Get With The Plan: January 30, 2011

Melanie is a young teacher with her future ahead of her. She tries to keep debt to a minimum and she’s a regular saver. She once thought a job in education, and the benefits that come with it, would be a smart financial move, but now those future benefits are in question.

“With the threat of pensions being eliminated, my main goal is to protect myself in retirement,” said Melanie, 33.

Melanie, whose name has been changed, has saved $19,799 in a 403(b) plan, $21,270 in mutual funds, $40,000 in a money market and $2,000 in checking. Her only debt is a car loan and her mortgage.

The Star-Ledger tapped Jerry Lynch, a certified financial planner with JFL Consulting in Fairfield, to help Melanie make sense of her future retirement concerns.

“Melanie is smart in being concerned about being a teacher and changes to retirement benefits that are being proposed by New Jersey,” Lynch says.

Lynch says the New Jersey pension system is severely underfunded for many reasons, primarily because the state hasn’t made payments into the system for many years.
The second reason, he says, is that “people are simply living too long.”

“The problem is that when Social Security was established in 1935, life expectancy was 64, and now it’s in the mid-80s, and probably in the next 20 to 30 years it will be close to 90,” he says.

He says paying out any benefit for that long amount of time requires a tremendous amount of money.

Lynch says when he considers a guaranteed benefit such as a pension or Social Security payment, he looks at what the benefit would be worth as a lump sum. For example, to pay out an annual Social Security benefit of $30,000, you’d need a lump sum benefit of $750,000. For a $45,000 per year pension, you’d need a lump sum of $1.125 million. (Both assume a 4 percent annual draw-down rate.)

“From a financial standpoint, when you add up these numbers for everyone covered under these programs, the liability numbers are astronomical and that is why, more likely than not, these benefits will see substantial changes over the next few years,” Lynch says, noting this doesn’t even include the cost of lifetime medical benefits.

He says Melanie is smart to realize she needs to have options, and she should just keep saving.

Lynch says in a financial plan, some items are characterized as defense and the others as offense. Defense is how you protect yourself, he says, while offense is how you grow your wealth.

“If you have one without the other, generally, your plan will fail,” Lynch says.

First, on defense, Melanie should expand her insurance coverage with an umbrella liability policy. He says, for example, most auto policies only have a few hundred thousand dollars of liability coverage. If you are sued and someone is seriously hurt, you lose almost everything. An umbrella policy adds additional liability coverage at very reasonable prices. He says his $5 million umbrella policy costs less than $425.

Next, Melanie needs to learn more about disability insurance. She has a plan through work, but she doesn’t understand how it works. Lynch says the type of disability coverage you have is important.

“Life insurance is easy. No pulse, someone gets a check and it is not you,” Lynch says.
Disability is more complicated. For example, if you have a specialized career and suffer an injury that stops you from working in that profession, you could be forced to “flip burgers at McDonald’s.” A disability policy could protect your ability to earn money at your specific career.

Lynch says because these contracts are very complex, it pays to work with a professional to understand the benefits. Generally, he says these policies will usually replace up to about 60 percent of income.

He recommends buyers pay attention to the definition of “disability” in a policy: It may only pay if you can’t work at “any” occupation. Better coverage will pay if you can’t work at your occupation.

He recommends policies be guaranteed renewable and non-cancellable and have a future option to increase benefits as income increases. He also says to watch out for policies with “integrations,” which mean if, during your disability, you get income from other sources like Social Security/Disability benefits, the disability policy would pay less, dollar-for-dollar.

On the offensive side, Lynch says Melanie has about 10 months worth of savings in cash, or $40,000. He says $30,000 is enough, so she should invest the rest for the long term.

Melanie describes herself as a very conservative investor, yet the large majority of her investments would be classified as very aggressive, with about 90 percent of her portfolio in equities. He recommends she try a more balanced approach with 60 percent in stocks.

Melanie should also refinance her mortgage. She has about 80 percent equity yet she’s still paying Private Mortgage Insurance (PMI) of $70 per month. With a little more than 23 years left on her 5.875 percent mortgage, Lynch says she could get a rate of about 4.375 with no PMI.