How Much Longer Do I Need to Work?
Nearly 70, a pre-retiree seeks guidance on his portfolio's viability--and its next steps.
Investing Specialists
Portfolio Makeover Profile
Investors: Pat and Judy | Ages: Late 60s
Assets: $419,454 | Key Financial Goals: Funding Retirement
"I am not sure how much longer I will want to work."
That was part of Pat's email requesting a portfolio makeover. At age 69, he's still working in his position as a commission-based salesperson; he's been with his employer for nearly 30 years. He intends to work a few more years, both to reduce demands on his portfolio and to delay Social Security until age 70. His wife Judy has been a stay-at-home mom, so she'll claim a spousal benefit rather than claiming Social Security benefits based on her own record. Pat's lucky in that he can work as much or as little as he'd like. "I can dictate my own workload," he said.
But at some point within the next few years, Pat says, he'd like to stop working. He and Judy would like to do more traveling in the United States, and Pat would also like to have more free time to volunteer with his church. He's looking for reassurance that retirement is reasonable given their current assets. "I think the concerns of most of those my age are having enough money to live on and not running out," he said.
In addition to checking up on the sustainability of his and Judy's portfolio, Pat says he'd like another set of eyes on its positioning. "I want to get my finances in order for the next phase of my life," he wrote.
Pat and Judy would also like to find a financial planner who can help them keep their plan on track.
The Before Portfolio
The bulk of Pat and Judy's $420,000 portfolio is in Pat's 401(k) plan. The pair holds additional assets in a taxable money market account, and they also have a small sum of money in an IRA. In aggregate, their portfolio consists of about 28% in stocks, 34% in bonds, and another 37% in cash. The equity portion of their portfolio is well-distributed across the Morningstar Style Box and also features good sector diversification, with only a modest overweighting in financial services and a mild underweighting in the consumer defensive sector.
Pat's 401(k) plan includes some solid, Silver-rated holdings--including AllianzGI NFJ Dividend Value , Mutual Global Discovery (TEDRX), and several strong-performing MFS funds, such as MFS Growth (MEGRX) and MFS Research International (MRSRX). The big drawback is that the share classes available in Pat's plan are on the costly side, with every one of his current holdings--even the bond funds--charging more than 1% in fees per year. Moreover, Pat's employer discontinued matching contributions during the 2008-09 recession and hasn't reinstated them. That raises the question of whether he might be better off investing in another account, such as an IRA or even a taxable account, rather than the 401(k).
Holding Market Value ($) Weight (%) Star Rating 401(k): MFS Research International (MRSRX) 16,055 3.83
The After Portfolio
At $420,000, Pat and Judy's portfolio isn't huge in absolute terms. But they have a lot going for them on the sustainability front. For one thing, delaying retirement reduces their in-retirement time horizon (the number of years they'll be tapping their portfolio). Delaying also increases their Social Security benefits and allows them to continue to save a portion of Pat's salary.
And perhaps most important, their income needs are modest. They've paid off their home, now worth about $400,000, and estimate their income needs in retirement will total about $55,000 per year, including a modest budget for travel. Nearly $54,000 of their income needs will come from Social Security alone, including Pat's benefit and Judy's spousal benefit. Thus, they're practically sipping from their portfolio, though they will need to begin taking required minimum distributions from Pat's retirement accounts once he finally retires. (Individuals who are still working past age 70 1/2--when RMDs would otherwise apply--can typically delay taking RMDs until they retire.)
Given those modest income demands, Pat and Judy's assets appear to be too conservatively positioned, even when allowing for a cushion for emergency expenses. Although cash provides peace of mind, such a large stake carries an opportunity cost--namely, that they're unlikely to outearn the inflation rate over time. The After Portfolio knocks the cash position down substantially, and also reduces the bond position somewhat, in favor of a higher equity weighting. The After Portfolio parks 35% in cash and bonds, with the remainder in equities.
In addition to adjustments in the total portfolio's asset allocation, I would also recommend that Pat consider rolling over his 401(k) to an IRA. He can do that now, if his plan offers in-service rollovers to employees who are age 59 1/2 or older, or wait until he finally leaves his employer. If Pat planned to continue working for several more years, staying put in the 401(k) might be a good idea in that he could defer the RMDs that he doesn't need. But given that he'd like to quit working within the next year or two, getting out of the high-cost 401(k) and into an IRA composed of mutual funds with very low fees should be a top priority. Rolling over into a Traditional IRA--rather than rolling over into a Roth and paying the taxes due--is the way to go, at least for now. After all, Pat's income is substantially higher now, while he's working, than it will be when he retires, so it's a mistake to trigger an extra tax bill in years when he and Judy are in a higher tax bracket.
I used a version of the bucket strategy for Pat's new IRA, staging the portfolio based on his upcoming RMDs. Because RMDs exceed Pat and Judy's living expenses, additional monies can be plowed back into their taxable account or, if Pat has some earned income in a given year, into a Roth IRA.
Within the IRA, enough funds to cover RMDs for years 1 and 2 of retirement are parked in cash (bucket 1), while another five years' worth of RMDs are stashed in high-quality bond funds (bucket 2). The remainder of the portfolio is stashed in high-quality equity funds, both U.S. and foreign (bucket 3). (A retiree could right-size these buckets based on risk preferences.) As he removes his RMDs from bucket 1, Pat can refill that bucket by removing assets from whichever bucket (2 or 3) has performed best.
In terms of security selection, I focused on low-maintenance, ultra-low-cost investments, mainly index funds, in keeping with the idea that simplicity is a virtue, especially in retirement. Pat's 401(k) included some fine active managers, but the benefit of using index funds is that we were able to reduce costs significantly. The Before Portfolio's asset-weighted expense ratio was 1.2% (roughly $3,300 per year), whereas the After Portfolio's asset-weighted expense ratio is just 1/10 as much--0.12%.
I would also reduce the cash holdings in Pat and Judy's taxable portfolio, which is apt to have a longer time horizon than Pat's IRA. I'd leave at least some cash and a short-term bond fund to meet emergency expenses in the event Pat and Judy encounter unforeseen costs that Pat's RMDs are insufficient to cover. I used Vanguard Wellington (VWENX) for the remainder of the portfolio because it's low-maintenance and provides a lot of diversification in a single shot. (A pure equity holding would also work, but I like the ballast that Wellington's fixed-income stake provides.
One big wild card is that Pat and Judy don't have long-term care insurance, and purchasing it now would be prohibitively expensive. In the event that either or both of them would require long-term care, which is generally not covered by Medicare, they would need to spend down most of their assets in order to qualify for government funding. (This article goes into more detail on the topic.)
Regarding Pat's question about finding a financial planner, I'd recommend seeking a fee-only advisor who works on a per-project or hourly basis. Pat and Judy's plan shouldn't require a lot of ongoing maintenance, but they might find it helpful to see an advisor periodically to look at their portfolio's performance and projected path. Paying for advice on an a la carte basis will be more cost-effective than paying an advisor a percentage of their assets each year.
Holding Market Value ($) Weight (%) Star Rating Rollover IRA: Money Market Fund 29,454 7.02 N/A Rollover IRA: Vanguard ST Inflation-Prot Bond (VTAPX) 25,000 5.96 N/A Rollover IRA: Vanguard Total Bond Market Index (VBTLX) 40,000 9.54
Data as of May 30
 | | | | |