Get With The Plan: July 15, 2012

Shayna is recently retired, but the 64-year-old single woman has a big decision to make. She needs to decide if she should take a lump-sum pension and invest the funds, or if she should take an annuity.

She’s been smart about her money so far, and she’s smart enough to know this isn’t a decision to take lightly.

“I have no outstanding liabilities,” the Somerset County woman says. “Both my home and car are paid for. I would like to do some traveling in my spare time and hopefully get a part-time job.”

Shayna, whose name has been changed, has set aside a healthy 401(k) plan worth $1.05 million, $43,000 in IRAs, a money market with $200,000 and $3,000 in checking. Her pension is worth $590,000 as a lump sum, or would give her a monthly payout of $3,700 for life with no cost-of-living increases.

The Star-Ledger asked Mark Cortazzo, a certified financial planner with MACRO Consulting Group in Parsippany, to help advise Shayna about her retirement income options.

“Her current cash flow has a very low risk of failure and most of the draw from the portfolio will be limited to discretionary spending and inflation adjustments to current expenses,” he says.

Cortazzo says his first recommendation for Shayna is to take her pension as an annuity rather than a lump sum.

“The monthly amount combined with her Social Security benefit would cover nearly all of her expenses,” Cortazzo says. “This would dramatically improve her chance of achieving her financial objectives.”

Cortazzo ran a Monte Carlo simulation, which takes into account thousands of variations, to see how well Shayna’s plan would fare under different market circumstances.

By taking a lump sum instead of the monthly annuity, there would be a 10 percent chance of her running out of money during her lifetime. But by taking the annuity, there was a minute 1 percent change of running out of money.

To further analyze the annuity versus lump sum option, Cortazzo compared what kind of annuity benefits Shayna could buy with a lump sum. This showed that the pension is a good deal.

“We take a look at what the lump sum amount is and price out what that would buy in an immediate annuity with the same terms to see how competitive the pension check is and sometimes it is 20 to 30 percent higher that what they could buy with the cash,” he says.

“A guaranteed check that you can’t outlive and that is backed by a government agency is also very appealing.”

In Shayna’s case, the pension was quite a bit more than the current market price on her lump sum check, Cortazzo says.

Cortazzo also recommends Shayna reallocate her 401(k) plan, which is worth $1.05 million.

Half of the account should be invested in a portfolio of index funds and exchange-traded funds, he says.

Another $200,000 to $300,000 could go in a tactical fund.

“This is available through a mutual fund format that invests to track this index, or as an individually managed account that uses index exchange-traded funds to invest,” he says. “The index looks at long-term average prices and short-term average prices to be fully invested, or removes exposure to sectors that become bearish.”

He says they can be temporarily in all cash, but that happens very rarely in extremely bearish markets. The objective is to capture the majority — not all — market upside, while dramatically reducing the downside participation, he says.

The remainder of the portfolio should be in structured notes, Cortazzo says.

“Structured notes are like bonds or CDs in that they are issued by financial service firms or banks and that they have a finite maturity,” he says. “The ones that we recommend most often and what we suggested Shayna use have a principal guarantee at the end of the term, but instead of paying a set interest rate, the five-year note would pay close to 75 percent of what the S&P index goes up — not all — but if it went down at the end of the five years they would get their principal back from the issuer.”

Except in the case of the FDIC-insured versions of these, Cortazzo says the financial strength of the issuer is very important.

“Shayna doesn’t need to hit a home run as almost all of her expenses are covered by her guaranteed income, but she would like the potential to have growth over time, so we think that these make a lot of sense for her particular circumstances,” he says.

Cortazzo says long-term care insurance would be a very wise investment for Shayna. He says that while finding a good policy will not be cheap because many of the providers in the area have raised rates or just gotten out of this business, it’s still worth it. Choosing a policy that has a longer waiting period before benefits start could lower premiums, especially because Shayna can afford to cover herself for the short-term. Then, she could afford a policy that would cover her for a longer period.