Get With The Plan: September 16, 2012

After years of saving, Jose and Halina, both 55, are looking for a change of pace when they retire.

“We’re concerned about accumulating sufficient funds to retire comfortably, with travel and owning a luxury home in San Francisco,” Jose says.

The couple would like Halina to retire at age 58 and Jose at 62.

At that time, Halina expects a $57,000 per year pension, and Jose will have a pension of $25,000 a year when he stops work. The couple has saved $398,000 in 401(k) plans, $1.127 million in IRAs, $19,900 in annuities, $93,500 in a brokerage account, $188,000 in mutual funds, $50,000 in bonds, $6,900 in savings and $24,000 in checking.

The Star-Ledger asked Andrew Novick, a certified financial planner with Condor Capital in Martinsville, to help Jose and Halina see if their dream retirement is feasible.

“They estimate their living expenses at about $100,000 per year, exclusive of taxes,” Novick says. “They both maximize savings in their 401(k)s and receive a company match, so their overall savings rate is about $60,000 per year.”
In order to project their success in retirement, Novick made some assumptions.

First, he assumed they’d each live to age 100. Their portfolio would earn 7 percent a year before retirement and 6 percent a year after retirement. The 7 percent rate of return corresponds to a moderate 70 percent equity and 30 percent fixed income asset allocation, while the 6 percent return reflects a 50-50 allocation at retirement.

He also assumed a 3 percent inflation rate and that Jose and Halina would continue to max out their 401(k) plans while working.

“Based on the assumptions, the projections calculate that the portfolio, in conjunction with pension and Social Security, can provide gross maximum expenditures of $203,393 in today’s dollars at their retirement,” he says.

But, because most of the couple’s income, including tax-deferred portfolio withdrawals, will be taxable when they take money out, Novick says it’s important to spend less than the maximum to account for taxes.

Assuming a combined average federal/state tax rate of 25 percent, the couple would have about $152,000 a year for living expenses, he says.

“This is still much higher than their current living expenses, so they should have no problem maintaining their current lifestyle in their retirement years, even if they travel more,” Novick says. “However, whether they have enough financial resources to relocate to a ‘luxury’ home in San Francisco is questionable since this is one of the most expensive real estate markets in the country.”

Novick says even a modestly priced home in San Francisco can cost twice as much as their New Jersey home, and a luxury home will cost even more. Assuming they simply apply the equity in their New Jersey home toward the down payment and take a $1 million 30-year-mortgage at 4 percent, their annual mortgage expense will increase from about $11,000 a year to $58,000 a year.

“This is a sizeable increase in housing costs and will essentially push them right up against the maximum recommended expenditure amount,” he says. “Purchasing a home in California with a smaller mortgage is certainly possible and will leave them with a more comfortable cushion.”

Another alternative, Novick says, would be to delay retirement, which will allow them to continue saving and reduce the number of years they need to withdraw from the portfolio. Additionally, their pensions and Social Security benefits should also increase if they delay retirement.

The couple needs to do some work on their portfolio to secure a comfortable retirement.
Jose and Halina consider themselves moderate risk investors, and they claim they want to be more conservative as they approach retirement. But their current portfolio is invested with approximately 80 percent in equities — a relatively aggressive allocation. A shift to a more balanced 70 percent equity and 30 percent fixed income target allocation seems appropriate today, Novick says.

When Halina retires, they should shirt to a 60/40 mix, and when Jose retires, a 50/50 mix.
Novick says mutual funds and exchange traded funds can be used to obtain diversified exposure to virtually any asset class, investment style, geographic region or specific sector and are terrific investment vehicles for do-it-yourself investors. He recommends investors have exposure to equity funds across market capitalizations (large, medium and small companies), investment styles (growth versus value) and geographic variety (U.S., developed international and emerging markets). Similarly, for bond funds, investors should look for funds that give them broad exposure to different areas of the bond market such as government, corporate and municipal bonds, he says.

Jose and Halina are already substantially invested in mutual funds, mostly through low-cost fund families. Novick recommends they consider shifting their focus to even lower cost exchange traded funds.

“Over the last several years, hundreds of new ETFs have become available, providing exposure to all of the same areas as mutual funds, but at lower cost,” he says.