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Making Retirement Work Without a Huge Nest Egg

With a carefully calibrated withdrawal rate and a well-constructed portfolio, this couple proves you don't need millions to retire.

"I think we're in a large cohort that will retire with less than $500,000 in portfolio assets, combined with a requirement to stretch our retirement over a possible 40-year span."

That was part of Andrew's email to me when he wrote in to request a portfolio makeover for himself and his wife Olivia. And he was right: Plenty of retirees and pre-retirees will see a lot of themselves in this couple.

At 69, Andrew expects to retire from his career at a midsize environmental sciences firm later this year. His wife Olivia, 57, expects to retire from her position as a library specialist with the local school district in five years. They have three grown children and a paid-off home.

But as is the case for many of today's retirees, leaving work doesn't mean senior specials and mall-walking for this couple--far from it. Andrew intends to pursue a lifelong dream of earning a graduate degree in philosophy once he retires, and he will also continue working part time. Together, the pair intends to stay active by helping the less fortunate in their community. They both love to travel, too, and as we were discussing the makeover, they were preparing for a vacation abroad.

As Andrew's email noted, their financial plan also reflects the current environment for today's retirees. Although Olivia's pension will cover roughly 20% of their living expenses when she retires, Social Security and withdrawals from their roughly $435,000 portfolio will supply the bulk of their income in retirement. The pair's goal for the portfolio makeover is to ensure that their current portfolio is on track to sustain itself for the fruitful and happy retirement years ahead. Andrew says he would also like help streamlining a portfolio that has, by his own admission, gotten a bit unwieldy. He wrote, "I may not have the mental resources five or 10 years from now to deal with a many-issue, wide-spectrum portfolio (a reluctant bow to realism)."

The Before Portfolio
A longtime Morningstar reader, Andrew has assembled a balanced, total-return-oriented portfolio consisting of many of Morningstar analyst favorites. The largest pool of money is his 401(k), with just more than $250,000 in assets. It includes roughly half of its assets in fixed-income funds, anchored by largest holding
 PIMCO Total Return (PTTRX) as well as an equity portfolio featuring solid funds from Thornburg, Davis, and Allianz NFJ.


Holding Market Value ($) Weight (%) Star Rating 401(k): Stable Value 37,024 8.51 N/A 401(k): Allianz NFJ Dividend Value (NFJEX) 6,055 1.39 401(k): Allianz NFJ Small Cap Value (PSVIX) 11,350 2.61 401(k): American Funds Capital World (RWIFX) 15,883 3.65 401(k): American Funds Growth Fund of Amer (RGAFX) 11,355 2.61 401(k): BlackRock Health Sciences Opps (SHSSX) 4,529 1.04 401(k): Davis NY Venture (NYVTX) 13,903 3.20 401(k): DWS US Bond Index 35,573 8.18 401(k): MainStay High Yield Corporate Bond (MHYIX) 24,114 5.54 401(k): MFS Utilities (MMUJX) 4,657 1.07 401(k): Oakmark Equity & Income (OAKBX) 28,230 6.49 401(k): PIMCO Total Return (PTTRX) 37,582 8.64 401(k): Prudential Jennison Mid Cap Growth (PEGZX) 10,743 2.47 401(k): Thornburg International Value (TGVIX) 16,362 3.76 IRA: T. Rowe Price Blue Chip Growth (TRBCX) 29,347 6.75 IRA: T. Rowe Price Emerging Markets Bond (PREMX) 3,848 0.88 IRA: T. Rowe Price Equity Income (PRFDX) 25,772 5.93 IRA: T. Rowe Price High-Yield (PRHYX) 575 0.13 IRA: T. Rowe Price International Bond (RPIBX) 3,690 0.85 IRA: T. Rowe Price Mid-Cap Growth (RPMGX) 6,133 1.41 IRA: T. Rowe Price Mid-Cap Value (TRMCX) 5,417 1.25 IRA: T. Rowe Price New Income (PRCIX) 24,636 5.66 IRA: T. Rowe Price Prime Reserve (PRRXX) 503 0.12 N/A IRA: T. Rowe Price Short-Term Bond (PRWBX) 11,136 2.56 IRA: T. Rowe Price Small-Cap Stock (OTCFX) 6,377 1.47 IRA: T. Rowe Price Spectrum International (PSILX) 16,280 3.74 Roth: DWS Municipal Income (KTF) 1,529 0.35 Roth: iShares Gold Trust (IAU) 1,678 0.39 N/A Roth: Vanguard REIT Index ETF (VNQ) 3,110 0.72 Roth: T. Rowe Price Prime Reserve (PRRXX) 4,214 0.97 N/A Roth: WisdomTree Emerging Markets Local Debt (ELD) 1,547 0.36 N/A Roth: Box Ships (TEU) 962 0.22 N/A Roth: CenturyLink (CTL) 1,405 0.32 Roth: Exelon (EXC) 2,458 0.57 Roth: Exxon Mobil (XOM) 1,998 0.46 Roth: General Electric (GE) 1,875 0.43 Roth: Hasbro (HAS) 1,491 0.34 N/A Roth: Intel (INTC) 2,784 0.64 Roth: Johnson & Johnson (JNJ) 3,086 0.71 Roth: Lucent Tech Capital Trust I Pref Share (LUTHP) 1,630 0.37 N/A Roth: Norfolk Southern (NSC) 3,316 0.76 Roth: Paychex (PAYX) 956 0.22 Roth: PDL BioPharma 1,394 0.32 N/A Roth: Procter & Gamble (PG) 1,668 0.38 Roth: Prospect Capital (PSEC) 1,456 0.33 N/A Roth: Sysco (SYY) 1,267 0.29 Roth: Waste Management (WM) 1,627 0.37 Roth: Wells Fargo (WFC) 1,195 0.27 Roth: Westpac Banking ADR 1,166 0.27 Total 434,886 100



Andrew's rollover IRA from a former employer is with T. Rowe Price; it has about two thirds of its assets in the firm's equity funds and the remainder in T. Rowe bond funds and cash. Andrew intends to combine the T. Rowe Price rollover IRA and his 401(k) assets into a single traditional IRA portfolio when he retires. The final component of the portfolio is a Roth IRA with roughly $45,000 in assets that's primarily invested in individual stocks, many of which Andrew scooped up on the cheap during the financial crisis. Taken together, the overall asset allocation of the three portfolios is roughly 55% equity and the remainder in bonds and cash.

The After Portfolio
A good starting point for a couple closing in on retirement is to forecast their income needs, then determine how much of that income will need to come from withdrawals from their retirement assets. Armed with that information, they can gauge the sustainability of their nest egg and establish an appropriate asset allocation for their portfolio.

Andrew and Olivia anticipate they'll need roughly $60,000 per year in retirement, but like many couples, the sources of that income will vary as their retirement progresses. For the first five years of Andrew's retirement, with Olivia still working, her income will contribute to their living expenses; the couple will also have income from a small pension of Andrew's, his Social Security benefit, and additional income from his part-time work. Portfolio withdrawals will supply the rest. Once Olivia retires, their total income from pensions will cover 20% of their income needs, Social Security will provide another 45%, and portfolio withdrawals will provide the rest. Andrew projects that they will need to withdraw roughly $20,000 per year, with an inflation adjustment, from their portfolios.

Holding Market Value ($) Weight (%) Star Rating IRA: T. Rowe Price Spectrum International (PSILX) 50,000 11.50 IRA: T. Rowe Price Small-Cap Value (PRSVX) 7,000 1.61 IRA: T. Rowe Price Small-Cap Stock (OTCFX) 5,000 1.15 IRA: T. Rowe Price Short-Term Bond (PRWBX) 25,000 5.75 IRA: T. Rowe Price Prime Reserve (PRRXX) 40,074 9.21 N/A IRA: T. Rowe Price New Income (PRCIX) 72,000 16.56 IRA: T. Rowe Price Mid-Cap Value (TRMCX) 10,000 2.30 IRA: T. Rowe Price Mid-Cap Growth (RPMGX) 7,000 1.61 IRA: T. Rowe Price Inflation Protected Bd (PRIPX) 30,000 6.90 IRA: T. Rowe Price High-Yield (PRHYX) 10,000 2.30 IRA: T. Rowe Price Equity Income (PRFDX) 75,000 17.25 IRA: T. Rowe Price Blue Chip Growth (TRBCX) 60,000 13.80 Roth: T. Rowe Price Prime Reserve (PRRXX) 1,812 0.42 N/A Roth: Sysco (SYY) 6,000 1.38 Roth: Procter & Gamble (PG) 6,000 1.38 Roth: Johnson & Johnson (JNJ) 6,000 1.38 Roth: iShares Gold Trust (IAU) 6,000 1.38 N/A Roth: General Electric (GE) 6,000 1.38 Roth: Exxon Mobil Corporation (XOM) 6,000 1.38 Roth: Exelon (EXC) 6,000 1.38 Total 434,886 100.00


Based on their $434,000 portfolio, that's about a 4.6% withdrawal rate, higher than the 4% rate of withdrawal generally considered safe by many planners and worrisome given that this couple needs to plan for a long time horizon. That's a red flag, but there are a few things the couple can do to bring their plan back near the sustainable zone. Andrew notes that he would like to work part time to help bring in a bit of extra income, which will help reduce withdrawals. Andrew and Olivia will also want to stay sensitive to market fluctuations, tightening their belts during periods of market weakness, as discussed in this article.

Based on their planned spending, their overall asset allocation looks to be roughly on track. My retirement bucketing framework holds income for years 1 and 2 of retirement in cash, years 3 through 10 in bonds, and 10 and beyond in stocks. Thus, they'd hold income for years 1 and 2 ($40,000) in cash and a short-term bond fund, years 3 through 10 ($140,000) in bonds, and the remainder in stocks. Key to making this strategy work is systematically replenishing their cash and bond buckets to ensure that they don't have to liquidate equities to meet to their living expenses.

Andrew indicated that he's interested in consolidating his 401(k) assets together with his traditional IRA monies, and I think that's a good idea. The T. Rowe Price funds in the traditional 401(k), including  T. Rowe Price New Income (PRCIX),
 Blue Chip Growth (TRBCX), and  Equity Income (PRFDX) provide a solid, no-fuss foundation for this couple's retirement assets. I'd also like to see them add some explicit inflation protection to the portfolio via a fund that focuses on Treasury Inflation-Protected Securities. Because their core bond fund, T. Rowe Price New Income, has the latitude to venture into foreign bonds, I think targeted emerging markets and world-bond exposure is redundant.

Because it's not a large part of their portfolio, their Roth IRA is arguably more complicated than it needs to be, with more than 20 holdings. However, because this is the component of their portfolio that they'll tap last, its stock-heavy positioning is on the money. I stuck with, and put more money behind, the holdings that currently have Morningstar Ratings for stocks of 4 or more stars, wide moats, and low fair value uncertainty ratings. Because Andrew's T. Rowe Price portfolio lists toward the growth side of the Morningstar Style Box, I emphasized more value-oriented names here. I excised the real estate fund, mainly because  T. Rowe Price Small-Cap Value (PRSVX), part of Andrew's traditional IRA, owns some REITs.

Data as of May 10


Webinar: Make Over Your Portfolio for Retirement
Friday, May 18 | 12 p.m. Central Time

Morningstar director of personal finance Christine Benz will tell you how to ready your own portfolio for retirement. Christine will discuss how to assess your in-retirement income needs and test the viability of your planned withdrawal rate. She'll also discuss how to segment your portfolio and arrive at an appropriate asset allocation based on your expected income needs. Finally, Christine will share tips for streamlining your in-retirement portfolio so that it requires little in the way of ongoing maintenance. Premium Members: Check back soon for the webinar replay link. Not a Premium Member? Take a free 14-day Premium trial today.

Visit our Portfolio Makeover Week 2012 homepage for more makeover reports.

Christine Benz has a position in the following securities mentioned above: OTCFX. Find out about Morningstar’s editorial policies.