Get With The Plan: November 13, 2011

Fred, 65, and Linda, 63, very much want to retire at the end of this year. Before they take this life-changing step, they want to make sure they will have financial security.

They’d like to sell their New Jersey home and move out of state to be close to their grandchildren, and they don’t plan on sitting still very much.

“We’d like to retire, but also take occasional large trips and numerous small ones,” Linda says.

The couple, whose names have been changed, have accumulated $489,000 in 401(k) plans, $917,500 in IRAs, $34,600 in mutual funds, $64,500 in savings and $29,000 in checking.

If Fred retires in January 2012, he’s eligible for a $2,100 annual pension with a 100 percent survivor benefit, and Linda would receive a pension of $9,600 a year for her lifetime only.

The Star-Ledger asked Laura Mattia, a certified financial planner with Baron Financial Group in Fair Lawn, to help the couple see if they’re ready for retirement.

“After a full evaluation, we determined that their goal is achievable,” Mattia said. “They have done an excellent job taking advantage of their companies’ qualified retirement plans. They have been able to save a nice lump sum of money.”

Also on this couple’s side? They each have a long-term care insurance policies that mitigate concerns of unexpected long-term health expenses, and in general, their expenses are modest.

In retirement, the couple will both receive small pensions and Social Security, but they will have to dip into their retirement savings to supplement their income.

A big question is when this couple should start taking Social Security. They have several options: starting immediately, waiting until age 66, delaying benefits further or a combination strategy.

The first thought might be for both Linda and Fred to take their benefits at retirement since Fred will be 66, which is his full retirement age, and Linda is entitled to take an early distribution, Mattia said. However, they may want to reconsider that option.

“If the benefit is taken prior to full retirement age, the monthly benefit will be reduced,” she said. “Because Linda and Fred will begin to receive their pension income and have a good amount of emergency savings in the bank, they may want to consider using a spousal benefit strategy.”

Social Security gives you the option to either take your full employment benefit at retirement, or 50 percent of your spouse’s benefit at retirement, Mattia said, calling it an interesting twist that can result in an optimum amount of benefit to the couple.

In this scenario, Linda can choose to begin receiving her benefits at age 64, while Fred chooses to take 50 percent of her spousal benefit simultaneously. Because Fred has the greater benefit, he can delay receiving his full Social Security benefit until age 70, at which time Linda can take 50 percent of his benefit.

“This will allow the couple to start an income stream now, while simultaneously allowing them to attain a higher overall benefit and a higher survivor benefit for Linda if Fred — the higher earner — dies first,” Mattia said.

This strategy does require the couple to delay some of the Social Security benefit, but over the long-term will strengthen their financial security both as a couple and as individuals because of the increased survivor benefit, she said.

When they decide to move, the couple is looking at homes in the $250,000 range with annual property taxes of $13,000. After they sell their New Jersey home and pay off the mortgage, they’ll have proceeds of about $200,000.

Mattia suggests they use that equity as their down payment, and then carry a small mortgage of $50,000. She said with today’s low interest rates, the payment on the mortgage would be around $500 per month, and even after adding taxes and insurance, their housing costs would be $1,200 a month less than they are today.

While the couple has saved well, they will need to be very careful in formulating a distribution strategy for their retirement assets, and this will be tied to their asset allocation.

Currently, their portfolio is 65 percent in equities, mostly in large-caps.

“The concern is that there are not enough market diversifiers in their current strategy,” Mattia says. “Due to their upcoming future cash needs, and their risk tolerance they should have at least 40 percent of their portfolio in fixed income.”

The fixed income portion should also be well diversified to reduce the volatility of the portfolio and to provide another mechanism to replenish their cash cushion through coupon payments and bond maturation.

Mattia says she has some concerns about the use of bond funds, which she says could be problematic should interest rates increase in the future.

“They should consider purchasing individual bonds where they would have more control over the quality and duration of the bonds purchased,” Mattia says. “Most importantly, they will get 100 percent of the principal back regardless of the changing interest rates, which will essentially lock in the yield of the bond.”

She says if they ladder the bond maturities, they can generate a higher blended yield and create more liquidity so that they can take advantage of opportunities in the markets when they arise. Mattia suggests they look for the highest quality investment grade insured bonds, rated “A” or better, so that they can minimize the probability of default risk.

If they make these portfolio changes, Mattia says the couple can easily afford to retire without a fear that they will run out of money in their later years.