A couple retires early, but they're not worry-free.
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By Christine Benz | 07-02-09 | 06:00 AM | Email Article

Unlike many of their newly retired peers, Ginnie and Alan Davidson aren't feeling particularly anxious about their ability to fund retirement, even though they're only in their early 60s and their retirement could last another 30 years or more. Both are former educators, and they're lucky enough to be drawing on pensions that cover their day-to-day living expenses. Ginnie notes that they have a frugal lifestyle and have no debt. So while the market downturn has hurt their investment portfolio, they've so far been enjoying a fairly carefree retirement, pursuing their hobbies as well as spending more time with their two adult children, both of whom live nearby.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

As idyllic as this sounds, the pair isn't completely worry-free. They've recently been repositioning some of their assets, having lost a sizable amount in a brokerage account, and they haven't yet invested a $250,000 inheritance that Alan received when his father passed away. Given the market downturn and its recently sharp snapback, they're unsure what their next steps should be. The bulk of their investment assets are sitting in cash, and Ginnie and Alan would like guidance on an appropriate asset mix for people in their situation. They'd also like advice on when to begin taking Social Security.

More important, they'd like to make sure they leave a legacy for their two daughters. While both are single and living and working on their own, their oldest daughter has special needs. She receives Social Security to supplement the income she earns, but a key priority for Ginnie and Alan is making sure that their daughter's financial future is as secure as it can possibly be. They've set up a special-needs trust for their daughter and would like advice on investing the assets in the trust.

 Ginnie and Alan's Portfolio--Before
 Star RatingCategoryHolding
Fidelity Export & Multinational 
Large Growth13,000
Fidelity Capital Appreciation 
Large Growth6,000
Fidelity International Discovery 
Foreign Large Blend18,700
Fidelity Ginnie Mae 
Intermediate Gov22,400
Fidelity Mortgage Securities 
Intermed-Term Bond28,000
Fidelity Short-Term Bond 
Short-Term Bond11,800
Transamerica Premier Equity 
Large Growth10,500
Gabelli Equity Income 
Large Value4,800

Ginnie and Alan's assets are in a few different silos. They both have IRAs, consisting mainly of cash currently and totaling roughly $200,000. Additionally, Ginnie has a small amount in a 403(b), also in cash.

The rest of the Davidsons' assets are in their taxable accounts. They hold a smattering of stock and bond funds, including some solid funds from Fidelity. In aggregate, their equity holdings skew toward the growth column of the Morningstar Style Box, while their bond funds are generally high-quality offerings. The bulk of their taxable portfolio consists of the inheritance, which is idling in a money market fund. Their daughter's special-needs trust is also in cash.

 Ginnie and Alan's Portfolio--After
 Star RatingCategoryHolding
Vanguard Selected Value 
Mid Value50,000
Vanguard Interm-Term Invest-Grade 
Intermed-Term Bond50,000
Vanguard Total Bond Market Index 
Intermed-Term Bond25,000
Vanguard International Explorer 
Foreign Small/Mid Gr25,000
Vanguard Inflation-Protected Sec 
Inflation-Protected Bd25,000
Vanguard Tax-Managed Cap App 
Large Blend150,000
Vanguard Tax-Managed Intl 
Foreign Large Blend50,000
Vanguard Total Stock Market Index 
Large Blend75,000
Vanguard High-Yield Corporate 
High-Yield Bond22,500
Vanguard Wellington 
Moderate Allocation75,000

The couple's pensions currently cover their living expenses. For that reason, I would recommend they defer receipt of Social Security for as long as possible, presuming that living on the pension income alone doesn't seriously cramp their ability to pursue the activities they'd like early in their retirement years. True, they could take Social Security sooner and invest the proceeds, but Social Security benefits increase at a guaranteed rate of return. Just as important, deferring Social Security will ensure that they'll receive full pension payments for the next several years. (Their pension income will be reduced by 10% once they begin taking Social Security.)

Given that generating current income and preserving capital are lesser concerns than growing their assets for their daughters, the Davidsons can hold more equities in their investment portfolio than would be typical for other retirees of the same age. Still, I would recommend holding some bonds for ballast as well as some cash in the portfolio to cover emergencies, and also keeping the bulk of their equity assets in more-conservatively positioned stock funds. Fidelity, where the Davidsons currently have most of their equity assets, fields some of the lowest-cost index funds in the business, but I would favor Vanguard for their assets because I prefer the latter's taxable-bond funds.

I would also urge this couple to check with an accountant about converting their traditional IRA assets to a Roth IRA. Because they may not tap their IRA assets during retirement, converting them to a Roth means they wouldn't have to take mandatory distributions at age 70 1/2, unlike with a traditional IRA. In turn, they would be able to stretch out the tax benefits of the IRA and leave some or all of those assets to their daughters. The bear market of the past 18 months has dramatically reduced investment gains in IRA portfolios, thereby making an IRA conversion quite beneficial for many individuals right now. (When you convert, you pay ordinary income taxes on any deductible contributions and investment earnings.)

Additionally, I think long-term care insurance could be a good idea for this couple. Some financial planners argue that long-term care insurance is usually "sold, not bought," and there's certainly an element of truth to that. Yet given that leaving an inheritance for their daughters is a key priority for the Davidsons, I would recommend it here. Although Alan has a health condition that could affect the pricing of this insurance, the fact that the pair is still quite young will work in their favor. In addition to improving the likelihood that the couple will be able to leave assets to their daughters, having this insurance could also provide this couple valuable peace of mind.

Finally, setting up a special-needs trust is a great step toward leaving a legacy for their daughter with special needs; Alan and Ginnie could also make the trust a beneficiary of their IRAs, if they so choose. Were they to leave assets outright to her, it could jeopardize her eligibility for government benefits such as Social Security. The assets in the special-needs trust are there to pay for extras such as hobbies, trips, and even caregiving--not for the basic living expenses that are covered by government programs.

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Morningstar - 2009/07/02 - Leaving a Legacy for a Special-Needs Child - <a href="http://www.morningstar.com/articles/author/30-christine-benz.aspx">Christine Benz</a>
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