Get With The Plan: July 3, 2011

7311Brett and Michelle want to know if their hard-earned savings will last a lifetime.

“Our concerns around retirement are twofold: Do we have sufficient assets and income to ensure income through 100 and do we need to purchase long term care insurance?” said Brett, 61. “We envision retirement as a time when we can continue/enhance our standard of living. Plans include travel and leisure.”

The couple, whose names have been changed, have saved $1.945 million in IRAs, $30,000 in a money market and $10,000 in savings. When Michelle, 62, turns 65, she will be eligible for a $1,300 monthly pension.

The Star-Ledger tapped Michael Gibney, a certified financial planner with Highland Financial Advisors in Riverdale, to help the couple analyze their retirement prospects.

“The first concern is whether they have enough money to ensure income through their age 100,” Gibney says. “The most difficult variable in this scenario is how much a couple will need per month or per year in retirement.”

Brett and Michelle say they’d like to retire on $160,000 a year or $13,333 per month. Their current monthly expenses are just over $7,000 per month, not including their home equity loan, which will be paid off in less than a year.

Gibney ran two scenarios: retiring when Brett is 65 in 2015, or when he’s 70 in 2020.

In either case, he says, the couple is vastly overestimating how much money they’d need in retirement.

Increasing their current monthly spending by 3 percent each year for inflation, Gibney says they’d need $7,880 monthly if they retired in 2015, and $9,133 monthly if they retired in 2020 — both far less than their stated goal of $13,333 per month.

Even when adding the cost of long-term care insurance, which for people their age would run about $6,000 a year or $500 a month, they’re still overestimating their retirement spending.

“This is a common issue: Clients have good knowledge of their current expenses, but they believe they will need a much higher amount in retirement,” Gibney says. “In this couple’s case, they are estimating they will need a monthly amount that is 60 percent higher than their current expenses.”

Let’s assume they still want to spend $160,000 a year in retirement. When they reach maximum retirement age, they will receive annual income in the form of Social Security and pensions of $76,840, Gibney says, leaving them $83,160 short of their goal. Those funds would need to come from investments.

The financial planning industry commonly refers to a 4 percent withdrawal rate as a guideline for how much of a distribution an investor can take from a portfolio each year without the investor outliving his money. That’s where asset allocation and the long-term growth of assets come in.

“This couple has done an admirable job of building a well-allocated portfolio. Most asset classes are covered and it has been built with well-managed and low-cost funds,” he says.

But the portfolio is still too conservative to generate enough income until they reach age 100, he says.

Looking at the current portfolio, assuming a rate of return of 7 percent a year, in 2015 the couple would have $2.55 million, and in 2020, they’d have $3.58 million.

“On the surface these seem like significant numbers which should meet their goals,” Gibney says. “However, when we factor in taxes and inflation, which are significant, they run the risk of running out of money with a retirement age of 65, but fare better at age 70.”

Gibney says taxes will have a significant impact for Brett and Michelle because the majority of their investments are in traditional IRAs and SEP IRAs, both of which are taxable as ordinary income. And while there’s talk in Washington of increasing marginal tax rates, there would be a big adverse effect on this plan.

Put it all together and they have two options, Gibney says: retire later or spend less. If they spend less, they will increase their probability of reaching their goal because they will be depleting their portfolio less each year. If they retire at age 70, they should be fine as long as they maintain the estimated 7 percent return and marginal tax rates are not increased, he says.

Gibney thinks long-term care insurance would be a smart move for this couple.

The annual cost of a long-term care facility can easily exceed $70,000 per year and is rising every year, he says.

“This expense has the potential to deplete a portfolio very quickly,” he says.

Brett and Michelle will have to consider their family’s history of need for care and their overall health, Gibney says. When they shop for a policy, he says, they should consider these very broad guidelines: a benefit period of approximately five years, coverage of about $200 a day in New Jersey with a simple inflation rider, and a rider for home health care.

“Premiums can be reduced by getting shared benefits, which allow a couple to share benefit periods if only one spouse requires coverage,” he says. “For example, if each spouse has a five-year coverage period and only one spouse requires coverage or one spouse dies, the surviving spouse can use ten years.”