Mac and Shirley, both 42, each earn a very healthy salary. But together, between costs for a vacation home and loans against their retirement plans, they’ve also earned themselves an unhealthy amount of debt.
“We have taken on a substantial amount of financial commitment that will continue over the next five to 10 years and need to obtain advice as to how to rebuild our savings and pay down debt,” Mac says.
The couple also would like to retire at age 70 and pay for a portion of college for their two children, ages 15 and 13.
Mac and Shirley, whose names have been changed, have saved $152,067 in 401(k) plans, $399,000 in IRAs, $7,500 in a money market and $500 in checking.
It’s their debt that’s eye-opening: A $560,000 mortgage on their primary residence, $585,000 for their vacation home, $175,000 for a home equity loan, $87,696 in auto loans, $62,000 in loans against their 401(k) plans and a $38,000 loan against a whole life insurance policy.
The Star-Ledger asked Jeffrey Boyer, a certified financial planner with RegentAtlantic Capital in Morristown, to help this high-earning, high-debt couple examine their overall financial picture.
Before getting to the debt, Boyer says families should have three to six months of living expenses in an emergency fund, but Mac and Shirley’s $7,500 money market doesn’t even cover one month of obligations. They need to set aside funds to replace income should they lose their jobs.
Taking a chunk out of debt will serve the couple well. Boyer says they should continue to pay the two mortgages as scheduled, but they should only make minimum payments on the home equity loan because of the favorable 2.5 percent interest rate.
Next, the 401(k) loans. Mac and Shirley contribute to their 401(k) plans as they make minimum payments against both loans. One strategy, Boyer says, may be to discontinue new contributions while more aggressively paying back the loans.
“Loans against a 401(k) account do carry some risk,” he says. “In the event that they lose or quit their jobs, they’re likely to have to pay back the entire loan within 60 days. If funds are not available to do this, the remaining balance will be considered an early withdrawal before age 59½.”
In that case, they’d incur a 10 percent early withdrawal penalty on the amount of the loan, and owe income taxes on the withdrawal amount.
They also should address the loans against their whole life insurance policies, Boyer says. They should ask their agent about flexibility in the loan payback, and if and when the loan needs to be repaid.
As for retirement, Boyer sees three main variables: How much will they earn going forward? What will they spend each year? How long will they continue to work?
Boyer made some assumptions and evaluated scenarios to determine how Mac and Shirley could best accomplish their goals and when they might attain financial independence.
The optimal scenario, Boyer says, has them retiring at age 70, receiving a 3 percent increase, with their annual living needs (annual spending after income taxes and after fixed-debt payments have been serviced) amounting to $200,000 a year, indexed at 3 percent inflation. It also assumes they will begin receiving Social Security benefits at age 67, and that in 2040, they will sell one of their properties and add the proceeds of this sale to their after-tax investment portfolio.
“The key variable in this equation is spending, as annual living needs in excess of $200,000 a year will cause the financial independence analysis to fail,” Boyer says.
Once the loans are repaid and an emergency savings account is established, Boyer says, Mac and Shirley should make maximum contributions into their 401(k) accounts. College will be another challenge. Mac and Shirley intend to fund a portion of college costs for the children, but cash flow and savings may prove restrictive in the short term, Boyer says.
They’re eligible for bonuses, so those may become a variable in the equation. Private or federal student loans payable to the children may be the best source for immediate financing, he says.
Because their financial independence revolves around their ability to sustain their income-generating activities to age 70, the couple should assess their life and disability insurance needs.
They’re both underinsured, Boyer says. Because of a health condition, additional coverage isn’t an option for Mac. But Shirley, who has $240,000 in whole coverage, should add an additional $1 million to $1.5 million of 30-year level term, Boyer says.