James is 68, retired, and planning for the next chapter of his life.
The grandfather of six is planning to sell one of his homes and he wants to use the proceeds to spend time in Florida, and to “live at the highest standard achievable.”
He and his girlfriend would either rent a place down south for three or four months each year, or they’d buy a property there together.
In addition to the rental home, James owns another place, which is his primary residence. He’s saved $573,000 in IRAs, $265,400 in a brokerage account, and $12,200 in cash accounts. He also has an inherited IRA worth $190,800 and a deferred compensation plan worth $81,000.
NJMoneyHelp.com asked Michael Green, a certified financial planner with Wechter Feldman Wealth Management in Parsippany, to help James come up with a plan to help him reach his goals.
Green found that James’ current plan will allow him to reach those goals, but there are some moves that can make James’ future even more secure.
Green made several assumptions when he analyzed James’ situation and took into account two plans: his current plan and a new one.
First, he assumed a life expectancy until age 95.
For the current plan, Green assumed James would stay in his current home for his lifetime, while in the proposed plan, it was assumed James would sell his home and buy a primary residence in Florida using the proceeds from the sale.
Both plans assumed James will continue his current Social Security and pension benefits, and that he’d continue withdrawing from his inherited IRA.
Both plans also assume James’ living expenses, including costs for medical care (inflation-adjusted), will remain the same.
The current plan shows that James is able to continue living in the manner to which he has become accustomed, Green said, and the proposed plan — a permanent move to Florida — illustrates he will be able to continue living as he is now.
“All of his financial goals can be achieved based on his current financial condition and assumptions about the future,” Green said. “However, it is important for him to monitor and evaluate his assumptions and progress periodically.”
MANAGING A RETIREMENT BUDGET
Green says James can afford to stay in New Jersey, but there are significant benefits to selling the home and moving to Florida permanently.
“An important benefit of maintaining a primary residence in Florida is that the state is income tax and estate tax free,” Green said. “This will eliminate a potentially large expense during retirement and save beneficiaries a sizeable amount of tax upon your passing.”
When James reaches age 70 ½, he will be required by law to begin taking Required Minimum Distributions (RMDs) from his qualified accounts.
Green said the law allows him to wait until the year following the year he turns 70 ½, but if he does this the IRS will require that he take his first two years of RMDs in the same year.
“Taking two years’ worth of RMDs presents the very real potential of pushing him into a higher tax bracket and costing him more money in taxes owed,” Green said. “Therefore, we recommend that he begin taking his RMD in the year he turns 70½.”
Additionally, the government allows him to take the RMD at any point during the calendar year including as a monthly withdrawal from his account spread over the 12-month period.
Green said he analyzed both methods of withdrawal and determined that the best method for James is to take his RMD is as a lump sum for each individual year in either November or December. This allows the dollars to continue growing tax-deferred for 11 additional months each year, he said.
James is currently withdrawing assets from his qualified and non-qualified accounts to pay for living expenses. Green said there are several schools of thought regarding the question of which assets to draw down first in retirement: qualified or non-qualified.
One strategy is to draw down non-qualified assets first to allow qualified, tax-advantaged assets to grow tax-deferred for a longer period of time.
The second strategy is to draw down qualified assets first and hold off drawing non-qualified assets for last. Green said this should lower the balance in qualified plans, so when it comes time to take RMDs at age 70 ½ and beyond, the balances that the calculations are based on will be lower and therefore the taxable distributions will be lower.
A third strategy is a combination of the previous two, which is the strategy James is already implementing. He is distributing smaller amounts from qualified accounts thereby lowering the overall balances, which means his RMDs will be calculated on smaller amounts.
“However, when he requires income beyond what he is taking already from his qualified assets, he withdraws from his non-qualified assets,” Green said. “Essentially, this is allowing him to spread the taxes out over more years than he would be required to if he waited for the RMDs to begin.”
This would also keep James in a lower tax bracket during the RMD years.
Green performed a Monte Carlo analysis, which is a statistical simulation method that demonstrates possibilities for James’ portfolio. He said the overall probability of success in a Monte Carlo analysis represents the most likely simulation case and is a good guide to illustrate a general idea of the likelihood of reaching your goals in the future.
James’ current plan shows a 78 percent probability of success, which is considered somewhat likely to succeed. The alternative plan improves the probability of success to 98 percent, which is very likely to succeed. This is in part from the benefits of eliminating state income tax by moving to Florida, Green said.
Strategic thinking about how to invest each portion of an investment portfolio is important because different asset classes vary in terms of risk and return characteristics, Green said.
Currently James’ portfolio is allocated to about 51 percent equities, 44 percent fixed income and 5 percent cash.
Green said a well-diversified portfolio reduces the risk of having “all your eggs in one basket,” while a proper asset allocation helps you maximize your rate of return for the level of risk that is within your comfort zone.
He said the rate of return James receives from his investments will impact his plan significantly.
For that reason, Green recommends that James seek the guidance of a professional investment manager, and that he evaluate his risk tolerance periodically, particularly if there are material changes in his life or finances.
Looking at James’ current portfolio, Green said James is taking on more risk than a typical benchmark 50-50 portfolio while still getting the same performance results.
“A professionally managed portfolio should maximize return for the given level of risk the investor is assuming,” Green said. “It does not appear that his portfolio is accomplishing this presently.”
Green also recommends James consolidate accounts wherever possible to make management of the accounts easier, less costly and more streamlined.
Green also said James’ emergency fund of approximately $34,000 in the right amount for both the current and the proposed plans.
When James begins RMDs in 2018, it will reduce his need for an emergency fund. At that time, Green suggests he invest a portion of the emergency reserves.
Green said James should be sure to have a current will, durable power of attorney and advance health care directives (living will, medical care proxy, HIPAA info release). James should schedule an appointment with a local estate planning attorney to have his documents reviewed and updated if it has been a few years since the last update.
James should make sure that his beneficiary and contingent beneficiary designations are accurate and up-to-date for retirement accounts.
He can also complete Payable on Death (POD) forms for bank accounts and Transfer on Death (TOD) forms for taxable brokerage accounts in an effort to avoid probate.
“Florida is one of a few states that does not have a state estate tax in place,” Green said. “In contrast, New Jersey has a state estate tax, and it’s one of the highest in the country. State laws change frequently, and we recommend he monitor them closely going forward.”Money makeovers offered by NJMoneyHelp.com should be treated as general advice about personal finance and money decisions. Before you make any changes to your personal financial plan, see a professional who can consider your entire financial situation. If you’d like a free money makeover, email moc.p1508317256leHye1508317256noMJN1508317256@ksA1508317256.
Total Assets: $2,000,900
Total Liabilities: $446,000
Total Net Worth: $1,554,900