Get With The Plan: May 5, 2013

5513Melody is playing it by ear.

Single and 50, she wants to save as much as she can for retirement, but she’s not sure when she wants to stop working, or what those days will look like.

“Not in New Jersey — too expensive,” she said. “I have no set time in my mind to retire and even when I move out of state, I may continue to work part time, depending on necessity, health and desire to do so.”

She said her only debt is her credit cards, and that’s because she’s been concentrating on paying off her mortgage. It was paid off in February, so she’s turning to other financial goals.

Melody, whose name has been changed, has saved $173,600 in 401(k) plans, $25,500 in IRAs, $27,800 in Certificates of Deposit, $200 in savings and $3,600 in a money market checking account.

Of her risk tolerance, she says, “I am afraid of my own shadow.”

The Star-Ledger asked Michael Green, a certified financial planner with Wechter Feldman Wealth Management in Parsippany, to help Melody determine her retirement future.

“The current plan shows a significant shortfall in Melody’s retirement scenario,” Green says. “However, with some adjustments to her strategy, the proposed plan illustrates a much greater ability to maintain her current lifestyle in retirement.”

To start, Green says she should pay off her outstanding credit card debt. Melody had planned to have it paid off in the next three months, and he agrees with the strategy.

“It is further recommended she maintain the various credit lines she has open, but begin using one of the cards for future purchases,” he says. “This will allow her credit rating to benefit while simplifying her budget.”

Looking at retirement savings, Melody says she plans to begin making contributions to her Roth IRA account toward the end of this year.

Green has a different suggestion.

He recommends she make maximum allowable contributions to her traditional IRA account instead of her Roth IRA, which would be $6,500 for 2013.

“Based on Melody’s current age, current income tax rates and the projection of her future rates as legislated, a current tax deduction would be more beneficial than the tax-free income of a Roth IRA at the time of withdrawal,” he says.

She should also maximize her 401(k) plan, which will allow her to earn the full employer-matching contribution and take advantage of tax-deferred growth.

Melody is currently stashing her extra cash in a savings account, but Green says she should open a different taxable investment account to deposit all surplus savings.

Next, Green looked at asset allocation.

Melody’s current allocation is 40 percent equities, 36 percent fixed income and 24 percent cash and cash equivalents.

“It is recommended that Melody consider rebalancing her investment portfolio to achieve a ‘fully-invested’ target of 44 percent equities, 46 percent fixed income and 10 percent cash and cash equivalents,” Green says.

Green says his company uses a cash-management strategy that involves temporary “step-outs” from the equity asset class when volatility is elevated and the risk of capital losses is perceived to be extremely high.

The protection strategy is designed to preserve principal and protect gains during potential protracted market and economic downturns, therefore the 44 percent target allocation for equities is not meant to be static and may be revised periodically.

Melody says she’s afraid of her own shadow when it comes to risk tolerance, so Green wants to clarify what risk means.

“There is a true distinction between risk tolerance, or willingness to take risk, and the ability to take risk,” he says. “It is paramount for the success of her plan that Melody understands the difference between these two terms.”

Green says a person’s risk tolerance is a measure of the willingness to accept more risk, or volatility, in exchange for greater returns. A person’s ability to take on more risk is based on a measure of their specific financial situation.

Melody needs to understand that her projected end of plan net worth is greater when using the higher rate of return associated with the proposed portfolio allocation, compared with her current plan.

Green says the lower level of risk she’s taking today is too conservative given her liquidity needs, time horizon, risk tolerance and financial goals.

Based on the objectivity of the plan analysis, Green says Melody can afford to take some more risk with her portfolio.

Green took a look at Melody’s cash reserves, which would cover 12 months of living expenses. That’s too much, really, he says, but she can wait before making adjustments.

“As a general rule of thumb, she should have at least six months of expenses saved in an emergency fund,” he says. “However, she has a large portion of her emergency cash tied up in Certificates of Deposit at this time.”

Green examined the best time for Melody to receive Social Security benefits, and he says she should wait until her full retirement age of 67.

“This recommendation is based on an assumption of family longevity, good health and projected future earnings,” he says. “Her payment at full retirement age is estimated to be $1,923 per month — indexed by inflation. If Melody takes her benefit immediately upon retirement, the monthly payment would be reduced by 13.8 percent to $1,656.”

Conversely, if she waits until age 70, her payment would increase to approximately $2,284 per month. But if she waits this long, it would take until she reaches her late 80s or early 90s to break even on the delayed payments she did not receive between ages 67 and 69.