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Jan and Tim need help deciding what to do with a lump sum of money. Call it something of a delayed inheritance. When they sold an inherited property, the couple extended a mortgage to the homebuyers. That worked nicely for years, but when the new homeowner eventually decided to get a new bank loan.

That meant a windfall of $800,000 before taxes for Jan and Tim. “We are concerned about tax consequences. We would like advice on how to invest the $800,000 safely and how to draw down the amount to maintain our current lifestyle,” said Jan, 69.

Tim, 70, is a disabled veteran, and Jan is retired. The couple receive Social Security benefits and pensions. They’re also looking at the future. “As a 100% disabled vet, my husband can go into a VA nursing home at no cost if necessary. I have no long-term care coverage,” Jan said. “I am also concerned to protect my financial future as my husband will likely predecease me and there is no life insurance.”

In addition to the inheritance, the couple has set aside $331,500 in individual retirement accounts, $150,500 in a brokerage account, $5,400 in savings bonds, $47,100 in certificates of deposit, $262,600 in savings and $201,700 in checking.

Brian Power, a certified financial planner with Gateway Advisory Group in Westfield, reviewed the couple’s situation. “They have a very high probability of not running out of money and will most likely keep their investment portfolio’s principal intact,” Power said.

How to Invest It All

Power said he used an after-tax retirement lifestyle of $60,000 per year, increasing every year for inflation, based on the budget Jan worked up. Instead of assuming a constant rate of return on their assets, Power used a Monte Carlo simulation to evaluate the outcome of their portfolio over time. By varying the rates of return and inflation to simulate the fluctuations that can be experienced in the marketplace, Power said, a more accurate reflection of the real-life ups and downs of the investment environment is presented.

“In order to create a Monte Carlo simulation model, historical performance of the securities market must be analyzed,” Power said. “The analysis does not utilize historical data for any specific securities. It uses the historical data for broad asset classes such as small-cap equities, long-term bonds, etc.” And the outcomes were good, but it was clear they still needed to make some changes to their current assets, plus make some decisions about the inheritance money.

He said of the $800,000, they will probably net $725,000 when the taxes are paid. That would give them, in all, a nest egg of about $1.5 million to invest.

Power took a look at the couple’s current asset allocation. They have about 50% in stocks and 50 percent in cash. “It is obvious there is no real investment process in place based on the lack of diversification in their investments,” he said. “They have 100% of their stocks in U.S. large-cap stocks, no bonds and the rest in cash.”

Of their stock holdings, a few are very concentrated, he said, representing 10% or more of their overall stock holdings. “This can create a lot more volatility in their portfolio than is necessary,” Power said. “One of the fundamentals of investing is to try to diversify away company-specific risk by not having too much of your investments in any one company.”

Power’s analysis — the one that showed they will probably not run out of money in their lifetimes and that they’d probably not have to touch their principal — assumed a moderate-conservative asset allocation of 35% stocks and 65% fixed income/money market. At their ages and with their assets, Power said they don’t need to “generate stock market-type of returns to achieve their goals.”

For that reason, he recommends reducing their stock market exposure to reduce future volatility in their portfolio. For the money that stays in stocks, Power recommends investing in the asset classes not represented in their current portfolio, such as U.S. mid-caps, U.S. small-caps, developed international countries, emerging markets, REITs and high-yield bonds. “They should consider international bonds and short-term bonds on the bonds side,” he said. “When re-allocating to have more bonds — both from stocks and cash — emphasizing towards short-term bonds could help protect their principal against rising interest rates.”

Estate Planning

Power said Jan and Tim should review their wills and estate documents to make sure they can both take advantage of the New Jersey estate tax exemption, which is currently $675,000. As part of this, they may need to re-title some of their assets. “They must each own $675,000 of assets in their individual names to be able to fully take advantage of the exemption,” Power said.

Because the couple is not expected to spend their assets down over their lifetimes, Power said they should consider implementing a formal gifting plan to start putting money away for their grandchildren’s college education. “College educations are becoming a very difficult goal to fund for young families so any and all help would most likely be very welcome by their children,” Power said. “This gifting will also make sure their estate doesn’t continue to grow, which would compound their New Jersey estate tax problem.”

Survivorship Analysis

No one likes to consider what could happen if a spouse dies, but it’s important to make sure both spouses would be financially secure should something happen. Power said his analysis showed that should something happen to Tim — who has health problems and is disabled — Jan can keep the same lifestyle and travel budget in place with a very high probability of keeping their investment principal intact. “This would take into consideration that Jan would only get 30% of Tim’s pension and that Tim’s Social Security benefit would stop,” Power said. “Getting more conservative and having a better diversified portfolio would better secure this area of their lives.”

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