Retirement planning is not a cut-and-dried process. This week, we look at a couple with a five-year retirement timeline and the decisions they are struggling to make.
The situation
Ron, 64, and Peggy, 63, have received Ron, a dentist in Denver for 35 years, and Peggy, a freelance portrait painter, have two grown children.
The couple will sell their home and net $500,000 cash at closing. With retirement in mind, they have But Ron and Peggy go back and forth on whether they should use the cash from the sale to pay off the new home — or use this money for investments, with the hopes that the earnings will exceed the 3 ⅝ percent interest they’d pay on the mortgage.
Ron wrote in to to ask about converting some of his traditional IRA to a Roth IRA. The couple would also like to gift each child with $50,000, but they want to be sure they are financially taken care of before they do this.
The recommendations
Ron and Peggy came to the right place. A large percentage of our clients are within five years of retirement.
Ron said he is very confident that the stock market is going to remain “happy” for the next three to five years, and has seriously considered converting $185,000 of his traditional IRA to a Roth IRA. This conversion would cost approximately $40,000 if it were taxed in the 28 percent federal bracket.
Converting to a Roth IRA is a great idea. It would allow the couple’s investment to grow tax-free, allowing flexibility for the couple to manage their tax bracket in their retirement years. The best time to convert these funds is late fall because it allows them time to accurately project their taxable income. If the couple files for an extension, they have until October of the following year to “recharacterize” the IRA, which would undo some or all of the conversion if their tax situation indicates this is wise.
However, I would advocate a slower approach for the couple, one that takes the long term into account. Ron and Peggy have the next 20 to 30 years to think about when making these changes. They should convert only an amount that will allow them to stay within the 15 percent tax bracket, avoiding volunteering for the 28 percent bracket.
When Ron turns 70, his Social Security coupled with Peggy’s and a small pension income will provide approximately $78,000 per year. If they decide to keep the new mortgage, they will need an additional $21,600 per year to live on. If they pay off the mortgage, they can live comfortably on their pensions alone in retirement.
Peggy and Ron should go with their gut on this one. Factors to consider are the psychological relief of having the home completely paid off; changes in the investment market that could negatively affect any new cash invested; and the greater amount of risk they might be willing to take with remaining assets because the home is paid off.
And I advise against giving away $100,000 to their children. The one serious hole in their retirement plan is the possibility of a health problem later in life.
That $100,000 would be better repurposed for long-term-care planning. The average amount spent for extended care per person in Colorado is $250,000. If only one spouse requires this care, the other will be stuck at home eating rice and beans. The plans with the strongest guarantees are life insurance and long-term-care hybrids.
Pam Dumonceau has 21 years of experience in the financial planning industry. What’s the Plan is not a substitute for financial planning or dedicated professional advice.
What’s your plan?
Ask Pam what you should do — e-mail whatstheplan@consistentvalues.com to get advice. Names and identifying information are changed to protect confidentiality, and there’s no charge for the column’s advice.
