Get With The Plan: October 25, 2009

102509Dana, 61, would like to retire in five years, and she’s starting to feel time moving quickly. Her biggest financial concerns are having enough money to live on and taking care of health care costs. But she has a dream, too.

“I’d like to split my time between New Jersey and wintering in Florida,” she said. “I’d like to purchase a small place.”

Dana, whose name has been changed for publication, has $107,119 in her 401(k) plan, $23,000 in IRAs and $11,500 in checking. She shares a home with her brother, so she owes half the mortgage on their Essex County home, and she also has half the equity.

The Star-Ledger asked Doug Buchan, a certified financial planner with Tilson Financial Group in Watchung, to help Dana see if her goals are achievable.

There’s good news and there’s bad news for this pre-retiree.

“Given her assets and expenses, retiring at 66 and buying a place in Florida without selling her existing place is not feasible,” says Buchan. “A second home in Florida may be possible if she puts off retirement a couple years.”

As Dana contemplates extending her working life by two more years, there are a couple significant planning strategies that will get her closer to her goals, Buchan says.

Two clear ways to help accelerate the path to a successful retirement are to lower expenses and increase assets. Buchan says Dana cashing out her whole life insurance policies will help achieve both.

Dana has two whole life insurance policies, both with a cash value, for which she pays about $1,400 a year.

“I’m not a big fan of whole life insurance policies in general, but I really find them to be a waste of money when either the death benefit is not critical for dependents’ livelihood (it’s not here) or when estate taxes are not an issue (they’re not here),” Buchan says.

Dana’s children are grown and financially independent, and no one is counting on her for financially support. She could instead save the expense of the insurance premiums and invest the cash value of the policies – worth nearly $25,000 – if the tax implications are not significant. She can also then bank the cost of annual premiums. This should help her plan considerably, Buchan says.

Secondly, Dana needs to rethink her investment strategy and her allocation of stock and bond investments.

She will need to take on some market volatility if she wants to come close to achieving her retirement goals. Currently, Dana’s 401(k) is invested in more than 90 percent stocks. As a self-described “conservative” investor, her current allocation doesn’t match what she says is her risk tolerance, Buchan says.

The bigger issue, though, says Buchan, is that Dana’s 401(k) is overly aggressive and her Roth IRA is overly conservative.

“I have seen this often and it’s a big mistake,” Buchan says. “I would advise flipping her allocations.”

These two retirement vehicles are very different from a tax standpoint. Every dollar that grows in traditional 401(k)s or traditional IRAs will be taxed at ordinary income tax rates when a distribution is taken. In contrast, every dollar earned in a Roth IRA is 100 percent tax-free at distribution.

“Therefore, it almost always is advised to get your growth, or take your risk in your Roth,” Buchan says.

Because Dana’s Roth is relatively small compared to her 401(k), Buchan suggests she invest her Roth in a low-cost diversified equity index fund. She could then lower the equity allocation in her 401(k) to somewhere between 50 and 60 percent diversified stocks, with the other 40 to 50 percent in high quality bonds.

“These changes will go a long way in helping her get closer to her goals, but 66 and a Florida house is not realistic,” Buchan says. “Excluding the Florida house, retiring at 66 is feasible, but it’s not a slam dunk.”

Dana will have to continue to watch expenses and she will need to stay invested to achieve the necessary growth. A small Florida home is possible to consider if Dana can withstand putting off retirement to age 68 or 69, Buchan says. The delay would give her more years to save and more years for her savings to grow before she starts drawing down her accounts for living expenses.