[Noozhawk’s note: Fourth in a series. Click here for the first part. Click here for the second part. Click here for the third part.]
Logan and Sarah Green swallowed a hard dose of reality regarding their retirement goals and financial resources. They entered the financial planning process with high hopes of a grand home remodel to the tune of $100,000 and retirement at age 65 with a $15,000 monthly lifestyle. After reviewing their financial plan, they realize these goals are not realistic.
In our last article, we discussed how the Monte Carlo Forecasting tool can provide an approximate probability of success. Because there are many unknowns, such as life expectancy, inflation and investment returns, Monte Carlo helps you formulate and compare different options and understand the long-term ramifications of financial decisions.
Ultimately, Logan and Sarah decided to come up with a compromise. They agreed that they would each sacrifice something today to give themselves a higher probability of success in retirement. Logan agreed to delay his full retirement to age 67, but that at age 65 he will scale back on his teaching duties and focus on writing and consulting. With Medicare qualification at age 65, this ensures continuity of health-care coverage for him, but the continued part-time income from 65 to 67 provides a bridge until his Social Security begins.
They also discussed the remodel in further detail and broke down the expenses by project category. Then they prioritized each project and determined a “Phase 1” and “Phase 2” schedule. In this discussion, Sarah outlined that $55,000 of immediate expenditures would cover what is really most important to her for the home remodel, “Phase 1.” They will pay for Phase 1 out of her brokerage account and then revisit the timing for Phase 2 over the next 12 to 24 months.
Although this is not the outcome they had hoped for, it does give them both a plan for the next few years. The following are some of the other actions the Greens decided to take as steps toward more financial security.
» They took advantage of historically low interest rates and refinanced their mortgage to a jumbo conforming at $729,000 at 4.875 percent. They used the $65,000 in Series EE bonds that were no longer paying interest to pay their mortgage balance down. This reduces their monthly payment by $800 and reduces their lifetime interest cost significantly.
» They do not want to “fritter” away these savings, so they agreed to set up an auto-investment program into Sarah’s SEP-IRA so they can save an additional $9,600 a year toward retirement. These pre-tax contributions will help them save on current income taxes.
» They decided to turn to professional money management for their retirement plans. Because they do not have the time or inclination to proactively review and rebalance their accounts, Logan did an in-service withdrawal of his 403(b) to an IRA with open architecture, and Sarah turned over the management of her SEP. This expands their investment choices and allows for more proactive management of their accounts. By assuming a balanced portfolio of stocks, bonds and cash, they expect their retirement plans to be worth a little more than $3 million by age 67. Using a conservative withdrawal rate of 4 percent, this would generate about $10,000 a month in gross income, almost two-thirds of their goal.
» Because they believe that the long-term capital gains tax rates are expected to increase in 2013, Sarah has established a plan to systematically sell a portion of her low-basis stock from now through the end of 2012. She is reinvesting these funds in more diversified yet still growth-oriented products. They are also using this stock as a charitable giving tool, and are donating a portion of the stock each year to their Donor Advised Fund, which mainly supports the Land Trust for Santa Barbara County.
» They decided to do a tax-deferred exchange of their investment property into a professionally managed fractional ownership property with a higher income yield. This increases their income by about $1,000 a month and reduces some of the headaches of being landlords.
» Because they felt their liquid savings were not adequate to cover any large unforeseen expenses or emergencies, they decided to redirect the increased income from their investment property into their savings account. This will slowly help them build their savings up from the current balance of $30,000 to their goal of $50,000 within two years.
» Regarding Logan’s mother, Louise, we ran a financial plan based on her assets and resources, and after talking with her about her desires Logan decided to have in-home care provided — at least for now.
» Regarding education funds for their soon-to-be-born grandchild, middle son and youngest daughter, they decided that their top priority is to maximize savings toward their own retirement. They expect to continue to fund their son’s college through cash flow, as well as continuing to set aside funds monthly to their younger daughter’s 529, but any further resources will be directed toward retirement, knowing that there are many options available for paying for college, such as loans, scholarships, work-study grants, etc.
» They have met with their CPA to run some projections based on their new mortgage and stock sale, and are also meeting with their estate planning attorney to update their trust to reflect their current desires.
Logan and Sarah now have a solid plan for their future, and look forward to continuing their progress toward financial success!
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— Dannell Stuart CFP, ChFC, CLU, CASL is business development director at Mission Wealth Management. She can be contacted at dstuart@missionwealth.com. Click here for more information.