The plan: Settle property matters firstMaria has positioned herself strongly enough so that she has options. Our projections indicate that Maria could reasonably maintain a comfortable income, even over her current standard of living, by maintaining the rental property or selling it.
Scenario No. 1: If she continued to receive her pension, took only the income and gains from her investments (assuming a 5 percent rate of return) and continued to rent the house in Silicon Valley, paying down the mortgage per the standard amortization, she would maintain a gross annual income above $100,000 in today's dollars, accounting for inflation.
Scenario No. 2: If she sold her primary residence in Napa Valley and paid off her mortgage and moved into her Silicon Valley property, her pension and investment income would still maintain a level of between $77,000 and $87,000 of gross annual income. If she were to choose this path, however, she had indicated she would want to put $100,000 to $150,000 into that home for renovations. Since the estimated value of her primary residence would likely only pay off the mortgage on the rental property, she should consider taking the money for renovations out of the cash proceeds of the sale and then refinance to a very low mortgage. This is preferable to taking the funds out of retirement accounts, in which case she would be required to pay tax on those distributions in the year they're taken.
Scenario No. 3: Both of the above scenarios presuppose that she would be taking the assumed annual average rate of return out of her investment portfolio each year for living expenses. However, she currently saves money each month, primarily living off of her pension. Therefore, if she left her investments untouched and they grew at a 5 percent rate of return, her accounts could be worth more than $2 million on her hundredth birthday. Better performance in her investments, coupled with added savings, would only further compound that gain.
As a side note, a capital gain exclusion of $250,000 would apply to the sale of her Napa Valley home, but not to the Silicon Valley investment property if Maria elected to sell it in her lifetime. In the past, a property owned as a rental property that became a primary residence would get the exclusion if the owner had made the home his or her primary residence for at least two years. The rules have changed, and her ownership of the home would be figured on a pro rata basis over time. But since the cost basis of the home is very low, she would realize a significant gain if she ever sold it.
But if she improves the investment property, moves in and lives there indefinitely, the heirs of the home would get a step-up in cost basis to the value of the home on her date of death. That would be a significant windfall for them.
Consolidate accountsMaria has her cash holdings scattered in several different bank accounts. While it's wonderful that she is cash-flow positive each month, there are inefficiencies in maintaining so many accounts. She's getting a higher than average rate of return on her Schwab checking account, so she should consider moving enough money there for emergency purposes. In addition, she should consider opening a liquid, taxable investment account in her name to warehouse cash that is beyond her emergency needs. This account should be invested more conservatively than her retirement accounts and could be used for short-, medium- or long-term needs.
Maria also has several 403(b) accounts that can be consolidated in her traditional IRA via direct rollovers. The only advantage to leaving them in these vehicles is that federal rules protect these accounts from access by creditors. Since that's not a concern for her, Maria has little to gain from that advantage, but can enjoy many benefits if she consolidates: efficiency, freedom of investment choice and preferential treatment for heirs. Beneficiaries of a 403(b) may be required to take a full, taxable distribution within five years of her death, but beneficiaries of an IRA may stretch the distributions over their lifetimes.However, before consolidating these accounts, Maria should determine what, if any, surrender charges may apply. She's likely beyond the surrender periods with two of the accounts, but one has a current surrender charge of 18 percent! (These products have fallen under close scrutiny in recent years for good reasons, including astronomical surrender charges.) Most of these contracts, however, allow you to take a 10 percent withdrawal "free" of surrender charges each contract (not calendar) year. After further review of the policy to determine if this is the case, she should consider conducting a trustee-to-trustee transfer of that free surrender amount each year to her consolidated IRA account and wait until the surrender charge goes down before taking additional principal withdrawals.