What should I do with a lump sum pension in an IRA?
I already have a personal IRA with a major mutual fund company. My lump sum pension will be going into this account because it is all tax free until I start to withdraw. I have a fear of co-mingling it with my other investments which are at a 60/40 split between stocks and bonds. What is your recommendation? I have a tentative fund picked out consisting of 88% bonds of all types and 12% in a stock fund. This fund is the least risky fund right above money markets on the companies risk and benefit sliding scale! Any thoughts?
One of many investment risks for a retiree is to take either too much risk or not enough. Taking too much may result in irrevocable loss that you cannot recuperate because your time horizon for investment is short. Taking too little may not get you very much purchasing power later in the retirement, especially considering the escalating cost for the healthcare.
Ideally you want to treat your portfolio as a whole, not multiple mini-portfolio. You already have a portfolio 60/40, but you’re afraid the new infusion of the pension money may disrupt the balance.
Here’s an idea: use a bucket approach. Have the first bucket stuffed with cash for your 3-5 years of living expense, a second-bucket mostly with the bonds (70-80%), and the third bucket with most equities (60%). Every year you do a rebalance to fill your first bucket of cash, and at the same time, you have both bonds for some protection and securities for future growth. Sounds good to you?
There’s no danger in co-mingling. I would put it in the same IRA because it’s easier to track. You can purchase the fund that you have picked out in the same IRA – you do not have to set up a separate account. This will help you re-balance, take income, and take your RMDs much easier. I suggest opening an IRA at a discount brokerage firm and you can purchase multiple mutual funds from different fund families. Everything will be in one account and you will receive one statement. A better question you should be asking is - When do I need the money and what other income sources will I have? What are my cash flow needs? How much risk am I willing to take? What is my tax bracket? Etc… You should know those things before you create a portfolio.
I like your idea--set up a 2nd IRA account to put this money into, and from there you can gage the results.
As far as the 88% bond, 12% stock allocation, this is not a bad idea, but have you considered an individual bond portfolio instead of a bond mutual fund? Even though the bond may be the "least risky fund," it shares the common flaw with all bond mutual funds: No defined maturity date!
When rates rise, and they will, you'll possibly experience a loss in the value of your fund based on the duration of the fund. An alternative idea that I love to propose to clients, with greater than $50K to invest, is to set up an individual bond portfolio, one that is diversified across 40-50 different companies, spread out among multiple sectors, asset classes,and time periods.
This way you'll get the diversification that you need, and the added certainty of a defined maturity date if rates do rise. As long as the company is still in business, you'll get face value (par value) on that bond, which is usually $1,000. Brilliant!
Don't let the other advisors tell you it can't be done for $50K....it can! The cost to purchase a bond, with the right custodian/broker, can be implemented for about a $1.00. So it is super inexpensive to set up and is much more efficient than the bond mutual fund when done the right way.
Hope that helps!
It is truly a personal preference on whether or not you should use one IRA or set up a new IRA. As far as your allocation question...what is your ultimate goal? I'd like to point out a couple of things.
While bonds have historically been less volatile than stocks, they are also currently experiencing very low yields, which means interest rates are low. When interest rates begin to rise, that will have an inverse effect on bond prices, which means bond prices will come down. With 88% of your portfolio in bonds, you could be very susceptible to interest rate risk. Not all bonds are created equal, just like not all stocks are created equal. Some bonds are more sensitive to changes in interest rates than others. Bonds with a longer duration are more sensitive to changes in interest rates, so make sure that if you have 88% of your portfolio in bonds, that you at least have some shorter duration bonds mixed in with longer duration bonds.
Also, are you diversified from a credit standpoint? Some bonds have a higher credit rating, while others consist of lower-ratings. This means that the likelihood of default is higher on the lower-rated bonds. Your credit allocation should be closely tied in to your risk tolerance. If you are conservative, you may not want to have many lower-rated bonds (which are often referred to as "high yield"). Although "high-yied" always sounds good, people may not understand that high-yield bonds are also referred to as "junk bonds" due to their low credit rating.
My point is that there are also risks when investing in bonds. Given the current interest-rate environment, those risks may not be worth the likely suppressed returns and it could make sense to mix in more stocks or equities into the equation. If that doesn't fit your risk tolerance, then perhaps you should look into purchasing an annuity with that lump sum, which could provide you with an income stream similar to what your pension would have provided (amount may be higher or lower than your pension).
Joe Allaria, CFP®