Giving Retirement a Trial Run Will Help Avoid Stumbling Later

Liz and Rob Cook are a two-income couple who are about to find out what it’s like to live on one paycheck.

That’s not necessarily a bad thing. At age 50, Liz has an opportunity to take early retirement, and in some respects, the timing couldn’t be better.

She’s eligible for early retirement from the telecommunications company where she has worked for the last 30 years. And if she retires by March, she can keep her fully paid health insurance and her option for a lump-sum buyout of her pension--worth about $250,000.

When Liz retires, however, the Cooks’ income will be cut in half, to $50,000 a year. Can they cover their expenses--and maintain at least some of their present quality of life--without depleting the nearly $600,000 Liz plans to have in retirement savings by next spring?

Yes, as long as they practice moderation, says Sandra Field, a financial planner with Asset Planning Inc. in Los Alamitos.

“I suggest that you start acting as though Liz is retired now, that her paycheck does not exist,” Field told the Cooks. “See how your life changes without her paycheck and then you can make a better decision about how things are working and how you’ll have to tailor your expenses after Liz retires.”

Field believes that the Cooks are likely to succeed because they’ve always more or less agreed on money management. They pay off their credit cards every month and contribute equal amounts to cover savings and household expenses. “Money causes so many conflicts in marriage, but we’ve never experienced those problems,” Rob said.

Their only debt is two car payments, which total $375 a month, and the $450-a-month mortgage on their Woodland Hills home, which will be paid off in 2004. When they list their assets, they include their 20-year-old daughter, Dana (“Value: priceless!”).

And after 26 years of marriage, their favorite activity is still just being together. Rob, a postal employee, loves watching sports on television while Liz works on a quilt beside him, and they often make bets on who will win a ballgame or what the weather will be, with the loser having to buy dinner.

Rob, 54, feels especially confident they can manage on one income because they’ve done it before: when he took seven years off to care for Dana after she was born.

“We did just fine then, and I tell Liz, if we can’t live on $50,000 a year, something is wrong,” Rob said.

But Liz is still worried. She hates to cook, and one of their favorite activities is eating out. She is addicted to crafting and feeds her habit with regular spending on supplies and shows. And she loves buying gifts for friends and family. She averages $800 a month on her credit card and she agrees she can trim her spending, but she likes buying for others.

“I’ll still continue to shop. I’ll just have to find better deals,” she said. “But I don’t want to diminish our quality of life. I know we can meet our expenses, but will we have enough for us to live our lifestyle?”

By pretending Liz is retired now, the Cooks can get a fair idea of how life will be on Rob’s income, Field said. And they can use Liz’s pre-retirement paychecks to bolster their emergency fund--now $9,000 in a money market account--to at least $15,000 to $30,000. Field also suggested splitting the emergency money three ways: a money market fund, a three-month certificate of deposit and a six-month CD to get the maximum interest while maintaining accessibility.

When Liz retires, she also expects to receive $23,000 from bonuses, unused-vacation pay and 401(k) contributions that were made after taxes early in her career. Those after-tax moneys can’t be rolled over into an investment retirement account after she retires. The Cooks thought they could use that $23,000 to supplement their income for a year or so after Liz retires, but Field recommends they use it to boost their emergency savings and start two Roth IRAs.

Both Liz and Rob are healthy and should plan for a life expectancy into their 90s, Field said, which gives them more than 30 years to build their Roths. Unlike traditional IRAs, which require distributions by the age of 70, there are no such restrictions on Roth IRAs. And withdrawals from a Roth IRA are tax-free after age 59 1/2.

Ultimately, Field said, early retirement works for the Cooks because they’ve been diligent savers, each putting 10% of their monthly salary into 401(k) plans. When she retires, Liz will have about $325,000 in her 401(k), which, coupled with the pension amount, will give her about $575,000 to invest. Rob’s 401(k) has about $115,000 now, and he expects it to grow to $225,000 by the time he’s ready to retire in five years, when he’s 59.

The Cooks want to roll the money from Liz’s pension and 401(k) into two IRAs after she retires, so she can make early withdrawals from both funds if they need the money to supplement Rob’s income. Typically there’s a 20% tax penalty for withdrawing money from IRAs before age 59, but the Internal Revenue Service’s 72T rules allow early withdrawals as long as the money is taken out in the same prescribed amount each month, until the recipient turns 59.

Field says Liz could take $15,000 a year from one of her IRAs--$1,250 a month--to supplement Rob’s salary without significantly hurting the growth of her retirement savings. Assuming Liz’s IRAs earn a conservative 8% each year, her retirement fund would still grow to more than $900,000 by the time she turned 59.

Liz’s and Rob’s 401(k)s are now invested in Barclay’s S&P; 500 fund. Rob wants to deploy Liz’s IRAs more aggressively, moving large portions of the money into Internet and biotechnology stocks.

But Field said it’s too risky to put their retirement money into such volatile sectors. Instead, she recommended investing broadly in nine mutual funds, including bond funds, to hedge against the market’s ups and downs.

The portfolio Field recommended earned about 50% this year, and its 10-year average return is 21%. She would put 20% into large-cap growth fund Gabelli Growth (GABGX); 15% into an international fund such as American Century International Discovery (TWEGX); 12% each into small-cap and mid-cap funds such as Invesco Small Company (FIGEX) and RS Emerging Growth (RSEGX); 10% each into bond funds such as American Century GNMA fund (BGNMX); and Vanguard’s Intermediate-Term Corporate Bond (VFICX); and 7% each into a money-market fund, health-care fund and technology fund, such as Firsthand Technology Value (TVFQX) and Vanguard Health Care (VGHCX).

Field was especially keen on the portion--about $40,000--ticketed for a money market fund.

“I call it my two-year sleep rule,” Field said. “You should always have two years of cash in the money market equal to the amount of distributions you’ll be taking out. That way you will not be redeeming assets in a down or flat market at a loss, and you’ll be able to sleep at night without worry.”

Field figures the Cooks will have fixed monthly expenses of about $3,100 after Liz retires, and with her IRA withdrawals, a take-home income of about $3,650. When Liz leaves work, their taxes will drop significantly, but they will face a few new expenses. Field recommends that Rob and Liz start buying long-term-care insurance through the California Public Employees’ Retirement System (CALPERS), available to Rob at work. Coverage for both of them should cost about $250 a month ($3,000 a year), a relatively cheap way to protect their assets from the staggering cost of nursing home care.

When Rob approaches 59, the Cooks will need to reevaluate and decide whether he should retire then or wait until he can start collecting about $1,300 a month in Social Security and pension payments at 62. He’d like to retire as early as possible, but there will be three lean years when they’ll have to rely entirely on their retirement savings for income. Field figures they’ll need to draw $38,000 from his 401(k) and about $15,000 from Liz’s to cover their expenses and pay their taxes.

“It’s workable, but if we have a down year, say the market drops by 25%, I’d be concerned if Rob was taking out that much” from his retirement savings, Field said.

Still, if push comes to shove, Rob noted, he and Liz can always go back to work.

“We always have options,” Rob said. “We have our daughter, we have our house, we enjoy being together and we’ve had a good life. We don’t have to have everything we think we need. And if we have to make sacrifices to have a good life, then we’ll do that.”

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Jeanette Marantos is a regular contributor to The Times.

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(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

This Week’s Make-Over

* Investors: Liz, 50, and Rob Cook, 54

* Combined annual income: $100,000 Goal

Allow Liz to retire in March at age 50, and Rob to retire at 59 without dramatically changing their lifestyle.

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Current portfolio

* Real estate: $325,000 house that’s nearly paid off

* Retirement accounts: Liz’s 401(k), worth about $324,000; Rob’s 401(k), worth about $115,000; Liz’s lump-sum pension buyout, worth about $250,000 in March 2001; about $23,000 in bonuses, unused vacation time and after-tax 401(k) contributions; Rob’s pension, worth about $300 a month when he turns 62 in 2008.

* Other assets: About $9,000 in a money market account; about $3,500 worth of individual stocks; 1994 Toyota Previa.

* Debt: $7,500 on 1997 Toyota 4-Runner; $7,000 on 1995 VW Jetta used by their daughter.

*

Recommendations

* Start living on just Rob’s salary now, to see how they’ll cope on one income.

* Use Liz’s salary to build their emergency fund.

* After Liz retires, begin taking annual distribution from one of her IRAs.

* Invest Liz’s IRAs in funds spread among equities, bonds and mortgage funds, keeping at least two years’ worth of distributions in a money market fund for emergencies.

* Get long-term-care insurance.

* Put together a living trust, wills and health-care directives.

*

Meet the planner

Sandra C. Field is a certified financial planner and certified senior advisor who specializes in pre- and post-retirement issues. She is the founder and president of Asset Planning Inc. in Los Alamitos.