Get With the Plan : September 14, 2014

Michelle is a young widow. She lost her husband in 2013, and at 54, she has a long retirement to plan for.

“I would like to know if I am on track to be able to retire within the next 10 years, or sooner” she said. “I recently received a life insurance claim and I would like to put this money to good use. What are my options?”

She says she’d like to move out of state in the next five years, and she wants to work part-time when she makes the move.

She also has to worry about paying college tuition for her youngest child, who just started her junior year.

Michelle, whose name has been changed, has saved $246,000 to her 401(k), $39,500 in her IRA, $11,400 in savings bonds, $7,000 in a money market, $2,400 in savings and $2,500 in checking. She also inherited a $35,300 401(k) from her husband and has $75,000 in insurance proceeds to invest. Her child’s college fund has $6,000 remaining.

The Star-Ledger asked Peter McKenna, a certified financial planner with Highland Financial in Riverdale, to help Michelle set up her savings for the long-term.

“With the benefit of a good pension, healthy retirement savings and death benefits from her late husband, her goals are achievable and she can retire and live the lifestyle she envisions,” McKenna says.

But, Michelle needs to make some adjustments.

Michelle is a diligent saver — socking away more than 20 percent of her salary in her 401(k) plan through work and receiving a match from her employer of roughly $2,600 per year.

Her 401(k) plan has an incredibly low expense ratio of only 0.05 percent for its investments, and that’s going to make a huge difference to Michelle’s bottom line.

“The expense ratio compares to average mutual fund expense ratios of 0.78 percent and numerous 401(k) plans that approach 2 percent,” McKenna says. “To put that in perspective, at the end of 20 years she would be $146,000 better off than an investor paying average expenses.”

Michelle describes herself as “willing to take some risk.” But looking at her 401(k) investment selections in isolation, Michelle is taking on a lot of investment risk, McKenna says.

She has 22 percent in fixed income and 78 percent in equities.

“In a market like the 2008 financial crisis, that mix would have lost around 35 percent of its value and is too risky for most of us, but Michelle is different,” McKenna says.

That’s because she has some guaranteed income streams in retirement: her Social Security, a pension and her survivor’s benefit.

“The income stream will resemble an inflation-protected government bond that pays interest for her lifetime and never matures,” McKenna says. “When this very safe `asset’ is combined with her `risky’ investments, her combined picture is in line with how she describes her appetite for risk.”

Michelle’s other investments total about $150,000. McKenna says some of these funds should be used to create an emergency fund to cover unexpected events.

“Since Michelle’s job is secure and most of her living expenses in retirement will be covered by reliable sources, the amount of the emergency fund should be based on what she feels is necessary,” he says, noting $6,000 could be a good starting point.

With the exception of her savings bonds — more on that in a moment — the remainder of her savings should be invested in low-cost mutual funds that complement the choices she has made within her 401(k), McKenna says. Most of this is currently in cash, but the remaining investments should probably be liquidated as there are better, lower cost investment options available, he says.

Overall, McKenna says, Michelle is well positioned for the future she envisions.

“This isn’t something that just happens,” McKenna says. “It is the result of a series of good financial decisions that were made over many years. We can be sure there were mistakes and setbacks along the way, some good or bad luck, but overall she is in good financial condition with minimal debt.”

McKenna says Michelle’s husband’s death shows that we can’t control all that happens in our lives, but we can establish a firm foundation to respond from.

He says given that Michelle is still in her first year as a widow, he recommends anyone who has experienced a major life change create a “decision-free zone” for a period of time. Of course there are time-sensitive decisions that need to be made, but delaying major decisions until the grieving process has evolved

may help prevent future regrets, he says. A year would be a good time frame for most people after a major life event, he says, and so far Michelle has done this — by leaving the insurance proceeds in cash, not rushing to sell her home and by continuing to work despite the life insurance settlement and the survivor’s benefit.

She’d eventually like to move out of New Jersey, where she projects her retirement living costs to be lower than current New Jersey expenses primarily due to property taxes. She hopes to sell her home and buy a new one without a mortgage.

McKenna used a retirement cost projection based on current spending, estimating $2,300 per month. He says all figures are in today’s dollars and his financial planning software adjusts them for inflation throughout retirement. In addition to regular monthly expenses, he included $25,000 for a new car in 2015 and every 10 years after that, plus $5,000 for annual travel for 20 years from retirement, or until Michelle is 76.

Janice would like to retire in two years at age 56, her official retirement date from the USPS. She wants to work part-time for the first few years to keep busy and this will help her maximize her lifetime benefits.

If Michelle waits to collect Social Security until her full retirement age of 67, her monthly retirement income — including the pension and survivor’s benefit — will total $5,466 in today’s dollars.

“This will be more than enough to cover all of her goals from age 67 for the rest of her lifetime,” McKenna says. “Funding her retirement expenses for the 11 years between retirement and age 67 will be more complicated, but very achievable with her resources.”

Working part-time and having a solid plan in advance will reduce the risk of raiding Social Security early and missing out on higher lifetime benefits, he says.

Michelle’s child has two more years of college, and Michelle is contributing to the cost.
One consideration is whether to cash in the savings bonds. They have scheduled maturity dates between 2036 and 2040, and the interest income on these could be tax-free if used for college expenses.

“If they can be redeemed now without material penalty, it is worth exploring,” McKenna says. “The remaining balance in her New Jersey 529 account is $6,000 and will be consumed very soon.”

Get With the Plan is designed to illuminate personal finance concepts and isn’t a substitute for actual financial planning or dedicated professional advice. Contact Karin Price Mueller at Bamboozled@njadvancemedia.com.

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