money market, $9,000 in savings and $1,500 in checking. Todd also has $120,000 in stock options, and there’s $30,000 remaining in college accounts for their kids.

Upon retirement, Todd will receive several smaller pensions that add up to about $1,400 a month.

The Star-Ledger asked Michael Gibney, a certified financial planner with Highland Financial in Riverdale, to help the couple determine when they can afford to retire.

Ideally, the couple would prefer to retire when Todd is 62, but Gibney’s analysis shows retirement that soon will give them a mere 40 percent chance of success.

Retirement at 65 is more realistic, and Gibney says at this age, the couple would have a 90 percent probability of success — 96 percent if they wait until Todd is 66.

“In order to reach their goals, they will need to continue to accelerate their mortgage payments, Todd will need to continue maxing out on his 401(k) including the catch-up (contribution) and Karen should begin to invest at least the max in an IRA or contribute to her 401(k),” Gibney says.

Gibney says they appear to have excess cash flow of as much as $80,000 a year given both of their salaries, so continuing these savings plans is more than doable.

Gibney based their retirement goal on expenses of $8,600 a month in retirement, adjusted for inflation. This matches their current expenses minus the cost of college. He then added a vacation costing $5,000 a year.

The high probability of success also assumes a balanced portfolio made up of 60 percent equities and 40 percent fixed income with an expected annual return of 7.5 percent.

“Anyone who invests this much in fixed income needs to be aware of the potential higher risk in fixed income for the next few years,” Gibney says. “Traditionally viewed as safe investments, fixed income securities may carry more risk and a much lower return as rates continue to rise.

Todd has restricted stock units (RSUs) and stock options, and Todd should continue to receive more RSUs as long as he stays with his current job. Gibney included the RSUs in the plan, but not the stock options.

“I did not include his stock options because they have a high probability of success without them, and also because the options are minor relative other assets and they are subject to the volatility of the stock price,” Gibney says. “If they expire ‘in the money,’ they will be icing on the cake.”

Gibney says the couple should rebalance their holdings more diversified portfolio, which should include assets they do not currently invest in, such as small-cap stocks, international stocks, emerging markets stocks, real estate and commodities.

“Further, they should employ asset location because they currently have a good mix of retirement and non-retirement accounts,” he says. “Asset location means placing tax efficient funds in their non-retirement account, such as muni bonds, large-cap growth stocks, and short-term Treasuries, and placing more tax inefficient funds, such as international stocks, real estate and corporate bonds in their retirement accounts.”

If done well, Gibney says this strategy can improve returns because it potentially reduces their tax liability, which can hamper returns.

He also says they would benefit by consolidating all of their accounts and getting a better understanding of their investment assets so that their portfolio can be viewed as one portfolio. Currently, it is a bit scattered, he says.

Gibney likes what he sees in their emergency fund, which is in excess of three months’ expenses — good for a family with two wage earners.

“With their excess cash, they may be able to also open a Roth IRA to increase their savings,” he says. “The Roth may be an option to ‘diversify’ their tax liability in retirement. They should ask their accountant which is more beneficial — the current tax deductibility of increasing Karen’s regular IRA contributions, or the future benefit of a Roth contribution.

Gibney says they have kept their debt in control, which is vital to a successful retirement.

If they continue to pay extra principal on their mortgage, as they’ve been doing, they will pay off their mortgage in 2027, rather than at the loan’s initial schedule of a payoff in 2039.

“I was going to suggest a 15-year mortgage, which would bring them to 2029, but by accelerating they are going to beat this date by two years,” he says. “So, if they don’t feel confident of continuing the accelerated payment of additional principal — which requires them to be proactive — they can ‘force’ this by refinancing and locking in the 15 years.”

He estimates that at their current balance of $203,000, if they refinance to a 15-year at 3.375 or 3.5 percent, they would keep their payment the same as what they’re paying with the extra payments on the principal.

“Doing either should enable them to stay in their current home,” he says.

When it comes time to collect Social Security, Gibney says they should consider waiting as long as possible to collect Todd’s benefits because the benefit will grow about 8 percent per year if he waits until age 70.

They also may want to consider a strategy called “file and suspend,” where the spouse with the greater benefit claims the benefit, but then suspends benefits.

“The advantage is that once the high earner’s benefit is claimed, the lower-earning spouse can now collect a spousal benefit of 50 percent of the top earner’s benefit, which could be more than her own benefit,” Gibney says.