Profile: George and Janice Timms

The problem:
Should the Timms pay cash for their home?

The plan:
A paid-up home brings peace of mind.
 
 The plan in 6 steps
 Use available cash to pay off debts
Tap money market fund to pay off $3,000 credit card debt.
Use proceeds from certificate of deposit to pay house in cash.
Live debt-free lifestyle during retirement.
Tip:

Use a spending plan work sheet to figure a monthly budget.
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  The plan

George’s plan to be debt-free is a sound one. Many advisers would encourage their clients to incur a long-term, low rate tax-deductible mortgage and invest their savings. This can work to their advantage if the investment rate of return is greater than the after-tax cost of the mortgage. George would make money, but there is more to life than money.

Pay the house off with available cash
Most people find satisfaction and contentment being debt-free, and the Timms are no exception. George and Janice are also not in a position to take on added risk. Borrowed funds add leverage to the couple’s finances and require wise investing of the proceeds. Being debt-free is a known commodity and will provide tremendous peace. We advise George to use his money to pay for the house and also pay off the credit card with a portion of the money market cash fund.

We also advise George to roll over his proceeds from the American Greeting 401(k) to an IRA since he has no liability concerns, and he is currently 59½ years of age. This will give him more investment possibilities and greater control over the account. We recommend that if he is familiar and comfortable with Vanguard, that he stay with that company.

It is difficult for us to make a firm asset allocation recommendation, since we believe the when-to-sell decision is more important than the when-to-buy decision. It is a marketing concept of the financial services industry to teach people to buy and hold. That philosophy is for the benefit of the financial services industry, which profits more from it than does the client. The buy-and-hold mantra was touted and proclaimed “sound” in the bull market over the last 27 years (1980-2007) rather than during the previous 80 years (1900-1980), when being in and out occasionally was critical.

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Keys to success
Live a debt-free lifestyle during retirement.
Use Social Security income to further build up retirement accounts.
Be aware of impact of employment earnings on Social Security benefit.
Restructure retirement assets to maximize tax benefits.
Reposition investment portfolio for more growth.
Make sure insurance coverage fits your needs.
Put together an estate plan.

Increase exposure to global firms
That said, we strongly encourage the Timms to think global and focus on good dividend-paying, strong international companies. The Target Retirement 2015 portfolio is not appropriate long-term for their retirement goals. If they stay with Vanguard then they should consider a different asset allocation strategy.

The Target Retirement 2015 fund will move more toward bonds as the year 2015 approaches. Currently the fund is 65 percent in stocks, and by 2015 the fund will be about 40 percent in stocks. This strategy would not devastate the Timms’ financial well-being unless we go into a period of inflationary pressures, which would have a significant financial impact on bonds.

We recommend the Timms put 20 percent in a solid income fund and 15 percent in an income-and-growth fund. They might allocate another 15 percent into a good growth fund, and 15 percent each in international growth and international value funds. Finally, they should put 20 percent in a Treasury Inflation-Protected Securities fund.

Alternatively, George and Janice might consider hiring an independent fee-only adviser that works full-time as a fiduciary to manage their funds for them, and they can find one by going to the NAPFA
Web site.

Invest Social Security income in an IRA
We analyzed what would happen if Janice began drawing Social Security benefits on Jan. 1, 2008, versus waiting until full retirement age in 2012. Our analysis shows the break-even age is 83. This means that after age 83, Janice would benefit more from the bigger payout. This assumes that Janice takes the income at age 62, pays the potential taxes on the Social Security income, and then invests $12,000 per year in two traditional IRAs for her and George. (The contribution limit goes up to $6,000 per person for 50-plus individuals in 2008.) It also assumes that she would get a 5 percent rate of return on the money, and that the inflation rate stays steady at 2 percent per year. But if she gets a higher return than that, the break-even age could be far older.

If Janice chooses to take Social Security at 62, then she should consider working fewer hours per month and let George work a few hours more per month. Their employer could accommodate this shift in work hours so that Janice’s salary per year is lower than $13,000, or else there would be a Social Security penalty of $1 for every $2 on earned income over that amount until she reaches her full retirement age of 66.

This advice holds if Janice invests her Social Security income. If she does not invest, then this strategy is not going to help their retirement. However, if in the future Janice discovers she can no longer work or doesn’t want to work, her Social Security income of about $13,000 at age 62 would be equivalent to her $15,000 a year salary when you consider FICA taxes and the difference of how Social Security is treated as taxable income. Therefore, if she quit and just drew Social Security, the Timms’ cash flow would be about the same.

While we recommend Janice take the Social Security income now and fund the IRAs, on the other hand, we think George should wait until his full retirement age to take his Social Security income. These recommendations are made on the assumption that George and Janice plan on a lifetime partnership together. This plan gives the couple the best of both worlds — early payout with the accumulation of funds in a tax-favorable vehicle, plus George’s higher inflation-adjusted income for life.

Consider long-term-care insurance
There is no tremendous risk-management purpose to the $40,000 life insurance policy of George. The greater need of the couple is for long-term-care insurance. The cost of a good policy would be about $4,000 per year, assuming Janice is rated at least standard.

I would recommend that George and Janice get quotes from several insurers for a $150 per day (or an amount equivalent for facilities in your area) long-term-care or home health benefit, with a 5 percent cost-of-living increase and with shared care. I would consider the benefits of canceling the life insurance policy to help fund the long-term-care insurance.

In other insurance matters, the Timms should consider increasing their auto bodily injury and uninsured motorist coverage up to $250,000/$500,000. They should also consider insuring their new house for 90 percent of the replacement cost of the house plus $300,000 of liability coverage. We suggest that the Timms contact auto insurance companies that are ranked in the top five by Consumer Reports.

Estate planning matters
It is strongly recommended that George and Janice think out their estate desires and draft a will. Once the will is drafted, they should work to coordinate their beneficiary designations and the account titling of assets to flow according to the estate plan. The current plan has many common mistakes that cause family difficulties amongst heirs.

This is especially true with stepchildren from previous marriages. The Timms need to get their estate plan in order with a simple will, a good durable general power of attorney (if George and Janice unconditionally trust each other), and a living will or advanced directive.

Consider a Roth conversion
George and Janice should carefully monitor their tax situation yearly and consider the benefits of Roth conversions on a regular yearly basis. There is high probability that they may be able to convert IRA assets to a Roth without much, if any, tax liability, thereby creating a nest egg of never-taxed assets growing tax-free forever. This needs to be monitored year-by-year the year after they retire. The reason we recommend they use traditional IRAs now is to maximize tax benefits while they are paying taxes, because when they retire their tax situation will be tremendously different.

Any liquid cash the Timms have after paying off debt and buying their home should be filtered into Roth IRAs for the year 2007. The beauty of the Roth is that the principal contributions can always be withdrawn tax-free without penalty at any time.

George had asked about reverse mortgages. We would suggest not using a reverse mortgage if at all possible. The exception is if you desire to stay in your home, have no concern about the cost of the loan and would just like additional monthly income. We find reverse mortgages to be expensive and to be of greatest benefit to the issuing mortgage company.

The Timms might consider a $75,000 home equity credit line on their home after they purchase the home. This is beneficial for planning strategies and emergencies. It is important that they not use the line of credit for any other purpose. It should not cost anything to establish and the interest rate should be equal to or less than the prime rate on any balance outstanding.

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