Get With The Plan: June 6, 2010

6610Jim and Nikki have some big payouts coming their way. The Morris County couple has one child in college, another almost there, and they’re hoping to retire in as early as six years — depending on the money.

“We want to pay for college tuition for our two kids and plan for retirement, plus help provide some financial assistance for my daughter with law school,” said Jim, 51.

Jim and Nikki, whose names have been changed, have set aside $102,467 for college expenses, plus they have $366,079 in 401(k) plans, $11,141 in an IRA and $26,938 in a checking account. Jim also expects a $30,000 a year pension when he retires.

The Star-Ledger asked Michael Maye, a certified financial planner and certified public accountant with MJM Financial Advisors in Berkeley Heights, to help the couple figure out how to fund their goals.

“The couple is in the middle of funding their children’s high school and college educations,” Maye said. “Tuition represents a huge earmark from their current cash flow — $31,000 a year.”

The couple is paying much of the college costs from their cash flow, but that’s also where a big piece of their financial puzzle is missing.

Maye took a closer look at the couple’s expenses. Based on what they reported, they should have excess cash flow of $27,820 a year, so something — or a lot of things — have been omitted from their budget.

The couple can’t account for those funds, nor do they think they have that much extra cash floating around.

“The couple should review their expenses more carefully to have a better understanding of where the other $27,820 a year in spending is going,” he says. “This represents roughly 36 percent in unknown, unaccounted for spending.”

The best way to know where money is going is to closely track all costs, big and small, for a couple of months. That’s especially important because they’re paying much of the college bills from cash flow.

When money is tight and they need some extra cash, Jim and Nikki tap their home equity line of credit, which has an interest rate of 2.49 percent. This is cheap money right now, but Maye says they should be aware that the rate is likely to rise once the Fed begins tightening after the economy shows permanent signs of recovery.

For retirement, the couple is saving approximately 12 percent of their gross salaries to their employer’s 401(k) plans, with Jim contributing the max and Nikki saving 4 percent of pay.

Maye says Nikki should increase her contributions to 6 percent of pay so she can take advantage of her employer’s full match. Right now she’s leaving $1,100 on the table. If cash flow is too tight, Maye said it’s worth Jim lowering his contribution so Nikki can increase hers, just to make sure that full match is received.

Maye considered two retirement scenarios. The first considered the outlook if they retired when Jim is 57, and the second when he is 62.

Working until age 62 will give the couple a lot more cash to spend in their retirement years, with a projected increase of 19 percent.

They should make some moves with their asset allocation, too.

Jim and Nikki describe themselves as conservative investors, which is evident by their 40 percent allocation to equities. But, 100 percent of their equity investments are U.S. large-cap stocks. Further, their stake in employer stock — 31 percent — is way higher than diversification would recommend. Many of those shares are held within Jim’s 401(k), so there would be no tax impact if he divested himself of those shares within the retirement account.

“The remainder is in their after-tax accounts and would be subject to long-term capital gains rates at 15 percent if sold now versus 20 percent if liquidated post-2010 with expiration of the Bush tax cuts,” he says.

Maye recommends the couple redirect a portion of their equity allocation to U.S. small cap stocks and international developed equities.

They should also diversify their fixed income investments, which are almost entirely in short-term investments. He suggests they gradually redeploy some of their short-term bond allocation into intermediate-term bonds, which he says should be done very gradually given the likelihood of rising interest rates.

“The couple’s goal of retiring between the ages of 57 and 62 is within reach and deciding when to retire will be determined by the spending money they want for retirement,” Maye said.