Get With The Plan: April 20, 2014

42014Archer and Nita, both age 50, are thinking “two down, one to go.”

Their youngest child will start college in the fall, and they’ve already paid higher education bills for their two older children. But they did it in a most interesting way, and it’s leading to trouble.

“Instead of saving for college for my two oldest children, I concentrated on paying down my mortgage. I then took out the biggest HELOC I could get in 2007, which was $369,000,” Archer says. “I then used the HELOC to pay for my two oldest children’s college expenses.”

But now, there’s a problem. Archer and Nita have no room left on the HELOC, and their home is worth less than the outstanding balance. That means they don’t know how to pay for four years of tuition at $35,000 a year for their youngest.

In addition to the college conundrum, the couple want to retire at age 56.

Archer and Nita, whose names have been changed, have saved $162,700 in 401(k) plans, $16,400 in IRAs, $11,600 in a brokerage account, $15,000 in savings and $1,000 in checking. Archer expects a pension worth $90,000 a year at age 56, while Nita is expecting a $41,000 per year pension at age 56.

The Star-Ledger asked Chadderdon O’Brien, a certified financial planner with Lassus Wherley in New Providence, to help this couple figure out a plan for their finances.

O’Brien started with a review of the couple’s expenses, but he found a big discrepancy.

“Using their original data form, their cash flow analysis indicated an annual surplus in excess of $40,000,” he says.

“The HELOC will not be available for that child’s education,” O’Brien says. “Meeting these expenses using current cash flow will leave them with annual deficits based on their current income and expense profile. Financing college at some level may be necessary.”

Another change to the couple’s cash flow could come from their tax return. They currently claim all three children as dependents, but it looks like only the youngest child may meet the standard of a dependent under the Qualifying Child or Qualifying Relative tests. He recommends they speak to their tax preparer to be sure.

The review of the couple’s ongoing expenses show they spend about $136,000 a year or $11,300 a month, excluding taxes and retirement plan contributions. O’Brien says he generally recommends keeping at least six months of expenses — or $67,800 — in an emergency fund. But based on the couple’s current situation, he suggests starting with a target of three months expenses, or $34,000.

So with large deficits in cash flow each year, which will grow with next year’s college bills, Archer and Nita need to understand this will impact their retirement wishes.

“Retiring at age 56 suggests a retirement date immediately after their child finishes school,” he says. “Upon retirement, their income levels will fall substantially from $211,000 per year to $131,000 per year.”

This is also the same time they plan to buy a $45,000 car.

Not great timing at all.

“If their expense levels are not reduced immediately after retirement, their 401(k) and Roth IRA savings will likely be depleted to support their standard of living,” O’Brien says. “Income levels are not projected to increase closer to pre-retirement levels until 2025/2026, when they are eligible for Social Security benefits.”

But by that time, their savings will be depleted and the cash flow projections suggest they will be unable to support their lifestyle.

The fix? O’Brien strongly suggests they delay retirement past age 56 and that they reduce their expense levels.

Using a retirement projection of age 62, O’Brien says the cash flow deficits are reduced, but not eliminated.

“Addressing your expense levels now in addition to delaying retirement will be extremely important to their long-term financial health,” he says.

While the couple could start taking Social Security benefits at age 62, O’Brien says they should wait.

“Receiving benefits at age 62 will cause a 30 percent reduction in their monthly benefits when compared to their Full Retirement Ages (FRA) of 67,” he says. “Based on their expected deficits in retirement, it will be important for you to maximize Social Security benefits.”

O’Brien says there are a number of strategies that could increase their benefits. The first is delaying taking the benefits up until age 70. Each year of delay will increase the payout by about 8 percent. A second strategy would be the “file and suspend” strategy.

“When Archer reaches FRA, he can ‘file and suspend’ his personal benefit. This means he will not receive a monthly benefit, but will defer until a later time,” O’Brien says. “When Nita turns 67 a few months later, she can begin receiving her spousal benefit, which will be 50 percent of Archer’s FRA benefit.”

This allows her personal benefit to grow, and when they each turn 70, they can switch to their own benefits, likely maximizing benefits.

So for this couple, success is possible, but not without planning and taking a hard look at where their money is going today.

“They should begin to itemize and track expenses in 2014 to gather a clearer picture of their cash outflows. They should focus on reducing expenses where possible to increase potential savings,” O’Brien says. “They should consider delaying retirement beyond age 56, which will significantly improve their financial outlook.”