Get With The Plan: November 17, 2013

111713Patrick, 65, and Regina, 68, are already retired. They’ve saved well, but they want to make sure they can afford their current lifestyle through their retirement years.

“Subject to maintaining good health, we envision a comfortable retirement with the ability to travel and continue our current activities and involvement in charitable organizations and artistic endeavors,” Patrick says. “We would also like to leave a nice estate to our kids.”

Patrick and Regina, whose names have changed, have saved $1 million in IRAs, $726,000 in mutual funds and $3,000 in checking. Patrick also expects to receive a lump sum payout from an annuity worth $210,000. Their primary home is in Monmouth County, and they also own a second home.

The Star-Ledger asked Jerry Lynch, a certified financial planner with JFL Total Wealth Management in Fairfield, to help Patrick and Regina maximize their investments and make sure they won’t run out of money.

Lynch says they’re in a very good position.

“Their expenses come in at around $12,000 per month, and their guaranteed income from two pensions and Social Security come in at $10,500 per month,” he says. “They only need to get $1,500 per month to cover their expenses from a $2 million portfolio — not counting real estate — so we need less than a 1 percent return to make this happen. That should not be that hard.”

Lynch took a look at the couple’s asset allocation, which is more than 70 percent in equities. Back in 2008, the portfolio lost 30 percent, or around $600,000. That’s the kind of hit the couple shouldn’t be risking today.

“My mom told me a long time ago, when you have eaten enough, you push away from the dinner table,” Lynch says. “There is no upside to investing this aggressively as they will not spend more if they are successful — as they are not spending it now. Never risk anything when there is no upside for you.”

Lynch says, given that they don’t need to rely much on their investments for living expenses, Patrick and Regina are really investing for their kids.

In the simplest terms, Lynch says, they are creating a life insurance policy for their kids. But because their investments are on the riskier side, the couple is assuming 100 percent of the risk, without the benefits an actual life insurance policy would provide.

“Life insurance is protected from creditors, at least in New Jersey, while investment accounts are not,” he said. “Life insurance is not subject to New Jersey inheritance tax, but investment accounts are subject to an 11 to 16 percent inheritance tax.”

Plus, he said, life insurance grows tax-deferred while some investment accounts do not.

Lynch said a 70 percent stock portfolio historically has averaged around 9.95 percent per year, however, it has the ability to lose 31 percent of its value. Compare that with a 40 percent stock portfolio, which averages around 8.03 percent and has the ability to lose around 18.69 percent.

“I do not think that they should put their money 100 percent in cash, but I do not feel that the risk they are taking is worth it,” he says. “By going to a 40 percent portfolio, they almost cut the risk in the portfolio in half while really not making that big of a difference in returns.”

“If you are age 20, an additional 2 percent return can really make a big difference in terms of how much money you end up with. When you are in your 60s, not so much,” he says.

He recommends they also re-examine their municipal bonds. Those investments can be beneficial for those in a high tax bracket, but this couple may do better with taxable bonds.

Lynch sees an opportunity in the couple’s tax situation. They’re in the low 25 percent bracket, and based on their income, Lynch doesn’t expect that to change. With the pensions and Social Security, they’re not likely to take distributions from their IRAs until they’re required to at age 70.5.

Lynch says that’s what makes them great candidates for a Roth IRA conversion.

“The 25 percent tax bracket goes up to $146,400 in income,” he says. “If we convert existing IRAs up to this $146,400 level, we are staying within the tax bracket that they are in now.”

The benefit is threefold, Lynch says. There would be no change in tax bracket, they will save themselves the requirement of taking distributions at age 70.5 on the money they convert, and if they don’t need the money during their lifetimes, it will go tax-free to their children.

While many people don’t like the idea of paying taxes now when they can pay them later, he says there is a “time bomb” in every IRA, 401(k) or pre-tax account.

“You will have to pay taxes at some point, so developing a strategy that reduces long-term taxes is critical to long-term tax savings,” he says. “It is very reasonable to assume that taxes for everyone will be going up, and setting up strategies today to help yourself and your family can be a tremendous planning tool.”

Short term for their tax return, the couple should look at what they’re paying throughout the year. Lynch said their annual refund is equal to a 60 percent overpayment each year.

“A tax refund is basically paying someone more than you should all year, getting no interest, and then having to fill out a lot of paperwork to get your money back,” he says. “You should not overpay anything by 60 percent.”

Patrick and Regina also donate a substantial amount of cash to charity, but Lynch says there may be a better way. New Jersey doesn’t give a deduction for charitable contributions. Plus, the couple have securities with very large gains.

He recommends they donate the appreciated securities into a charitable trust such as a donor-advised fund, which would give them a full deduction on the amount on the securities on a federal level. It would also save them New Jersey taxes on the gain.

“This helps to clean out the portfolio, reduce taxes, and support your favorite charities,” he says.