Get With The Plan: September 25, 2011

92511Scott and Candace, both 64, are half retired. They’d like to go all the way. Candace has already stopped working, and Scott wants to know when he can stop.

They know their potentially long-term time horizon makes funding a challenge.

“My wife and I hope to have enough money to provide a reasonable retirement income for the next 30 years,” Scott says. “Once retired, we hope to spend more time traveling and spending more time with our grandchildren and friends.”

Scott and Candace, whose names have been changed, have saved $16,000 in 401(k)s, $296,000 in IRAs, $158,000 in annuities, $84,300 in mutual funds, $170,000 in bonds, $139,000 in Certificates of Deposit, $2,000 in a money market and $3,000 in checking.

The Star-Ledger asked Christopher Cordaro, a certified financial planner with RegentAtlantic Capital in Morristown, to help the couple determine if they’re on track to have their money outlive them.

“Based on my analysis they are in good shape for retirement and they should be able to spend a fair amount on vacations,” Cordaro says. “Their investment allocation does impact this decision. A higher allocation toward growth assets would increase their odds of not outliving their money and allow for higher spending.”

Cordaro says when he ran the analysis based on their current plan, he found Scott and Candace with a 71 percent chance of not running out of money.

A change in the couple’s asset allocation would make a difference.

If they increase their stake in equity investments from 60 percent of their portfolio to 80 percent, that would increase their chance of success to 76 percent, Cordaro says. But that may not be a prudent course of action.

“It doesn’t move the confidence level that much and they seem to be risk averse,” he says. “They would have to put their hand on the Bible and swear that they could stay the course in volatile markets before I would consider this option for them.”

The couple told Cordaro they’re flexible when it comes to a few issues: their retirement age and their travel spending in retirement. Those items could make a difference, Cordaro says.

“If Scott were to extend retirement to age 69 instead of 67, he would increase the confidence level to 90 percent,” Cordaro says. “They said they would like to spend $5,000 a year on travel in retirement. If they reduced that to $2,500, it increases the confidence to 79 percent.”

The couple asked Cordaro about two specific planning recommendations: exchanging their life insurance policy for an annuity and paying off their car loan.

On the annuity option, Cordaro says as the couple approaches retirement, their life insurance needs will decline. When they’re both retired, their need for life insurance to insure survivor income approaches zero.

“They have already saved enough to provide a lifetime income for Candace if Scott was to die,” he says.

The couple currently has a $650,000 universal life policy with a $5,600 annual premium and a $2,400 cash value. The couple has been paying into this policy for 20 years, so their cost basis in the policy is about $112,000 ($5,600 x 20 years) and the value is $2,400 if they were to surrender the policy; a $110,000 loss.

“They cannot deduct a loss on a life insurance policy,” Cordaro says. “However, there is a technique that they can use to benefit from the loss.”

He says they can make a tax-free exchange, called a 1035 exchange, from a life insurance policy into an annuity.

They have two annuities today, so they can exchange the life insurance policy into one of the annuities. That would move the $110,000 loss on the insurance policy into the annuity, Cordaro says.

“The loss in the annuity would go against any gain they already have in the annuity so that they would be able to withdraw from the annuity tax-free,” Cordaro says. “Normally, any withdrawal from an annuity comes out earnings first. This loss would eat up the gain in annuity, giving them the tax-free withdrawal.”

For this couple, Cordaro says the life insurance exchange to an annuity is amazingly beneficial.

“It allows them to shelter $110,000 of potential taxable income from the annuity,” he says. “I am not a big fan of variable annuities. They are very expensive and poor tax management vehicles. We are taking two lemons here and making lemonade.”

Cordaro says generally, variable annuities are expensive and have embedded gains, so Scott would have been better off with a 20-year level term insurance many years ago.

Now there is no longer a need for the insurance and there is not enough value in the policy for it to carry itself, he says, so the best recommendation is to terminate the insurance, but do so in a way to receive some benefit for the amount of premiums he has paid in over his lifetime.

If they can shelter $110,000 of income at a 25 percent tax rate, that’s $27,500 of tax savings, Cordaro says.

The couple also wanted to know what they should do about their car loan, with a balance of $21,000 at 2.5 percent. Scott and Candace were considering paying off the loan with some of the $140,000 they have in cash, earning less than 1 percent.

“It would make sense to use $21,000 to pay off the car loan,” Cordaro says. “That would save them at least 1.5 percent on the amount of the loan, or roughly $300.”