Get With The Plan: October 7, 2012

Abel, 74, and Andrea, 63, have raised children who are financially independent, so the couple wants to make sure they, too, are financially independent in their later years.

Abel is already retired, and Andrea plans to retire next year. Some of their income is from a rental property, which nets $18,000 a year, but they’re tired of being landlords.

“We would like to dispose (the property) and find other alternative investment opportunities giving us a safe and reasonably risk-free return of 5 percent to 6 percent,” Abel says. “Our objective is to have a total monthly income of $3,500 combining all sources of benefits and investment returns.”
If Andrea retires next year as planned, she’ll receive $7,200 a year from Social Security, but the couple will lose her working income. They considered a reverse mortgage that would pay $7,200 a year as one source of retirement funding, but they haven’t made up their minds yet.

The couple, whose names have been changed, have only a modest amount of savings. Their big assets are their primary home, worth $225,000, and their rental property, worth $300,000. Both are mortgage-free.

The Star-Ledger asked Brian Power, a certified financial planner with Gateway Advisory in Westfield, to help the Abel and Andrea make the most of their assets.
“After analyzing their situation, it became clear to me that they will be in a very tentative cash flow situation once Andrea retires, and in addition, they have a lack of liquidity,” Power says.

He carefully examined the various options of how to make the equity in their properties work for them.

First, he addressed the possibility of a reverse mortgage. If they did keep their real estate and took out a reverse mortgage, they would not have any liquid assets to fall back on in case of an emergency. If someone fell ill and they needed additional assets to cover expenses, this could lead to big problems, he said.

“This could easily cause a situation in which they would be forced to sell a piece of real estate in a rush and possibly not get full value for it — a fire sale,” Power says.

A better strategy would be to sell either the rental property or their primary residence and rent a new home — sooner rather than later — and make sure Andrea stays at work until the sale is completed.

If they did this, Power says they should plan to sell the remaining real estate 10 years down the road.

Power says the sale of the first property would release the pressure valve on their lack of liquidity and give them plenty of assets that could be drawn down to live on until the remaining property is sold.

Then later, the sale of the second property would help build up their liquidity again and take Andrea through to the end of her life, given that she’s 11 years younger than Abel.

Power looked at several scenarios based on selling the properties at one time or another.

His projections showed that selling the primary residence and renting a place to live, while keeping the rental property for 10 years, is their best scenario. This projection showed they’d end up with $250,000 to $300,000 more in their portfolio at the projected end of Andrea’s life compared to the other options, he said.
“The primary reason for this is that it would be very difficult, if not impossible, to match the income the rental property is generating — 6 percent net cash flow — and could possibly generate over the next 10 years prior to selling it,” he said.

In this low interest rate environment, a portfolio of stocks and bonds would be hard-pressed to find an equivalent guaranteed return.

Keeping the property has another problem, though. Abel is tired of being a landlord, and he’s concerned that Andrea would be stuck managing the property should Abel predecease her — and that’s something Andrea doesn’t want to do.

That is a significant issue, but Power said if they sell the rental property now and keep their primary home, they will face a big risk of drawing down on their investment principal at a much greater rate.

This all means the couple has to decide what they will be comfortable doing.
Power says there is another option, if selling the rental property first is the only psychologically acceptable choice for the couple.

“I’d recommend that they sell the rental property now and Andrea work a few more years to help minimize the drawdown on their investment assets for the years she continues to work,” he says.

Every additional year of working would not only help minimize the drawdown on their investments for those years, but it would also shorten the amount of time their investments would have to supplement their lifestyle in retirement, Power says.
Whichever home they decide to sell, Power says the couple must be prudent with investing the proceeds.

The funds should be invested in a very conservative asset allocation with principal protection as the No. 1 goal of the portfolio, he says.