Get With The Plan: May 13, 2012

At age 63, Carol is planning for a very active retirement. She hopes to sell her home and move to what she calls a more retirement-friendly state. October is her self-imposed deadline.

“I will be traveling, wining and dining extensively for the next five years, and for the succeeding five years, less. And less with each succeeding five-year intervals,” she said.

Carol, whose name has been changed, has saved more than $1.15 million in 401(k) plans, $57,700 in IRAs. $18,500 in a brokerage account, $141,400 in money markets and $18,000 in checking. She also plans to take Social Security before her full retirement age, and she expects benefits of $1,787 a month.

The Star-Ledger asked Jerry Lynch, a certified financial planner with JFL Consulting in Fairfield, to help Carol determine if she can afford the retirement she wants.

“She is healthy, has been consistently saving for many years, she makes a good living and has been living below her means, which is great,” Lynch says. “She now wants to see if she can retire in style at an income of around $100,000 after taxes annually.”

Lynch says a large concern for any financial plan is outliving your money. He says he will look at a family’s history to determine how long someone might live.

“What scares me is that while Carol’s parents lived into their mid-80s, her grandmother lived to be 102,” he says. “If she only lives as long as her grandmother, that would be being retired for almost 40 years while going through a variety of different market cycles. This makes it very difficult to plan.”

Lynch ran through a couple of different possibilities to give Carol a predictable stream of income in retirement so she doesn’t have to worry about running out of money.

Social Security is one area. She can take a monthly benefit of $1,787 if she starts soon, but by waiting longer, Lynch says her benefit would be increased by 8 percent a year. If she waits until age 70, her benefit would be about 50 percent higher than the benefit she would receive at her normal full retirement age, he said. (Waiting is always beneficial — compared to what she could have received at age 62, the benefit at age 70 would have been 80 percent higher, Lynch said.)

“For someone with a long life expectancy, this is really something to consider,” Lynch says.

Next Lynch considered annuities.

“In spite of all the criticisms that I have heard on these products, there is something to be said about having guarantees on some — not all — of your funds in retirement,” he says.

Annuities can give you guaranteed returns and guaranteed income for life, he says, and you can also choose for the annuity invested more aggressively because the insurer is assuming the risk, which would allow an investor to be more conservative with other funds.

There’s also the possibility of a reverse mortgage. Lynch says these are very misunderstood products, and in Carol’s case, she could take a reverse mortgage as soon as she moves — she’s planning to pay cash for her new home. This means she could use the tax-free income from a reverse mortgage to defer her Social Security benefits to age 70.

Carol says she wants $100,000 of income, after taxes, in retirement. Lynch says that means about $120,000 before taxes. Assuming that she sells her primary home and uses the proceeds for her new place, she’d have about $1.25 million in funds to draw from. But Lynch has concerns.

Assuming that she takes Social Security at age 64, this gives her $21,444 annually. She’d need another $100,000 a year to get her the target income.

If she waits until age 70, she’d have more than $30,000 coming in from Social Security, so her investments would need to provide $90,000 a year.

“Generally the draw-down rate I would suggest is around 4 percent, which would give us around $50,000 per year,” he says. “I cannot reasonably get the income close to where her target is.”

Lynch says working a few more years may not be appealing to Carol, but it’s a better option than trying to find a job when she’s in her late 70s or early 80s and finds she’s short on cash.

Lynch also took a look at Carol’s tax situation. She’s in the 28 percent federal tax bracket and pays New Jersey taxes on top of that. He says her investments are unnecessarily adding to her tax bill. For example, she received $6,400 in taxable interest last year, which cost her over $2,000 in taxes. He recommends she consider New Jersey short-duration municipal bonds that should pay similar interest, but would be free of both federal and state tax.

So what does it all mean?

Lynch says Carol should lower her expectations for income in retirement. Her goal of $100,000 after taxes is not realistic, but $70,000 to $80,000 is.

She should consider pushing back her retirement date. This would allow her Social Security to grow, and she could continue saving to her retirement accounts. He says her retirement accounts could grow to nearly $1.6 million at age 70, which would translate to a 4 percent drawdown rate of $63,000.

Another option is semi-retirement and working part time. But this income would have to be enough to sustain her without dipping into investments or starting Social Security benefits.

Carol also needs to be cognizant that she could need long-term care someday, and she’d have to foot the bill.

“With a grandmother that lived to 102 … if she lives that long at some point she will need care,” he said. “A long-term care situation can blow up an otherwise solid financial plan.”