Get With The Plan: November 25, 2012

Kesha’s three children are just about out of the house, so now she’s thinking about her future retirement needs. The divorced woman has been able to save, but she’s not sure it’s enough to fund her long-term goals.

“I want to understand what I need to save for retirement, and if I lose my job, what is the impact and risk to my current finances and retirement?” said Kesha, 51. “I am selling my marital home and trying to understand if I am financially secure to purchase a home at the Jersey Shore or Cape Cod for vacationing and retirement.”

Kesha, whose name has been changed, has saved $118,000 in 401(k) plans, $290,000 in IRAs, $23,000 in a money market and $7,000 in checking. She also has $210,000 in a Qualified Domestic Relations Order (QDRO), which is her portion of her ex-husband’s retirement accounts, and she receives $90,000 in annual alimony.

The Star-Ledger asked Edward Leach, a certified financial planner with Highland Financial Advisors in Riverdale, to help Kesha plan her financial future.

“Being at this stage of transition in her life, she is unsure whether or not she can afford to meet her goals,” he says. “Additionally, she is concerned about the possibility of losing her job and the effect it could have on her financial picture.”

Leach says Kesha has done an excellent job of saving for retirement through her 401(k) and a traditional IRA. In addition, she has the QDRO, which will be available during retirement.

Kesha is juggling several goals.

When she sells her home, she expects to receive $250,000, and she’d buy a home for about $500,000, which would be her primary home until retirement. In the meantime, she says she hopes to buy a piece of land for $150,000, upon which she’d build a home for $250,000 to $300,000. That would be the home where she’d retire in 15 years.

After reviewing Kesha’s current cash flow and living expenses, Leach says she has a monthly surplus of roughly $4,700.

Based on her current living expenses, ideal lifestyle goals and retirement goals, Leach created a “what-if” cash flow scenario using the following assumptions:

Kesha finances $300,000 for her new home with a 15-year fixed-rate mortgage at about 3.125 percent interest. She also finances $350,000 for construction on her second property with 30-year fixed-rate mortgage at about 3.75 percent. The $250,000 from the sale of her current home would serve as the down payments on both properties.

“Using these assumptions and if all else remains constant, she will have roughly $1,300 in monthly cash flow surplus,” Leach says. “On a cash flow basis, she appears to be successful in achieving these goals.”

If she were to lose her job, Kesha would need to reassess.

Looking at Kesha’s investment choices, Leach says she could make some improvements.

The large majority of her portfolio is in tax-deferred accounts.

“Considering her resources for retirement, it may be prudent to focus on after-tax savings in a taxable investment account,” he said.

He says investors should look at retirement resources using three savings “buckets:” tax-deferred, taxable and tax-free.

Tax-deferred accounts include 401(k)s, qualified retirement plans and traditional IRAs. Money goes in pre-tax and taxes are deferred until you withdraw the funds, he says.
A Roth IRA is a tax-free account. Money goes in after-tax, grows tax-deferred and is distributed tax-free.

The third and final type of account is the traditional taxable account. Money goes in after-tax, and all interest, dividends and capital gains are taxed as you recognize them.

“Just as you would diversify your investment options in your portfolio, you should also diversify your types of investment savings,” he says.

Kesha says she has a high tolerance for investment risk, but that she may move to a more conservative slant as she gets closer to retirement.

That could be trouble, Leach says.

“If a conservative approach is taken during the accumulation phase with assets earmarked for retirement, it may hurt the chances of meeting retirement goals,” he says. “This is why time horizon is such an important aspect of deciding your risk tolerance.”

Leach says Kesha has diversified well, but there is more than $100,000 of cash in a tax-deferred investment vehicle.

“She is missing out on the benefit of letting the markets work for her in a tax-deferred investment vehicle,” he says. “Investors usually believe that by holding large cash positions in assets set aside for retirement, it means they are ‘playing it safe,’ but considering the low interest rate environment and that inflation has historically been around 3 percent, the cash portion of the portfolio will not keep pace with inflation.”

The investment side is pretty well-diversified, but he says Kesha is overweighted in U.S. large-cap stocks. He says further diversification in international equities and small-cap stocks will help to reduce the volatility of her portfolio.

“Based on the information she provided us and her goals for retirement, we find that she is well-suited overall to meet her goals,” Leach says.