Get With The Plan: March 29, 2009

Andrew and Dee are facing a giant dept. Rather than saddle their two children with college debt, the couple decided to pay the large bills, totaling $275,000, on their own.

Payments are deferred until January 2010, but then they’ll need an additional $1,865 a month.

“We are trying to determine whether we should sell our home to pay off some of our debts to avoid cash flow problems in 2010,” says Dee, 50. “Plus, Andrew’s job is highly uncertain and income cannot be relied upon.”

Andrew, 56, and Dee, whose names have been changed, recently stopped retirement contributions to improve cash flow.

They have $261,000 in 401(k) plans, $339,000 in IRAs, $40,000 in a brokerage account and $100 in checking. In addition to their massive college debt, they owe $90,000 on their mortgage, $160,000 on a home-equity loan and $5,000 on a car loan. 

The Star-Ledger asked Michael Pirrello, a certified financial planner with Mill Ridge Wealth Management in Chester, to help the couple manage their goals.

“They are struggling with managing their debt reduction from college loans with the need to continue to save for retirement,” Pirrello says.

Andrew and Dee resigned themselves to the idea of working until age 70 or later if necessary. That gives Andrew 14 more years of potential savings.

“Stopping their retirement savings now could have disastrous consequences down the road,” Pirrello says.

Andrew is foregoing a generous 7 percent employer match. If Andrew contributed 7 percent, or $8,750, a year, he’d double that amount in matching funds. Pirrello says just one year of contributions, compounded at 7 percent for 14 years, equals $22,562 at age 70. If he’s able to contribute every year, the number would grow substantially.

To hit their retirement goal of 70 percent of their current income, they need to save 15 percent of their salaries for 14 years, added to their Social Security benefits and Dee’s $60,000 annual pension.

Other than Andrew’s lack of job security, the biggest threat to retirement is their enormous college debt. Andrew and Dee have considered withdrawing money from retirement accounts or selling their home the pay it down.

Pirrello says “absolutely not” to retirement withdrawals. They’re not yet 59½ and they’d be subject to a 10 percent penalty, and income taxes on withdrawals equaling a major haircut on the proceeds, Pirrello says.

The couple would be taking money out while the market is down, they’d give up potential investment returns and because most retirement assets are protected from creditors, using retirement assets to pay off debts is generally not recommended, he says.

Downsizing also has challenges because of the real estate market. Pirello says while home values are down, they will lock in a reduced price for their home and miss out on any recovery in prices.

If they did downsize to a condo in the $250,000 range, they could make a dent in the debt. Pirrello says if their home sells for $575,000 and they net $547,000 after expenses, they could pay real estate debt of $250,000, leaving them with $297,000. From that, they could pay a $147,000 chunk of student loans (the ones with the highest interest rates) and use the remaining $150,000 to purchase a condo with a small mortgage.

If they want to stay in their home, they could refinance to a 30-year fixed-rate mortgage at 5 percent, consolidating their first and second mortgages and $107,000 of higher interest student debt.

They’d have a new mortgage balance of $357,000, with monthly tax-deductible principal and interest payments of about $1,908. This would make a big difference in their cash flow, giving them $1,000 a month in student loan debt and a mortgage that’s $368 more per month than it was before.

“Will it be easy? No, but they knew that taking on $275,000 in student loans would require work and discipline to pay off,” Pirrello says. “They have a choice. If they refinance and make adjustments to stay in their home and pay down the loans over time, they always have an ‘out’ to downsize at a later time if circumstances dictate.”