Jake and Tara are in their mid-30s and in the throes of parenthood, with three children, 8, 6 and 4. Jake has a healthy income, while Tara is a stay-at-home mom. Together, they want to build a comfortable life for their family and for their future.
Long-term, it’s all about retirement planning, with Jake retiring at age 60, they hope, and college savings. Short-term, they’re thinking about a vacation home.
“The goal would be to either use (the vacation home) for college payments if required or simply as a place to enjoy our savings instead of continuing to buy mutual funds,” Jake says. “We’d like to do that while not compromising our lifestyle and not risking our financial independence.”
The couple, whose names have been changed, have saved $311,900 in 401(k) plans, $63,000 in IRAs, $13,000 in annuities, $80,300 in mutual funds, $4,900 in a brokerage account, $96,000 in money markets and $12,500 in checking. They’ve also set aside $61,600 for future college expenses.
The Star-Ledger asked Mike Maye, a certified financial planner and certified public accountant with MJM Financial in Berkeley Heights, to give the couple an outlook for their long- and short-term goals.
Maye says there are several risks to the couple’s situation.
“They are a one-income family dependent on Jake’s income,” Maye says. “His industry pays well but is known for rapid downsizing as well as burning out employees.”
Additionally, much of his compensation is variable with no guarantee of what it will be from year to year.
On the plus side, Jake and Tara have set aside a cash reserve large enough to cover one year of expenses, which Maye calls a critical back-up plan should something happen to Jake’s job.
The couple’s current cash flow is also positive, he said.
They’ve twice refinanced their mortgage, most recently in December to a 4.25 percent 20-year fixed rate loan, and they’ve been making extra principal payments on their mortgage each month.
“The couple is on track to have their mortgage paid off by retirement, which is excellent,” Maye says.
They’re also strong savers.
Jake saves the maximum to his 401(k) and receives a healthy employer match, and they live below their means, which leaves them with approximately $10,000 extra to save each year to their taxable accounts.
Maye says the couple has to crunch some numbers before they decide if they want the responsibility of a second property.
Today, the couple spends 21 percent of Jake’s income (without the bonus) on their primary home’s principal, interest, real estate taxes and insurance (PITI). With the bonus, that percentage is 18 percent of Jake’s income.
Maye says if the couple buys a $160,000 home and puts down 20 percent, their PITI would be 29 percent of Jake’s income without the bonus, or 24 percent of his income with the bonus.
“Lending institutions typically like this percentage to be 28 percent or less,” he says.
Buying a vacation home would increase their annual living expenses by $12,000 a year, net of taxes, Maye says.
He projects that if the couple buys the home and Jake doesn’t get his bonus, the couple’s cash flow would break even and give them no extra money to continue their after-tax savings.
One option the couple is considering is for Tara to get a part-time job earning $10,000 a year. If she does, and even if
Jake receives no bonus, the couple would have $5,000 available for after-tax savings.
If they buy the home and Jake does get his bonus, they’d have $20,000 for after-tax savings.
“The couple is considering renting the property to offset some of the costs, but they plan on using a management company to ease administrative burden,” Maye says. “We recommend Jake and Tara make sure they can fund the purchase out of their own cash flow and not rely on potential income.” That’s if they’re willing to sacrifice college funding for a vacation home.
Jake and Tara say they want to save enough for their children to attend a four-year public school. Maye says they’re underfunding their college accounts to reach that goal, and they should use substantial portions of Jake’s bonuses to boost the savings. He still recommended they target only enough to pay for 60 percent of the cost of school.
As for their portfolio, Jake and Tara describe themselves as moderate investors, but their asset allocation tells a different story. They have 75 percent of their assets in equities, which means they have a higher-risk portfolio. “However, given their ages — 36 and 37 — a 75 percent equity allocation makes sense,” he says.
While their current allocation of 17 percent in cash appears high, this is appropriate given the need for a one-year cash reserve. Maye says over time, the cash allocation should decline as they continue to build their retirement and after-tax savings.
Maye says overall, the couple’s retirement projections are mixed because of their various goals. The best scenarios are ones in which they first focus on retirement and college savings.
“However, buying the vacation house might work out well depending on Jake’s level of variable compensation, whether Tara works and possibly generating some rental income,” he says. “I would recommend the couple really think hard about taking on such a big additional fixed expense.”