Get With The Plan: September 12, 2010

91210Jeff and Debbie are new retirees. Both in their early 60s, they know they need to change their investment strategy from an accumulation phase to one that delivers a steady stream of income. They hope their investments can supplement their pensions and Social Security to support their lifestyles.

“We wish to have a comfortable retirement, travel, gift money to our two children on an annual basis and contribute to a 529 college fund for our new grandchild,” Jeff says.

Jeff and Debbie, whose names have been changed, have set aside $512,538 in 401(k) plans, $130,523 in a brokerage account, $172,335 in mutual funds, $12,500 in money markets and $13,000 in checking. They each receive pensions and Social Security, and they own their home mortgage-free.

The Star-Ledger asked Jerry Lynch, a certified financial planner with JFL Consulting in Fairfield, to help this couple ensure they have a steady stream of income through their retirement years.

“They are in a good position,” says Lynch, noting that their expenses are less than their guaranteed income through pensions and Social Security, giving them a surplus of about $1,500 each month.

“This is before they ever touch their investments of over $800,000 which would give them another $2,600 per month,” he says.

That gives the couple a total surplus of about $4,000 per month.

Lynch says the tough thing for this couple is their mind-set. They have always been savers, so “flipping the switch” and starting to spend is something they won’t feel comfortable with right away.

Lynch says new retirees, especially those who are not spenders, need to be put on a “paycheck” so they can get used to living on their investments.

“It is critical that retirees, especially newly retired retirees, feel very comfortable that they will not run out of money or their retirement will be extremely stressful,” Lynch says. The focus for Jeff and Debbie should be protecting what they have, being sensitive to taxes and developing an estate plan.

The couple considers themselves moderate investors, moving to the conservative side. Yet today, their investments are 86 percent in equities, which puts them in an aggressive portfolio. Additionally, Lynch says they have portions of their portfolio in only a few funds, adding to the risk.

“They have more than enough money so taking extra risk gives them no real benefit and has the potential to lose a lot of money,” he says.

Lynch’s first observation is the couple’s $130,000 stake in dividend-paying stocks. Right now that makes sense, but in 2011, income from these will be taxed as ordinary income, at 28 percent, rather than the current rate of capital gains, 15 percent.

“This is an 86 percent increase on the taxes from this money,” Lynch says. “They need to be aware of this increase.”

Lynch also says the couple should consider a Roth IRA conversion.

First, they do not need the money for immediate living expenses. Second, Lynch says, Jeff and Debbie have the cash available to pay the conversion taxes outside of their retirement account.

Finally, the couple would be forced to take required minimum distributions, or RMDs, from this account after they reach age 70½, but they would not have to do so for a Roth.

“Special planning needs to be done to make sure that the conversion does not bump up their income into a higher tax bracket,” Lynch says. “Partial conversions over time are generally much better than ‘total conversions’ that generally will bump them up into substantially higher tax brackets.”

Lynch says Jeff and Debbie also need to consider some estate planning moves, such as looking at their titling and beneficiary information. Most major assets are not distributed through wills, but rather by the beneficiary designation or how the asset is titled. For example, IRAs and life insurance annuities go through the beneficiary election, Lynch says, no matter what the will says. Joint accounts or property owned as “Joint Tenants with Rights of Survivorship” also do not go through a will.

“This is especially important in 2011 when the estate tax is limited to $1 million per person,” Lynch says. “If the asset is not titled correctly, it is very easy to lose your exemption.”

The couple’s current will is referred to as an “I love you” will where the spouse gets everything. The problem, Lynch says, is that in 2011 when the estate tax liability kicks in at $1 million, the couple could be left with a potential estate tax liability of $275,000 — and that doesn’t count the New Jersey estate tax.

Proper estate planning could eliminate the liabilities, Lynch says.

“Overall, they are in a good position as long as they do not make any big mistakes,” he says. “Big mistakes with a little bit of money is a little bit of money. Those same mistakes with a lot of money — that’s a lot of money.”