Retirement queston

[ifonlyIknew]

My mother is 70 y.o and is going to retire finally. Her household financial needs are $2000.00 per month, plus medical expenses not covered by medicare--she is in good health. She gets about $1700 per month in SS.

Question:

She has about $350000 in a company pension plan. They've given her the option of keeping the money there and receiving a guaranteed 4% return.

I'm assuming that this money is FDIC insured only up to 100K. Lets say she leaves 100K with her company, what would you do with the rest of the money? Please be specific.

My thoughts are
1. a rollover IRA with Fidelity into a conservative mutual fund for 100K,
2. Pay off HELOC of $65,000(would need to take out $78,000 minus20% tax to get the $65000). As I type this, I'm not sure if it's a good idea. She says she has to pay 20% on withdrawls, her interest rate is 6.5% fixed on the HELOC. Now I'm thinking it would be better for her to just make the monthly payments on the HELOC.




Thanks.

[disneysteve]

1. FDIC insurance doesn't apply to her company pension plan assets.

2. She needs to generate at least $300/month income plus medical expenses from her $350,000. A 4% return would give her over $1,100/month which is well above her anticipated needs. So if she just leaves the money in the pension, she is all set.

3. If she wants to try and boost her returns a bit, she could take that 350K and divide it up. 100K left in the plan or put in a CD or bond paying 4% would provide the $300/month needed (plus a little extra for taxes). She could then invest the other 250K in something that could return more than 4% such as a balanced mutual fund or growth and income fund or dividend-paying stocks or slightly lower rated bonds or some combination of those things. It all depends on her risk tolerance and how much she is looking to stretch this money.

4. As for the HELOC, I'm assuming her $2,000/month need includes the payments on that loan. If her monthly need is $2,000, SS provides $1,700 and the pension provides $1,100, she would have an extra $800/month that could go to prepay that loan (I'm not including taxes here so these numbers aren't quite right but you get the point).

[jIM_Ohio]

Is the 2k need above the 1.7k SS benefit?

4% is not FDIC. It is probably an annuity.
I would take the $350k and invest it conservatively. Mutual funds like T Rowe Spectrum Income (85% bonds) has a 4%+ yield and will grow principal. Similar funds like Wellesley (60% bonds) can do the same thing (generate a 4% yield and grow principal).

Withdrawing 4% per year from 350k should allow the money to last your grandmother's lifetime (should be able to sustain withdraws for 30 years or so at 4% plus).

[ifonlyIknew]

The $2000/month is a generous estimate of her monthly needs. So I'm estimating that she needs an additional 300/month to meet this estimate. Medical expenses would be my dad's copays, medications, etc. I need to figure out if his meds would be completely covered with medicare. My mom is healthy, on 1 med.

She does have the option of keeping the money where it is, but with so many companies going bankrupt, i was concerned about her having so much money in one location.

"4% is not FDIC. It is probably an annuity"-- not sure what this means, are you saying that you think her pension plan is being held in an annuity fund? Would this make a difference in deciding whether or not to keep the money where it is versus moving it to a mutual fund/bonds, etc.?

One aspect that's confusing is that her company is offering her the guaranteed 4% with monthly distributions(amount established upon retirement), then if she dies, they keep whatever remains. The fact that someone even offered this option to her concerns me, which is why i'm leaning towards getting all of the money away from her company.

[atomicrc11]

One aspect that's confusing is that her company is offering her the guaranteed 4% with monthly distributions(amount established upon retirement), then if she dies, they keep whatever remains. The fact that someone even offered this option to her concerns me, which is why i'm leaning towards getting all of the money away from her company.

What you just described here is called a Fixed Annuity with no death benefits. Basically, they will gaurantee she will get a certain amount per month as long as she lives. If that means she outlives the $350k she put in, they keep paying and eat the cost. If she doesn't they keep the rest.

Another type of annuity would be 50% or full death benefits for a spouse, which would mean lower payments because the chances of the spouse continuing to get the payments after the death of beneficiary is quite high. With 50%, the payments when she is alive would be higher than with no spousal benefits but only 50% of the number would be paid to the spouse.

The full spousal death benefit would mean the lowest amount would be paid monthly but the same amount of money would be paid out per month until both spouses passed away.

[simpletron]

"4% is not FDIC. It is probably an annuity"-- not sure what this means, are you saying that you think her pension plan is being held in an annuity fund? Would this make a difference in deciding whether or not to keep the money where it is versus moving it to a mutual fund/bonds, etc.?

the pension fund, itself is probably invested all sorts of things(mutual funds, debt securities, real estate,... anything and everything under the rainbow), but its payments are being setup like an annuity. you give up a large sum of money for guaranteed fixed payments for life and lost of principle upon death sounds like an annuity to me.

I'm just going to prove that it is a bad deal.

first if you took the money out as big pile of cash and store it under your matress, you could sustain those payments for 20 years(this is after the 20% penalty). if you took that same cash and invested conservative like jim said, you have like a 99.99% chance of substaining those payments for at least 30 years. in both of these case you get to keep what is leftover.

taking the money out and put it into an annuity is a better deal than the pension. I priced out annuity on vanguard using the following:
70 year female in alabama
280,000 after-tax lump sum
single-life fixed-payment with full cash refund
starts ASAP and no cancellation option
will payout 1979.14/month(vs 1166.66) for life and gives cash back if you don't get at least 280,000 in payments.

[disneysteve]

simpletron gave you a great response. The reason the company can guarantee her a 4% return is because they are sure they will make much more than that and keep whatever remains when she dies. Better to give up the 20% now, take the lump sum distribution, and invest it herself, even if she buys an annuity herself, as simpletron illustrated.

She could also part part in an annnuity for guaranteed income and invest the remainder elsewhere. Lots of options, all of which are better than leaving the money in the plan.

[Like2Plan]

It would probably be a good idea to pay off the HELOC, if it is done in a measured approach. I don't think a lump sum of 78k in one tax year is a good idea. It will bump her up into a higher tax bracket. The 20% is only an arbitrary withholding amount. (I am assuming this is something like a 401k?) The money she draws from the retirement account will be taxed as ordinary income. She could have a higher tax bill or she could have a lower tax bill.

If she does a rollover to an IRA, she could take out enough each year so as to keep her tax liabilty down. If she receives too much income, her SS benefits become taxed. For single head of household benefits are not taxed if income is below 25K. Between 25K and 34K, 50% of the benefits are taxed. Above 34K 85% of the benefits are taxed. Here is a link to an article and explanation of how that is derived:
More retirees paying taxes on Social Security benefits

From the IRA she sets up from the direct rollover she could withdraw up to her limit each year and use the proceeds to pay down the HELOC, she could accelerate her payoff and futher reduce her expenses.

[jIM_Ohio]

Look up RPSIX- T Rowe Price spectrum incone- it will shoot off 4%+ in dividends and interest per year (paid quarterly).

It invests in:
dividend paying stocks (15%)
US government and corporate bonds
US real estate bonds
foreign government and corporate bonds- including junk and emerging markets.
Money markets and cash

Then analyze the historic yield of the fund and the historic total return of the fund (approaches 6%). The 6% total return is 2% growth of principal and 4% annual yield.

If the company guaranteed 7%, it would be worth considering. 4% can be done with CDs or mutual funds and have better taxation charactoristics and also will have survivor/ beneficiary issues too.

If the money from pension would be rolled into an IRA, an IRA has a beneficiary and the spouse can be listed so they receive the proceeds on death of account holder.

Bad idea to accept a pension with 4% guaranteed payout- more than likely they offered such a low amount so you would cash out.

[jIM_Ohio]

Look up RPSIX- T Rowe Price spectrum incone- it will shoot off 4%+ in dividends and interest per year (paid quarterly).

It invests in:
dividend paying stocks (15%)
US government and corporate bonds
US real estate bonds
foreign government and corporate bonds- including junk and emerging markets.
Money markets and cash

Then analyze the historic yield of the fund and the historic total return of the fund (approaches 6%). The 6% total return is 2% growth of principal and 4% annual yield.

If the company guaranteed 7%, it would be worth considering. 4% can be done with CDs or mutual funds and have better taxation charactoristics and also will have survivor/ beneficiary issues too.

If the money from pension would be rolled into an IRA, an IRA has a beneficiary and the spouse can be listed so they receive the proceeds on death of account holder.

Bad idea to accept a pension with 4% guaranteed payout- more than likely they offered such a low amount so you would cash out.

[ifonlyIknew]

Great feedback. I really appreciate it.

I'm going to look up the funds mentioned. I'm def. going to encourage her to rollover the funds into an IRA. Actually she wants me to tell her exactly what to do with the money, so I have some research to do.

One more question. She has just enough in a personal savings account to pay off the HELOC. Can you think of any reason why she should pay is off now vs just continue to make the monthly payments?

[maat55]

I would payoff the heloc and set aside an EF. I would consider breaking the 350k into three different risk investments. 100k into Bond funds that have a decent track record.
100k into a balance fund and 100k into an S&P index fund.
The other 50k I would set aside for the EF. 10k locally and 40k into an high yield online account. I'm not a fan of annuities because they die with you.

[atomicrc11]

Also with annuities, if there is money left that will be paid to your beneficiaries, it gets taxed at the regular income tax rates.

[jIM_Ohio]

I would payoff the heloc and set aside an EF. I would consider breaking the 350k into three different risk investments. 100k into Bond funds that have a decent track record.
100k into a balance fund and 100k into an S&P index fund.
The other 50k I would set aside for the EF. 10k locally and 40k into an high yield online account. I'm not a fan of annuities because they die with you.

Maybe- but consider if you own a stock fund, and then own a bond fund, and then own a balanced fund which owns stocks and bonds, there is duplication.

Vanguard Wellesley is a popular choice (40-60) because it has low expenses and has not a negative year in quite some time, and sends off 4% in interest and dividends.

I like Spectrum Income because I have my investments with T Rowe Price, and it is the most diversified bond fund I have ever found. Same 4% yield of Wellesley, lower percentage to stocks (only 15%) and similar long term returns to Wellesley.

Assuming the entire 350k from pension is rolled over to an IRA, the withdraws will have RMDs. This will complicate the 4% withdraw strategy- RMD is required minmum distribution- the IRS technique to make sure taxes are paid on the money in your lifetime.

The first few years the interest/dividends might be the RMD
After a few years the RMD will require selling shares and drawing down principal.

Because of your mother's age (is it mother or grandmother)- I believe age was ~70, I would suggest taking any money NOT needed and investing it in muni bonds in a taxable account- the interest on the muni bonds would not be taxed.

I don't know full tax situation- it is possible that having the same balanced fund in a taxable account and in the IRA is simpler and easier to manage.

If you own more than one fund in the IRA, the RMD can really change the asset allocation because one fund or other needs to be drawn down, and that can change the risks taken.

[Like2Plan]

Great feedback. I really appreciate it.

I'm going to look up the funds mentioned. I'm def. going to encourage her to rollover the funds into an IRA. Actually she wants me to tell her exactly what to do with the money, so I have some research to do.

Another aspect (as Jim mentioned above) you are going to have to take into consideration is the minimum required distribution your Mom is going to have to take--Link to info on minimum required distribution The penalties are very stiff if you don't take the MRD, so it is better that your Mom gets the money than the IRS.
MRD Calculator. It looks like she will have to take out more than she really needs to start off .

One more question. She has just enough in a personal savings account to pay off the HELOC. Can you think of any reason why she should pay is off now vs just continue to make the monthly payments?

I can not think of any reason why she would continue to make payments if she is paying 6.5% interest and she has money to pay it off. I agree with Matt that she should keep an emergency fund.