Get With The Plan: September 4, 2011

9411While the stock market’s turbulence has put many retirement dreams on hold, Mack and Eileen are going for it.

The couple, both 53, would like to retire in the next 18 months.

“The first goal is to retire without having to take on supplemental jobs and still maintain a relatively debt-free lifestyle,” Mack says. “We also want to be able to pay for our two children, who are 16 and 14, to attend a state or community college.”

The couple, whose names have been changed, hope their two healthy pensions will get them there. Mack will receive $6,915 a month upon retirement, and Eileen will receive a $3,920 monthly check.

They have also saved $322,600 in 457 retirement plans, $92,300 in a brokerage account, $18,000 in mutual funds, $4,000 in certificates of deposit, $95,000 in a money market, $5,000 in savings and $16,000 in checking.

The Star-Ledger asked Taylor Thomas, a certified financial planner with Highland Financial Advisors in Riverdale, to help Mack and Eileen see if they’re ready for an early retirement.

Taylor says the couple will be highly capable of reaching their goals — with a little tweaking.

“The current allocation of their investment portfolio is highly concentrated in a few asset classes, which increases the amount of risk they are taking for their expected return,” he says. “This can have an impact on achieving goals.”

Taylor examined their current allocation and almost 90 percent of their retirement and savings accounts are invested in only three asset classes: large-cap growth, large-cap value and cash.

Their current allocation lacks diversification, which, when implemented, can increase the annual returns of their investments while actually decreasing the overall risk of the portfolio, he says. Taylor recommends a more diversified portfolio across more asset classes.

“By allocating to very diverse asset classes including inflation-protected securities, foreign bonds, U.S. small- and micro-cap equities, foreign equities, real estate and commodities, Mack and Eileen can reduce the risk in the portfolio over the long term,” he says.

And to optimize their portfolio for their time horizon, Taylor recommends they consider an allocation of 30 percent fixed income securities and 70 percent equities.

“It is evident that their pensions afford them the ability to retire at an early retirement age of 54. Without it they have a significant shortfall,” Taylor says. “It also permits them to be a little more aggressive with their investments because the pension is like a fixed income allocation.”

Taylor says the couple should also take better advantage of tax-deferred savings opportunities.

Today, they’re both contributing $650 per pay period, or $16,900 per year, to their employer-sponsored 457 retirement plans. Because they’re both over the age of 50, they can contribute a total annual amount of $22,000 per person, and Taylor recommends they up their contributions.

Once they retire, Mack and Eileen should roll over their 457 plans to traditional IRA accounts at any major brokerage firm, such as Fidelity, TD Ameritrade or Schwab.

“The 457 plan uses an insurance product which usually contains unnecessary ‘mortality and expense’ fees, which can be eliminated when the assets are rolled over to an IRA,” Taylor says. “This cannot be done until they are retired, and they should make sure there will be no surrender charges if they were to roll over the accounts.”

To calculate the couple’s ability to fund four years of higher education for their two children at state colleges, Taylor made several assumptions. The average cost of a state college in New Jersey is currently about $20,000, and this amount is expected to increase about 6 percent a year. He assumed their older child will start school in 2013 and the younger child in 2015.

“As these are relatively short-term time frames, they should be more conservatively allocated,” Taylor says. “Use a low cost 529 plan invested in index funds like Fidelity, American Funds or Vanguard. Select the age-based option or consider allocating those funds with no more than 20 percent in equities.”

If the couple decides not to implement any of the suggested changes, Taylor says they have less than a 40 percent probability of success. If they do make the changes, they will increase their probability of success to 73 percent.

“This is due to the benefits of diversification, which lowers the amount of volatility within the portfolio while providing the opportunity for higher returns over their lifetimes,” he says.

To further increase confidence they will achieve their goals without changing their retirement age, they can take a few more steps.

Taylor suggests they decrease their annual retirement spending by 5 percent, or $4,200 in today’s dollars. That will increase their probability of success increases to 84 percent.

If they can save an additional $124,000 before retirement, including the previously discussed 457 plan contribution increases, they would also increase their success rate to 84 percent. These extra savings should first go to fund education accounts for the kids — $40,000 each — and then they can make annual IRA contributions of $6,000 each, which includes a $1,000 catch-up contribution for those over age 50.

Taylor says a review of the couple’s monthly income shows there should be a cash surplus of several thousand dollars a month. That with a small cutback in today’s spending frees up dollars for the additional savings.