Jack and Michele are in their 40s. They have three children and lots of goals. Their first child is heading to college next year and they’d like to pay $100,000 toward that education, plus help the other kids when it’s their time. They’re also thinking about a larger home.
And then there’s retirement.
“Both of us do not have any pensions from our employers,” said Jack, 47. “We have to rely on 401(k)/IRA savings, savings from other non-retirement savings and Social Security. We need a plan that will preserve the current retirement savings we have and grow for next 15 years.”
The couple, whose names have been changed, have so far set aside $110,000 in 401(k) plans, $156,000 in IRAs, $11,900 in a brokerage account, $96,700 in mutual funds, $50,000 in bonds, $82,500 in money markets and $500 in checking.
The Star-Ledger asked Jody D’Agostini, a certified financial planner with AXA Advisors/RICH Planning Group in Morristown, to look at the couple’s financial picture.
“Jack and Michele will not be able to retire at the ages of 60 and 55 if they continue with the same savings rate now established,” D’Agostini said. “Their plan will be viable, however, if they save at the same pace, and continue to work until the ages of 65 and 60.”
Because asset allocation — the diversification of investments among different investment categories — can account for more than 90 percent of the return of a portfolio, D’Agostini had the couple complete a risk tolerance questionnaire to see where their propensities lie.
The couple have more than 45 percent of their retirement account in cash, which is returning on average well less than the general inflation rate of 3 percent. Therefore, even though they feel like they are taking on less risk, they are actually not keeping up with inflation and this will eventually erode their purchasing power, D’Agostini said.
Additionally, Jack and Michele will need to add more to these accounts for their future needs. They proved to be moderate investors, which means they could indeed expect their accounts to return 5 percent to 7 percent over time, but there is a disconnect with what the current asset allocation is and where it should be.
D’Agostini said the asset allocation of each account needs to be addressed and rebalanced at least annually to take advantage of gains and losses.
It will stop a portfolio from becoming too overweighted in a particular asset class and help to achieve the expected level of risk and return.
“In rebalancing, you would seek to sell the overweighted asset class and buy the under-weighted one,” she said. “Generally, this is done when a normal portfolio shifts in its mix of bonds to stocks plus or minus 5 to 10 percent.”
Jack currently saves $8,000 a year, or 6 percent of pay, with an additional employer match of $8,000, or 6 percent. They need to save more.
To retire at the ages they would like, they could save an extra $2,189 per month, which doesn’t seem to be feasible with the competing interests of college education for three children on the horizon. They need to reconsider what retirement age they will shoot for and what sacrifices they will have to make to get there.
Jack and Michele should also rethink moving to a larger home, which would mean more debt, especially as they face large costs for college. Also, a new home would probably mean higher costs for taxes, utilities, maintenance and more.
They may want to refinance their current mortgage, which has a 3.88 percent rate that may balloon up at some point. Since mortgage rates are at historic lows currently, D’Agostini said now is a good time to refinance to a fixed rate, as interest rates may rise.
On to college.
“The costs for private education for their three children, in today’s dollars, would total more than $800,000,” D’Agostini said.
They currently have $100,000 saved for college. With one child only a year away from school, they’re severely underfunded, D’Agostini warned. She recommends they open 529 Plans for their younger two children because they have sufficient time until matriculation and could enjoy tax-deferred accumulation and tax-free distribution for college expenses from these accounts.
Currently, their savings are growing in taxable accounts and incurring taxes each year. Also, because Jack and Michele show a fair amount of liquidity, they will not be as well positioned for college financial aid.
“The colleges first look for you to spend down these accounts. Getting the money out of their names and into 529 Plans will prove to be more advantageous when filling out the FAFSA forms for college financial assistance,” D’Agostini said.
Jack and Michele should consider putting money away each month to continue to accumulate in both of these accounts.