Get With The Plan: August 12, 2012

Samantha, 47, and Adam, 51, say they’re doing the best they can. They have two children, 12 and 10, and the family wants to make savings a priority.

“I want to grow my emergency fund,” Samantha says. “Saving seems very difficult. I try to put a little away each month, but my monthly expenses are high.”

The couple, whose names have been changed, have saved $63,200 in 401(k) plans, $119,200 in IRAs, $500 in savings bonds, $18,400 in money markets and $1,800 in checking. They’ve also set aside $11,300 in college savings for their children.

The Star-Ledger asked Doug Buchan, a certified financial planner with Main Street Financial Solutions in Pennington, to help the couple see if their money management is on track.

“The priority of having an emergency fund is a solid one,” Buchan says. “Too many folks use their credit cards as their emergency fund. That approach can wipe away wealth swiftly and painfully — it is not advised.”

He says there is no one correct answer as to how much a family needs in cash reserve because there are many factors to consider. The first is how many incomes are in the household.

“Samantha and Adam both earn, which should lower the amount needed for an emergency fund. However, Samantha earns the lion’s share,” Buchan says. “Because the vast majority of income comes from one spouse, the emergency fund needs to be greater than if both earned equal money.”

The next factor is job security. Samantha says she feels it’s extremely unlikely that she’d lose her job, giving job security a 9 on a scale of 1 to 10. This also lowers the need for an extensive emergency fund.

The next factor is the volatility of earnings. Samantha’s income has no volatility, while Adam’s does fluctuate. But given that he earns less, it’s not a really big factor.

Finally — although not a textbook variable — Buchan says how much the couple wants to have in an emergency fund should be considered.

“What amount would help them sleep at night?” he asks. “I can advise that they only need three months on the sideline, but if they’re spending sleepless nights worrying that they don’t have enough in cash for ‘just in case,’ then they don’t have enough.”

Buchan says given the couple’s situation, he’s comfortable with them having an emergency fund of six months of monthly expenses.

“Less than three months is too little and with greater than nine months worth of monthly expenses, they are leaving too much opportunity on the table to grow their assets,” he says.

Right now, they have about three months of expenses set aside, so they need to double their cash reserves. But how?

Buchan says the lowest hanging fruit to fund an emergency fund quickly would be in the equity of their home.

“Let me be clear — I am not an advocate of using equity in homes as an ATM machine. This can and will get a lot of families in trouble,” he says. “But it’s clear to me that Samantha and Adam are quite disciplined.”

The couple has no credit card bills — a triumph in this day and age — and a 15-year mortgage, which exhibits more financial strength than a 30-year loan. They also have a good amount of equity and he recommends they tap a little more. They have a 15-year mortgage of $182,000 at 4.625 percent, with a current payment of $1,618.

He says they could refinance to a $200,000 15-year loan at 3.25 percent, and use the leftover $18,000 for the emergency fund. This would drop their monthly payment to $1,403 and add only two-and-a-half years to the loan.

“The downside that a refinance cost will be about $2,000 to $3,000 and their monthly mortgage payments would last 2.5 years longer, but their monthly positive cash flow would increase over $200 per month so the cost of refinance would be paid off in a year and can be lumped into the loan,” he says. “I believe it’s worth the tradeoff. Again, not for everyone. If you have a dime of credit card debt, I wouldn’t advise this for you.”

As far as retirement goes, Buchan says they’re in good shape. Samantha hopes to leave work in 13 years, and Adam in 15 years. Samantha can expect a pension of more than $50,000 — the amount will go up for each additional year she works.

At that time, there would only be two years left on the mortgage and the pension income would cover their non-mortgage expenses — this is before Social Security or investment income is counted.

“Samantha and Adam have stated their retirement goals are to be debt free, some travel, but nothing excessive,” he says. “As long as Samantha stays employed — which she believes is highly likely — their retirement goals are very attainable.”

College funding is also a goal but not a major priority.

Buchan suggests they take the $200 per month savings from the refinance and put it in their kids’ 529 plans, but they may want to consider a change away from the NJBEST plan they use today.

“I don’t love New Jersey’s 529 plan as the costs of the plan are simply too high,” Buchan says. “If you don’t receive a state income tax deduction for investing in your home state — and New Jersey doesn’t offer such credit, surprise, surprise — I usually recommend New Hampshire Age Based Index 529 plan through Fidelity.”