Rina, 55, is a divorced woman with a bunch of expenses coming her way. She would like to pay half of her 16-year-old’s coming college expenses, while her ex-husband is responsible for the other half. She’s also looking at some home repairs and buying a used car for her child.
“I’m thinking of a home equity line of credit,” Rina said. “I want to do all these things and still have a hopefully comfortable and worry-free retirement.”
Rina, whose name has been changed, has saved $204,000 to a 401(k) plan, $9,000 to IRAs, $12,600 to a brokerage account, $10,000 in savings and $3,000 in checking.
The Star-Ledger asked Bryan Smalley, a certified financial planner with RegentAtlantic Capital in Morristown, to help Rina figure out the best way to fund these coming expenses while not jeopardizing retirement.
Smalley applauds Rina’s savings ethic: She contributes 10 percent of her salary (and gets a 5 percent match) to her 401(k) plan, puts another $400 a month in her IRA and yet $200 more per month to a brokerage account.
Rina’s child plans to attend an out-of-state public school, which will be an estimated cost of $36,000 a year. Rina’s responsibility is half the cost, and she hasn’t yet earmarked any money for that specific goal.
“While it’s always best to start early when saving for a large expense such as a child’s education, it is better to start late than to never start,” Smalley says.
He recommends college savings go into a tax-advantaged 529 plan, which he says offers significant benefits for college savings.
“With a 529 plan, money grows tax-deferred and distributions are tax-free if used for qualified higher education expenses,” Smalley says. “I recommend that Rina move the money in her brokerage account into a direct sold Michigan Education Savings Plan 529 account and have the account invested in an appropriate age-based investment model.”
He says if she then stops her brokerage account savings and redirects the funds to the 529 account, she should have enough money to pay for her child’s first year of college.
After the account balance is exhausted, he suggests that both she and her child apply for family and student government loans.
“Rina’s child should first apply for a subsidized Federal Stafford Loan, because the interest rates are lower, they are easier to obtain, and have better repayment terms than parent education loans and private student loans,” he says.
Because of the limit on the amount of federal loans Rina’s child will be able to take, Smalley recommends Rina apply for a Parent PLUS Loan to cover the additional amount needed. While Parent PLUS loans have a higher interest rate, Smalley says, it allows a parent to borrow the full amount of undergraduate education — minus any aid the child is already receiving. Also, Parent PLUS loans have more favorable repayment options than private loans.
Once Rina’s child finishes college — assuming after four years in 2020 — Smalley says Rina should begin making payments on the loans. To free up cash in the budget, she should move the money going to her IRA — $4,800 a year — to pay down the college loans until her mortgage is paid off.
And when the mortgage is done, she can restart her IRA contributions, and use the remainder of what used to be allocated to the mortgage payments to pay off the remaining student loans.
Smalley says this strategy should allow her to pay off the loans by retirement, which Smalley says Rina should be able to afford by age 67.
She does need to look at how her nest egg is invested.
Currently her 401(k), IRA and brokerage account are all invested in equities.
“This has benefited Rina over the last few years in which the stock markets have posted solid returns,” Smalley says. “Even with the recent performance of the stock market, I recommend that Rina add fixed income into her portfolio in order to help lower the volatility that comes with being invested in stocks.”
He says a portfolio of 70 percent stocks and 30 percent fixed income should provide the risk-return profile needed meet Rina’s retirement goals. Plus, adding fixed income will help Rina align her portfolio with her conservative preferences.
Turning to the money Rina is planning to spend — $2,000 on a house renovation project and $6,000 for a car for her child — Rina was thinking of using a home equity line of credit. . She was also thinking of using the HELOC to pay off her own car payment.
Smalley says while a HELOC can be a valuable resource, especially in providing liquidity for short-term cash needs, it should be used cautiously.
“The ease of access to the HELOC may mean that a person can easily drive up a debt level that they cannot sustain,” Smalley says. “If one can use the HELOC with discipline, it provides one an opportunity to consolidate other debt with higher interest rates into a lower-interest-rate vehicle and presents the opportunity to deduct the interest paid on the HELOC.”
For Rina, Smalley says she should keep her car loan unless she can lock in a HELOC interest rate that is lower than what she is paying on the car loan. And rather than use the HELOC for her
child’s car and the home repair, he recommends she use the cash she has in the bank first.
“Knowing that Rina will have to focus a good amount of her extra funds to pay off her child’s college loans before retirement, she should try to keep any additional debt to a minimum,” he says. “While it’s important for Rina to be able to identify ways to help pay for her child’s education and near-term expenses, its paramount that these goals do not impede her ability to take care of her own financial independence.”
Get With the Plan is designed to illuminate personal finance concepts and isn’t a substitute for actual financial planning or dedicated professional advice. To participate, contact Karin Price Mueller at email@example.com.