James and Julie see the end of college tuition payments is in sight. One child has graduated, and the other has two years to go, with a price tag of $40,000 per year.
They’re wondering how close retirement could be.
“We want to invest our 401(k)s and other available cash in the right vehicles for our ages,” James says. “Among the things we wonder are: Should our investments be more aggressive and/or should we buy an investment property? And in general, are we saving enough to retire in 10 years?”
The couple, in their early 50s, is also concerned about the cost of health insurance when they no longer have employer plans.
James and Julie, whose names have changed, have saved $91,000 in 401(k) plans, $241,000 in IRAs, $1,000 in bonds, $3,000 in a money market earmarked for college payments, $169,000 in savings and $20,000 in checking. They also own a piece of a small business partnership worth an estimated $20,000.
The Star-Ledger asked Ronald Garutti, a certified financial planner with Langdon Ford Financial in Parsippany, to help this couple shift from college payments to retirement readiness.
“James seems very concerned about retirement,” Garutti says. “He would like to retire in 10 but could also see himself working to age 65 until Medicare kicks in.”
Garutti says he examined the couple’s cash flow and found they have between $24,000 and $48,000 of unaccounted-for cash flow. That means it’s time for some budget tracking to see where the money is going, as it seems the couple may not have accounted for every dollar they spend when they submitted a budget for this analysis.
James is considered to be a “highly compensated executive” at his job, and as a result, he’s not permitted to hit the annual IRS maximum for retirement contributions into his 401(k).
“He could definitely afford to contribute more, especially since contributions to 401(k) would receive a federal and a New Jersey tax benefit,” Garutti said.
Garutti says because James is very concerned about retirement, excess cash flow and too much cash in the bank, the couple they definitely need to fund retirement with increased vigilance.
Today, Julie is only contributing $5,000 to her 401(k), which Garutti says means they’re missing out on $18,000 in possible contributions and tax benefits if they were to increase her plan to the IRS limit. Her limit is $23,000 in 2013 because she’s over age 50.
“This should be addressed immediately,” he says. “They agree that they can fund this difference via cash flow but even if they couldn’t, they have $189,000 in cash earning less than 1 percent in local banks that should be re-directed into their retirement plans.”
Garutti says increasing their 401(k) contributions by $18,000 will reduce their federal tax liability by $5,040, assuming a 28 percent federal tax bracket. It will also reduce their New Jersey tax liability by $994.50, assuming a 5.525 percent state tax bracket, he says.
“As a result, if they were to add an extra $18,000 into their 401(k) assets annually they would only pay $11,965.50, and New Jersey and Uncle Sam would pay the rest,” he says. “They should do this ASAP or yesterday, whichever comes first!”
Garutti says they may be invested too conservatively. Because they have 10 or possibly more years until they start retirement, let alone a 30-plus-year life expectancy in retirement, they should consider better positioning their long-term accounts to increase their exposure to equities.
“They should not start gambling and run to Atlantic City with their assets, but they could consider further diversifying their existing 401(k) and IRA assets,” he says.
James and Julie are paying 100 percent of their children’s college educations because they don’t want the kids to have big debt in the future. With only two years of tuition to go — which is being funded from Julie’s salary — the couple will have an extra $40,000 to invest in two years. Redirecting those funds will give them an opportunity to supercharge their retirement savings.
Garutti recommends they take another look at their large cash stake.
“Some of this cash needs to be invested or the lost opportunity cost will continue,” he says. “Since they can afford to max out additional 401(k) contributions via cash flow, they need to identify how much money they need in emergency reserves, how much money they need in future one-time expenses and then they should invest the remainder.”
Their life insurance plans make sense, he says. They have laddered term policies in place where a portion will expire every few years. James also has a permanent policy with a small cash value.
Garutti also wants them to be smart about their debt. He recommends they pay their $3,000 credit card bill immediately using their cash.
They may want to consider changes to their mortgage, too. They have an interest-only loan with a rate of 4.1 percent and they make extra payments, so they’re scheduled to have this paid off between ages 62 and 65.
“Continuing to overfund this loan is highly recommended,” he says.
James and Julie also have a home equity line of credit with a 2.75 percent interest rate. Once college payments are over, they can pay this loan off in a year using current cash flow.
Garutti does recommend they pay off their car loans with idle cash, or consider lowering the interest rate on the loans by using the home equity line of credit to pay them off.