A 'Sandwich Generation' Couple Checks Their Retirement Readiness

Amy and her husband Jeff have witnessed a lot of changes during the past few years, some happy, some not. At age 55 and 56, respectively, she and Jeff have had the thrill of sending two kids off to college, and their youngest, now 17, will head off to school next year. They've enjoyed successful careers, Amy as a marketing executive, now working part time, and Jeff as an administrator with a large hospital.

Yet as is typical with people in their age band, this couple has had to take the bad with the good. While Jeff's parents are still alive and well, Amy's mother passed away five years ago, and her father died last year.

Her father's passing is what prompted her inquiry about a portfolio makeover, as she and Jeff inherited a $900,000 pool of assets, both in individual stocks and mutual funds, from her dad. Of the inherited assets, Amy asked, "Is it the right mix for us with our other assets?" In addition, Amy would like to use the inheritance as an impetus to check up on the whole of their financial plan: whether they're on track with their goal of retiring in 10 years and whether their current investment program is appropriate for their life stage.

The Before Portfolio
Amy and Jeff have advantages that many others in the same age bracket do not. In retirement, they'll be able to rely on a small pension that amounts to $10,000 per year. Their kids' college funds are also under control, as they saved enough in 529 plans to fully cover college for all three children. They also have good insurance coverage, including life insurance and long-term care insurance for both.

Holding Market Value ($) Weight (%) Star Rating Taxable: Hanover Insurance Group 4,300 0.21 N/A Taxable: National Fuel Gas 1,163 0.06 Taxable: Cash 57,327 2.79 N/A Taxable: AT&T 64,833 3.15 Taxable: DirectTV 2,023 0.10 Taxable: Comcast 7,683 0.37 Taxable: Prudential Financial 7,226 0.35 Taxable: Verizon Communications 18,045 0.88 Taxable: Vodafone 8,107 0.39 Taxable: American Bond Fund of America 48,045 2.34 Taxable: American Capital Inc Builder 16,275 0.79 Taxable: American SMALLCAP World 17,223 0.84 Taxable: American Growth Fund of America 22,978 1.12 Taxable: American Income Fund of America 48,640 2.37 Taxable: American Investment Co of America 86,435 4.20 Taxable: American Washington Mutual 12,563 0.61 Taxable: BlackRock S&P 500 40,859 1.99 Taxable: CGM Advisor Targeted 108,809 5.29 Taxable: Columbia Global Equity 12,723 0.62 Taxable: Fidelity Asset Manager 50% 73,172 3.56 Taxable: Loomis Sayles Strategic 27,943 1.36 Taxable: Loomis Sayles Core Plus 24,240 1.18 Taxable: Natixis US Multi-Cap Equity  35,099 1.71 Taxable: Neuberger Berman Partners 17,956 0.87 Taxable: Putnam Growth & Income 29,870 1.45 Taxable: Putnam Global Health Care 34,766 1.69 Taxable: RS Small Cap Growth 122,701 5.97 Amy's IRA: Cash 21,925 1.07 N/A Amy's IRA: Natixis CGM Advisor Targeted 31,824 1.55 Amy's Old 401(k): Private Label Growth Fund 34,281 1.67 N/A Amy's Old 401(k): Columbia Mid Cap Index 23,856 1.16 Amy's Old 401(k): Dodge & Cox Stock 77,272 3.76 Amy's Old 401(k): Gabelli Small Cap Growth 13,772 0.67 Amy's Old 401(k): Northern Small Value 18,863 0.92 Amy's Old 401(k): PIMCO Real Return 17,607 0.86 Amy's Old 401(k): PIMCO Low Duration 21,489 1.05 Amy's Old 401(k): Schwab S&P 500 85,804 4.17 Amy's Old 401(k): Third Ave Real Este Val  18,387 0.89 Amy's Roth: Cash 69,910 3.40 N/A Amy's Roth: Vanguard International Value 3,238 0.16 Jeff's IRA: Natixis CGM Advisor Targeted Eq  31,688 1.54 Jeff's Old 401(k): Vanguard Inst Index 39,990 1.95 Jeff's Old 401(k): Fidelity Magellan 29,435 1.43 Jeff's Old 401(k): Dodge & Cox Balanced 27,821 1.35 Jeff's Old 401(k):UBS Multi-Asset 191,804 9.33 N/A Jeff's 401(k): American Capital Income Builder 22,856 1.11 Jeff's 401(k): American Capital World G/I 29,230 1.42 Jeff's 401(k): American New Perspective 53,978 2.63 Jeff's 401(k): American SMALLCAP World 56,492 2.75 Jeff's 401(k): Fidelity Advisor Canada 3,987 0.19 Jeff's 401(k): American Fundamental Investors 38,960 1.89 Jeff's 401(k): American Growth Fund of America 50,886 2.48 Jeff's 401(k): BlackRock Equity Dividend 50,752 2.47 Jeff's 401(k): American Inc Fund of America 22,757 1.11 Jeff's Roth: Cash 6,001 0.29 N/A Jeff's Roth: Vanguard International Value 3,049 0.15 Jeff's Roth: Baron Growth 2,391 0.12 Jeff's Roth: BlackRock S&P 500 2,396 0.12 Jeff's Roth: FBR Large Cap 2,273 0.11 Total 2,055,978 100

 

Their investment portfolio has a few major parts. There's Jeff's 401(k) with his current employer, amounting to $330,000 in assets, as well as two 401(k)s from former employers, one belonging to Amy and the other to Jeff, each of which has roughly $300,000. The pair also have traditional and Roth IRAs in both of their names, as well as $50,000 in cash on hand. Finally, they have the inheritance money.

Most of their assets are parked in mutual funds, though they also have a handful of individual stocks, several of them from the telecommunications sector. Their aggregate portfolio skews heavily toward equities, at nearly 80% of assets; they hold another 10% apiece in bonds and cash. Several of their holdings are from the American Funds family, while the Ken Heebner-managed Natixis CGM Advisor Targeted Equity is another large holding, appearing in their traditional IRAs as well as being one of the largest holdings in their inherited portfolio. The aggregate portfolio is also notable for its unwieldiness, with nearly 60 separate holdings. Thus, it's not surprising that the equity portion of the portfolio is marketlike, with sector and Morningstar Style Box exposures closely aligned with the S&P 500. ​

The After Portfolio
Given that Amy and Jeff would like to retire within the next 10 years or so, it's possible to take a realistic look at how much they expect to spend during retirement as well as whether their portfolio can support their planned withdrawal rate. Planners often assume that retirees will spend 75%-80% of what they spent while they were working. But Amy said she'd prefer to assume retirement spending of $145,000 per year--roughly in line with her and Jeff's current income of $150,000 per year--to account for higher health-care costs in retirement. 

Assuming a 4% withdrawal rate from their current portfolio (and giving a portion of those withdrawals a haircut to account for the taxes they'll pay on 401(k) and IRA distributions), that's $70,000 annually. Adding in expected pension and Social Security income, their total income would come in at roughly $140,000 per year, a touch below Amy's target. With additional contributions during the next decade, however, the couple's portfolio should fall comfortably in line with their income targets without running the risk of prematurely depleting their assets over a 30-year retirement. Amy notes that Jeff has been maxing out his 401(k) contributions each year, and the couple has also been making Roth IRA contributions to Amy's account.

That's reassuring, but I still think their portfolio could use some adjustments. First and foremost, it's unwieldy. Thus, a good first step is to roll over their old 401(k)s into their IRAs. As part of this process, Amy and Jeff should speak with a tax advisor to discuss the tax hit that rolling over those assets to a Roth--rather than a traditional IRA--would trigger. That seems especially valuable given that they're forecasting an in-retirement income level that's on par with what it is now; it also helps that the couple has the cash on hand to pay the taxes that a rollover to Roths would entail. For modeling purposes, however, I'm assuming a rollover to a traditional IRA, to keep the "before" and "after" portfolio amounts the same. Rolling over to Roths would reduce the "after" portfolio as a result of the taxes paid.

Holding Market Value ($) Weight (%) Star Rating Taxable: Cash 51,004 2.48 N/A Taxable: Fidelity Intermediate Muni Income 225,000 10.94 Taxable: Fidelity Short-Interm Muni Income 150,000 7.30 Taxable: Fidelity Total Bond 75,000 3.65 Taxable: Vanguard Total Stock Market 375,000 18.24 Taxable: Vanguard FTSE All-World ex-US (VEU) 75,000 3.65 Amy's IRA: Vanguard Total Stock Market 190,000 9.24 Amy's IRA: Vanguard FTSE All-World ex-US (VEU) 65,000 3.16 Amy's IRA: Vanguard Total Bond Market (BND) 70,080 3.41 Amy's IRA: iShares Barclays TIPS Bond (TIP) 20,000 0.97 Amy's IRA: SPDR BarCap High Yield (JNK) 10,000 0.49 Amy's IRA: SPDR DB Int'l Govt Infl-Protected (WIP) 10,000 0.49 Amy's Roth: Vanguard Total World Stock Index (VT) 73,148 3.56 Jeff's IRA: Vanguard Total Stock Market 170,000 8.27 Jeff's IRA: Vanguard FTSE All-World ex-US (VEU) 55,000 2.68 Jeff's IRA: Vanguard Total Bond Market (BND) 65,738 3.20 Jeff's IRA: iShares Barclays TIPS Bond (TIP) 15,000 0.73 Jeff's IRA: SPDR BarCap High Yield (JNK) 7,500 0.36 Jeff's IRA: SPDR DB Int'l Govt Infl-Protected (WIP) 7,500 0.36 Jeff's 401(k): American Capital Income Builder 50,000 2.43 Jeff's 401(k): American Funds Growth Fund 100,000 4.86 Jeff's 401(k): American SMALLCAP World 30,000 1.46 Jeff's 401(k): American Inc Fund of America 100,000 4.86 Jeff's 401(k): American Bond Fund of America 49,898 2.43 Jeff's Roth: Vanguard Total World Stock Index (VT) 16,110 0.78 Total 2,055,978 100

 

In addition, the asset allocation of Amy and Jeff's total portfolio is too aggressive and stock-heavy given that they would like to retire in 10 years. Even the aggressive version of Morningstar's Lifetime Allocation Indexes for investors retiring in 2020 features less than their portfolio's 80% in equities; an equity allocation target of 60%-65% is more reasonable. Should stocks experience a sharp downdraft between now and their retirement, it could throw the plan far off course. I targeted a 60% equity/40% bond allocation for the total portfolio but used different allocations for different components of the portfolio. 

Because their taxable portfolio would likely be among the first asset pools to be tapped in retirement, based on the sequence laid out in this article, those assets would be a sensible starting point when adding more bonds; thus, I used a 50% equity/50% bond target for that pool. Of course, buying a lot of bonds right now isn't without peril itself, particularly given the threat of higher interest rates. As I discussed in this article, a sensible strategy is to move the assets they have earmarked for bonds into cash and short-duration bonds, then slowly move the money into intermediate-term bonds over a period of years. My "after" portfolio features target bond weightings, but it might take a while to build those positions.

An inheritance can carry baggage. For example, it's not uncommon for those who inherit assets to feel uneasy or sad about selling, particularly if they've inherited stock of their loved one's employer. But Amy and Jeff should focus on the real meaning of their inheritance: Amy's father wanted to leave them on a solid financial footing, and the best way to bring that wish to fruition is to make sure their investments align with their goals and life stage. And from a practical standpoint, because they've received a step-up in cost basis on the inherited assets, it's a good time to make changes.

For their taxable portfolio, my aim was to keep it streamlined, low-cost, and tax-friendly. I used the excellent municipal-bond funds from Fidelity as well as ultracheap Vanguard exchange-traded funds for equity exposure. I also added some taxable-bond exposure for diversification away from the muni market, as discussed in this article. If Amy and Jeff would like the convenience of dealing with a single provider, they could use Vanguard's solid, low-cost municipal funds rather than Fidelity's, or stick with the Fidelity munis and use Fidelity index funds instead of the ETFs. Using index trackers, both here and in their IRAs, will allow them to easily tailor their asset mix to become more conservative as retirement draws near.

For both Amy and Jeff's IRAs, which consist of their original IRAs as well as their 401(k)s from former employers, I used a more equity-heavy mix (70% equity/30% bond) because those accounts would follow taxable assets in the queue for distributions. I also sought to streamline with inexpensive ETFs. However, I mixed in some categories that would be a poor fit for their taxable portfolio, including Treasury Inflation-Protected Securities and high-yield bonds. I also added a dash of global inflation-protected bond exposure. Again, Amy and Jeff could swap in alternate options if they'd like to stick with a single provider. Even though Vanguard doesn't offer ETFs tracking the high-yield and TIPS sectors, it does field fine, low-cost actively managed funds that they could use alongside the ETFs.

I like nearly all of the funds in Jeff's 401(k), though gave it a more conservative cast by adding dedicated fixed-income exposure and boosting positions in American Funds' stock/bond vehicles, including  American Funds Income Fund of America and  American Funds Capital Income Builder . For the couple's Roth investments, I kept it simple, using global index tracker  Vanguard Total World Stock Market Index (VT). Because the Roth assets would come last in the distribution sequence--and may never be tapped during this couple's lifetime--they should remain in stocks so the assets can grow.

Data as of May 15. 

 

 

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