Get With The Plan: July 27, 2014

72714Vinny, 47, and Onal, 48, are managing their money with a negative cash flow, and they know it.

“We are at least $10,000 in debt at the end of every year and have to use our tax refund each year to pay off outstanding balances. This year we have $21,000 in credit card debt,” Vinny says. “My wife is an impulsive spender with extremely poor money-management skills and habits.”

Vinny is also worried they haven’t saved anything for college for their three kids — a 15-year-old from Vinny’s previous marriage and the two they have together, ages 10 and 9.

Vinny’s not optimistic, but he’d love to enjoy what he calls a comfortable retirement near their current lifestyle without having to work beyond their early 60s.

The couple, whose names have been changed, have saved $223,300 in 401(k) plans, $469,500 in IRAs, $38,500 in a lump sum pension payout, $4,000 in mutual funds, $400 in a brokerage account, $37,200 in a money market and $8,000 in checking.

They’ve also been paying an extra $250 per month to their mortgage.

The Star-Ledger asked Brian Power, a certified financial planner with Gateway Advisory in Westfield, to help the couple get out of the red and into the green.

Power doesn’t like their cash flow, their need to use tax refunds to pay off credit card debt or their general overspending.

“This is a very dicey game to play,” Power says. “They are a major house expense, health issue to a family member or lost income away from careening them down a path of debt that could be difficult to overcome. This must be a very stressful situation.”

Power says nothing can combat this situation better than making some hard choices about their spending habits.

Hard choices, for sure.

Power says with spending $700 per month on day care and $900 a month on child support for Vinny’s child from a previous marriage, it looks like things will be tight until those payments stop.

“This calls for some cash flow crisis maneuvers,” Power says, noting many suggestions to help them navigate their situation and maybe release the pressure valve a bit.

For starters, the couple have too much cash given the amount of credit card debt they carry.

“Pay off credit cards in full now and every month. I’d rather see them with very little in the bank and no credit card debt,” Power says. “They should think of their savings account as their own personal line of credit. Throughout the year, they can draw down on the balance and replenish every year with their tax return.”

This will help them to avoid paying heavy interest on the non-deductible credit card debt and they aren’t missing anything by using their cash because savings accounts pay nearly zero interest, Power says.

Next, the extra money they’re paying to their mortgage. He recommends they instead use those funds for their other monthly bills and credit card payments.

“The mortgage is only 4 percent interest, plus they’re getting a deduction,” he says. “Credit cards are non-deductible and have a much higher APR (annual percentage rate).”

Now for the hard choice.

Power recommends they reduce Vinny’s 401(k) contribution from 18 percent of salary to 6 percent.

This will still make him eligible for his employer’s full matching funds, and based on Power’s retirement projections, the couple can still meet their retirement goals.

“This is possible because they’ve done a nice job accumulating retirement assets and with child support, day care costs and mortgage costs dropping off by the time they retire, their lifestyle will be $30,000 a year less than it is today,” he says.

Reducing the retirement contribution will free up another $800 per month in net cash flow that they can use toward their credit cards and everyday expenses.

With that and stopping the extra mortgage payments, they shouldn’t accumulate any more credit card debt or spend down their savings, Power says.

Next, the couple should speak to their tax preparer about adjusting their tax withholding from their paychecks.

“They are getting about a $5,000 to $6,000 tax refund every year,” Power says. “With the proper tax withholding, their tax refund can be spread out monthly throughout the year.”

With all the moves Power has recommended, the couple shouldn’t need a tax refund to pay off credit card debt.

The bad news is that college savings doesn’t seem possible at this point, Power says.

He says once child support and day care costs go away, that will be $1,600 per month net cash flow that can be put toward college costs. With a 15-year-old who is three years away, and two more children eight years away from college, getting the couple’s debt situation under control first becomes all the more important, Power says.

“If all else remains the same, the reality is that they will need a combination of freed up cash flow with day care and child support costs dropping, financial aid and going to modestly priced colleges to get their children through college,” he says.

Turning to the couple’s investments, Vinny and Onal say they are moderate to high risk takers, with their current allocation 80 percent in stocks and 20 percent fixed income.

For the analysis, Power assumed a moderate aggressive asset allocation during their working years (65 percent stock and 35 percent fixed income/money market) and a moderate asset allocation during their retirement years (50 percent stock and 50 percent fixed income/money market).

“They have a lower probability of retirement projection success of 88 percent versus a 99 percent probability of success with a more conservative asset allocation prior to retirement because it levels out the ride for their portfolio and should have less potential for really bad downturns in the future,” he says.