Get With The Plan: October 11, 2009

101109Thomas, 57, and Pam, 49, are juggling quite a bit as they near retirement. Both in their second marriage, the couple are paying tuition and other expenses out of their cash flow for Pam’s child, who has two more years of college to go. Thomas’ kids are financially independent.

“We’d like to be debt-free, living in our current home and maintaining our current standard of living,” Thomas says. “If I retire before she does, which is very likely, given the age difference, I envision retiring by age 65. Pam’s ability to retire will depend critically on health insurance coverage options.”

They’d also like to pay off their mortgage in the next 10 years.

So far, Thomas and Pam, whose names have been changed, have set aside $253,000 in 401(k) plans, $59,000 in IRAs, $581,400 in mutual funds, $56,604 in a brokerage account and $4,500 in checking.

The Star-Ledger asked Gerard Papetti, a certified financial planner and certified public accountant with U.S. Financial Services in Fairfield, to help the couple prepare their finances for retirement.

“They will have a short-term challenge to meet their living expenses, debt service and funding college expenses in 2010 and 2011,” Papetti says. “Based on the fact that there were no funds set aside to pay for college, they will need to fund these costs from their income or they will need to withdraw funds from savings to cover these expenses.”

As long as they’re making college payments, they’ll have a bit of a cash-flow deficit. After that, they’re going to have a surplus — even after adding to their work savings accounts.

“Once they complete the college funding in 2011, our analysis indicates that they will be able to save on an after-tax basis approximately $5,000 per month or $60,000,” Papetti says.

Papetti recommends the couple keep a close eye on their expenses. If they spend a lot differently than indicated in their budget worksheets, their whole plan could be thrown off.

Papetti ran the numbers to see how the couple are prepared for financial independence in retirement. He assumed an inflation rate of 3.65 percent, pre-retirement rates of return of 8.75 percent and a post-retirement return of 5.25 percent. He also assumed they’d continue today’s savings of $14,000 a year, and then save their extra cash flow when the college bills are done.

When they each retire at age 65, their only non-investment income sources will be Social Security. Thomas is anticipating annual benefits of $27,431 in 2017, and $32,475 for Pam when she reaches age 65 in 2025.

When they retire, Papetti projects their nest egg to be worth approximately $2.5 million, and their annual expenses would be about $118,415, including taxes.

“Under these assumptions, they are projected not to begin depleting capital when they retire until Thomas is age 93 and Pam’s age 85,” Papetti says.

Thomas says his risk tolerance is moderate, while Pam says she has a high risk tolerance or one that’s geared towards capital growth. Papetti says their investments are in the right place, given their tolerances, but there are some areas they could improve.

Their investment accounts have a higher cash allocation than their tolerances indicate they should have. Also, Thomas has about 7 percent of his portfolio in municipal bonds, but he might benefit from more.

“Based upon the 33 percent marginal federal tax rate, increasing this allocation may provide a higher net after-tax return than taxable corporate bonds,” Papetti says.

The couple could also use some exposure to emerging markets investments.

One large risk area the couple face is life insurance. While Thomas has a group policy through his employer and a separate individual policy, it’s not enough. To make sure Pam’s income needs are met and so she can maintain her current lifestyle, Thomas needs another $1 million of coverage.

Papetti says it’s also important to consider disability coverage.

“Your chances of being disabled for longer than three months are much greater than your chances of dying prematurely, due in part to medicine that has made many fatal illnesses treatable,” he says. He recommends they consider disability insurance.

Then there’s long-term care. Papetti says nearly 40 percent of people receiving long-term care are between the ages of 18 and 64. This is worth addressing, he says, although for this couple the disability income shortfall is a greater risk.