A typical couple’s retirement income plan
Back in the day, it didn’t take a finance degree to retire. Most people could count on receiving generous pension and Social Security checks.
Getting to the bank to cash them was the biggest challenge.
Those days are gone. Even if they have money saved and can count on income from other sources, one of the biggest challenges for today’s retirees is setting up their accounts in ways that will provide dependable streams of retirement income.
We devised a case study of a typical couple and shared it with three financial planners, asking them for ideas about how to best manage their resources.
We wanted to see how the experts would structure the couple’s finances so they would get the most out of what they have.
Harry and Mary Typical
Harry is 61 and earns $75,000 per year. He has $200,000 in his 401(k) plan. His wife Mary is 58 and earns $36,000 per year. She has saved $60,000 in her retirement account at work.
Here’s what they will get from Social Security, according to the calculator on the Social Security website:
|62 and 1 month||$1,359||$854|
Harry used to work for a company that gave him a conventional pension, and he expects to get $750 per month from that; when he dies, Mary will receive about half of that — $350.
They inherited $100,000 from Harry’s mother when she died earlier this year.
Harry would like to work until he is 66, at full retirement age. Mary thinks she wants to quit at 62, but she’s willing to work longer if she must.
Mary and Harry own their own house free and clear. They could possibly sell it for $175,000, but they don’t want to. They see themselves living there for the duration.
Harry is considering taking a part-time job after retirement that pays minimum wage and provides him with free golf.
Read on to see what our advisers say about how the Typicals should manage their retirement income.
Craig Brimhall, CFP
Vice president of retirement wealth strategies at Ameriprise Financial.
Brimhall says: “If you don’t have beaucoup bucks, retiring is a challenge.”
The first step, he says, is to “Start with the end in mind — what you’d really like to have to live on — and figure out whether it is within the realm of reality.”
Many retirement planning experts say couples should shoot for getting 80 percent of their current gross income after retirement. While that’s a simple guideline, Brimhall says, it would be better to arrive at a more precise number by examining Harry and Mary’s budget and discussing their needs and wants during retirement. Without this information, we’ll assume Mary and Harry would need about $88,000 in income per year.
Brimhall starts by adding up all of Mary and Harry’s guaranteed income, including the amount of Social Security Harry will get at 66 and Mary will get at 62, plus the $750 pension that Harry will receive at 65. That gives the couple $3,502 per month or $42,024 per year. “Only halfway there,” Brimhall says.
If Harry continues to work and save 10 percent in his 401(k) and his employer continues to provide matching contributions of 3 percent until he’s 66, and Mary and her employer do the same, and they earn 5 percent on their savings, they could have as much as $415,451 in their accounts in five years, according to Bankrate’s 401(k) savings calculator.
They also will earn a little money on Harry’s inheritance. Even at a conservative 2 percent, their savings will increase by more than $10,408, bringing their total nest egg to at least $525,859.
To have a total of $88,000 in retirement income annually, they need to earn about $46,000 per year from their investments. “If you believe in a 4 percent sustainable withdrawal rate,” Brimhall says — the accepted “safe” withdrawal percentage so you continue to have money as long as you need it — then the Typicals will only be able to withdraw about $21,000 per year from their savings. That leaves them short about $25,000 per year.
Brimhall says they might consider annuitizing their savings. According to ImmediateAnnuities, a joint life and 100 percent to survivor annuity worth $525,859 will pay about $31,000, bringing the Typical’s annual income to roughly $73,000, which might be close enough for them, depending on where they live, their health and their lifestyle.
But Brimhall says a lot of people don’t like to annuitize their savings for a variety of reasons. If they annuitize all of it, that leaves them with no emergency cash. What will they do if they need a few dollars to put a roof on the house or buy a new car? It also makes it difficult to leave their children an inheritance.
Brimhall says a better option is for Harry and Mary to take part-time jobs. If each makes $250 a week, they’ll earn enough to augment their savings and the extra income won’t interfere with their Social Security payments. The job Harry describes — working at the golf course for minimum wage and golf privileges — sounds perfect.
Retirement planning specialist and president of Fortune Financial Group, a financial advisory practice in Dunmore, Pa.
“I would advise Mary not to collect on her own Social Security until she reaches age 70. Instead, I would advise her to file for spousal benefits, which will net her $949. When she reaches age 70, then she can switch to her own benefits — $1,628 a month. A lot of people don’t know you can do that, but this strategy makes a big difference,” Scalese says.
If the Typicals take that route, when he’s 66 and she’s 62, they’ll get $2,847 in Social Security per month, plus $750 in pension for a total of $3,597 a month or $43,164 a year at the age when they’d prefer to retire. When Mary reaches age 70, between their Social Security and his pension, they’d get $4,276 per month or $51,312 per year in guaranteed income.
Scalese estimates that the Typicals’ real yearly income requirement — since they don’t have a house payment or other debt — is closer to $60,000. “If they were still carrying a $300,000 mortgage with a $2,000 monthly payment, I’d feel differently. That alone can eat up 40 percent of their income needs,” Scalese says.
Without those obligations, “Most retired couples at their income level are only going to need 50 percent to 60 percent of their pre-retirement income,” Scalese says.
Income from their 401(k)s and Harry’s inheritance will augment their fixed income. If they were much younger, Scalese says he would urge them to switch to Roth 401(k)s so they would have no tax obligations, but since they are close to retirement age, he thinks it’s unlikely that conversion is affordable. Even with their money in regular 401(k)s and considering that Harry will have to meet IRS minimum distribution requirements when he turns 70½, Scalese doesn’t think their federal tax liability will be much greater than 15 percent.
Scalese says he would urge the couple to put Harry’s inheritance into an annuity that matured when Harry turned 85, the age at which Social Security actuaries expect him to live to. At that point, Mary’s income would drop dramatically, since Harry’s Social Security check would stop coming and the pension benefit would be halved. The maturing annuity, also known as longevity insurance, would compensate.
Kevin Kautzmann, CFP
President and founder of EBNY Financial LLC in New York City.
Kautzmann immediately saw something about Harry and Mary’s finances that made him dubious — they had no debt. “Everybody has some debt,” he says.
So, we agreed that it was possible that Harry and Mary had $5,000 in credit card debt. Kautzmann said they should immediately pay it off using Harry’s inheritance. “A lot of people carry credit card debt at 19 percent or even higher,” Kautzmann says. “There’s no way to make 19 percent in this market, so that’s 19 percent that is chipping away at your net worth.”
Kautzmann also was surprised the Typicals had paid off their mortgage. “I see a lot of 65-year-olds with $500,000 mortgages — they’re going to be 90 years old before they pay them off. It’s crippling.”
After paying off the credit card, Kautzmann would have the Typicals divide Harry’s now-$95,000 inheritance into two buckets — 50 percent in a fixed-rate annuity to defer and shelter some taxes. “I’m not a huge fan of annuities,” Kautzmann says, but “in this case, I think it makes sense. It will give them a guaranteed decent rate of return — and it’s an inheritance — they don’t need to leave that money liquid.”
He would put the other 50 percent of the inheritance in short-term municipal bonds or municipal bond funds. “The income is tax-free. I would stay on the shorter end of the yield curve. You don’t want a fund where the average maturity is 25 years. Some funds are paying 4 percent. But if inflation or interest rates kick up, these bonds are going to go down in value as rates go up.”
Are bonds really safe these days? Kautzmann says yes. “I think the fear is overblown. There have been serious cutbacks in municipal spending in most places. I live in New Jersey and I wouldn’t buy Jersey municipals, but (I) own New York munis.”
If the Typicals didn’t like the idea of an annuity, Kautzmann would recommend they put half of Harry’s inheritance in dividend-paying stocks. “Even with the recent market downturn, the average dividend-paying stock is only down 2 percent to 3 percent. Between municipals and dividends, they’ll outpace inflation and make money even if the stock market goes sideways for several years,” he says.
With many municipals tax-free and stock dividends subject to only 15 percent capital gains tax through 2012, this strategy also will protect the Typicals from rising taxes, which Kautzmann believes are almost inevitable.
Kautzmann would urge them to leave their 401(k)s in diversified investments — the best strategies their employers make available. “You can’t go wrong with a diversified portfolio.”
Beyond that, he thinks both Mary and Harry should keep working — maybe until both are 70 years old. “It’s not what you make, it’s what you save,” he says.
If both of the Typicals keep plugging away at their current jobs until they are 70 years old, here’s what their retirement income will look like:
At 70, Harry will get $2,571 from Social Security, and at 70, Mary will get $1,628, for a total of $50,388 annually from Social Security.
If they continue to save at their current 10 percent level for the next nine years in Harry’s case and 12 years in Mary’s, and get their employer matches plus 5 percent interest, they’ll have a nest egg of $609,833, which will allow them to safely pull $24,393 from their 401(k)s annually.
Kautzmann figures the inheritance will grow so it will provide $6,700 in income every year and they’ll get $9,000 from Harry’s pension.
This amounts to an annual total income of $90,481 — very comfortable with money to spare for a nice cruise each year.
To protect themselves, Kautzmann urges them to buy a long-term care health insurance policy right away. “Even home health care can run $12,000 a month in some parts of the country,” he says. “Buy a policy young and it’s pretty cheap. Even if you only buy three years’ worth of benefits, it will help out and protect your estate.”