Get With The Plan: March 18, 2012

John, 62 and single with no dependents, wants a secure retirement. He’ll be vested for his pension at age 65, and he hopes he can take the plunge then.

“I’m a realist,” he says. “Retirement will be modest. I hope to maintain cultural activities, a little travel and deal with unknowns like health changes and energy costs.”

He says he would consider moving to a 55-and-older community, but he’s concerned about whether or not he can afford it.

John, whose name was changed, has $140,000 in a 401(k) plan, $70,500 in IRAs, $104,000 in a money market, $10,000 in savings and $2,000 in checking. He can also expect an annual pension of $18,500, starting in 2017 and indexed for inflation.

The Star-Ledger asked Chadderdon O’Brien, a certified financial planner with Lassus Wherley in New Providence, to help John see when he will be ready for retirement.

“John is extremely prudent and diligent with his personal finances. He maintains no significant levels of debt, spends well within his means and saves aggressively,” O’Brien says. “However, John does not have a clear understanding of his financial needs in retirement and if his savings, investments and retirement income will allow for the lifestyle he desires.”

O’Brien says John requires a comprehensive cash flow analysis to determine where he may stand in the future, given no significant changes to his levels of expenses.

John makes the maximum allowable contribution, including the catchup contribution for those over 50, to his employer-sponsored retirement plan ($22,000 in 2011 and $22,500 in 2012). When possible, he makes the maximum IRA contribution ($6,000 in 2011).

O’Brien says John’s cash reserves are too high. He only needs six to 12 months of emergency reserves, or $15,000 to $30,000.

O’Brien recommends John use these excess cash dollars to open a nonqualified investment account, which he could invest in a conservative “cash alternative” vehicle to increase the potential for growth while keeping the risks of principal loss low.

“John mentioned that he has specifically saved these dollars in a cash account because he doesn’t want to risk losing them in the market,” O’Brien says.

Given his concerns, potential investment options may include high-quality short-duration bond funds. O’Brien says given the current low interest rate environment, bond fund investments should be short-term by mandate and measured by duration to limit the amount of interest rate risk assumed with the eventual increase in interest rates.

While John can count on a pension, Social Security and mandatory distributions from his IRAs, O’Brien recommends he consider equity funds that focus on dividend-paying companies.

“The fund shouldn’t necessarily only focus on the highest dividend payers,” he says. “This may not be sustainable in all economic environments. The fund should focus on companies that have shown the ability to maintain, if not increase, dividends over a long period of time.”

He says John should look at funds that consider healthy companies with steady cash flows and low levels of debt.

This would be the more risky alternative for his cash surpluses.

O’Brien recommends he make some changes to his investments, starting with his employer plan. He says it’s currently invested in a “managed strategy,” which is allocated to the most aggressive option, thereby having no fixed income exposure. As a result, the investment performance has been highly volatile over the last few years.

“Overall, he currently has a very low fixed income allocation,” he says.

He says John should optimize his portfolio to alter the composition of risky assets with the goal of attaining a more efficient mix.

Adding both domestic and international fixed income, as well as alternative investments such as hedging strategies, may be beneficial to the overall portfolio, he says.

John was interested in reducing the volatility of the overall portfolio, which O’Brien says is especially important as John heads into retirement and may begin drawing down on his assets.

“While the proposed strategy lowers the probability of outsized returns in the future, it also reduces the probability and magnitude of large losses going forward,” O’Brien says. “The allocation reduces the risk profile versus his current portfolio.”

Rather than use the aggressive profile for his work account, John should switch to the moderate risk plan, which has a 6- to 10-year time horizon.

As for whether or not relocating to a retirement community is prudent, O’Brien says John is considering communities with homes in the $150,000 to $200,000 range.

“This is in line with the approximate value of his home,” he says. “Any surplus netted from the sale of the house and subsequent buy into the retirement community could be added to his investment strategy for potential growth or saved for his other retirement goals.”

On estate-planning considerations, O’Brien says John has done a good job of keeping current with his documents. His medical power of attorney, advanced directives and will were updated in 2007.

He recommends people review these documents every five years to make sure they’re current with their wishes.

John has one estate-planning move to make, though.

“A successor executor should be named in his will,” he says. “It was something he had not thought of.”