Get With The Plan: October 28, 2012

Garcia and Cher are in the midst of a big move. They’re selling their home and moving across the country to build a new home on a piece of land they own.

“I estimate the net proceeds after paying off our mortgage at about $450,000,” said Garcia, 67. “It will take probably another $150,000 to $200,000 of our current investment money in addition to the proceeds of our house sale for our new house.”

The couple has saved $1.669 million in IRAs, $122,200 in mutual funds and $22,500 in checking. Cher will receive a pension: either a lump sum of between $100,000 and $125,000 or a life annuity of $882 per month, which would be reduced 50 percent if the joint and survivor option is chosen.

The Star-Ledger asked Michael Green, a certified financial planner with Wechter Feldman Wealth Management in Parsippany, to help the couple plan their retirement.

“Garcia and Cher are concerned they will face a large tax bill when they withdraw assets from their qualified retirement account to fund the purchase of their new home,” Green said.

The couple is also concerned about diversification. Green said in the most recent major downturn, the couple lost about half their life savings and they want to make sure it won’t happen again.

After reviewing the couple’s current plan, Green says both the current plan and his proposed plan illustrate they have the ability to maintain their current lifestyle in retirement. However, there are some very important steps they can take to improve their outlook further.

First, they should set up an emergency cash account with $11,000 of non-qualified assets immediately. They should also pay off their credit cards so they can save on interest, and they should research other credit cards so they can reduce or eliminate annual fees.

Next, retirement planning.

She should also postpone receiving her Social Security retirement benefits until she reaches the full retirement age of 66.

“Her payment at full retirement age is estimated to be $2,050 per month,” he says. “If she takes her benefit immediately upon retirement, the monthly payment would be reduced by 6.7 percent to $1,913.”

If she can wait until age 70 to collect, her benefit would be $2,706 per month, but it would take until her late 80s or early 90s to break even on the delayed payments received between ages 66 and 69.

Tax planning will be important as they make their big move.

The couple will need approximately $200,000 from savings to build their new home, and how much they need to withdraw from retirement accounts will depend greatly on the sale price of their New Jersey home.

“Taking a large lump sum withdrawal from qualified retirement accounts will push Garcia and Cher into a higher marginal tax bracket and create an excessive tax bill,” Green says. “Withdrawal needs will increase further to help fund the taxes in 2013.”
He recommends they withdraw the IRA assets for the new home in 2012.

The tax savings would be between $13,000 and $15,000 if they withdraw $80,000 in 2012 to spread the tax burden over 2012 and 2013.

“If the house construction should happen to carry over into 2014, then Garcia and Cher would have the ability to spread the withdrawals over three calendar years, thereby reducing their tax burden even further,” Green says.

The analysis assumed tax rates will increase in 2013 as currently legislated and that the Bush-era tax cuts will be extended. Spreading the tax over 2012 and 2013 should allow them to remain in a moderate tax bracket (i.e., 25 to 31 percent) versus jumping to a high tax bracket (i.e., 33 to 36 percent), Green says, noting they should meet with a tax accountant to obtain tax projections for 2012 and 2013 before they make a move.

When Garcia and Cher begin taking Required Minimum Distributions (RMDs) from their IRA accounts at age 70½, they will not need the full after-tax amount for cash flow, Green says, so surpluses should be directed to individually titled non-qualified investment accounts.

The couple’s current portfolio allocated 98.8 percent in equities and the rest in cash — too risky.

“Due to the high level of exposure and correlation to the equity markets, it is not surprising that their portfolio fell by about 50 percent in the most recent market crash,” he says.

Green says in addition to diversifying the asset allocation, sectors, and individual holdings within the portfolio, there are other strategies that can be used to minimize risk and help prevent a catastrophic loss similar to the one experienced several years ago.

He says they should start by rebalancing their investment portfolio to achieve a “fully invested” target of 75 percent equities, 21 percent fixed income and 4 percent cash and cash equivalents.

While they reallocate, Green suggests Garcia and Cher both consolidate their IRAs into one account for easier management, and when Cher leaves work, she should roll her employer-sponsored retirement plan into an IRA.