Get With The Plan: May 24, 2009

Jill, 51, and Brent, 50, are really feeling this recession.

Jill recently suffered a permanent salary reduction of 5 percent and she lost her bonus, worth 16 percent of her annual salary.

She also had a 10 percent pay cut for the month of April.

The lower salary isn’t helping the couple’s efforts to pay down their massive $90,000 of credit card debt, which was mostly from a business investment that went bad. They’ve stopped retirement savings to channel more funds to pay debt.

“We’re not crazy about doing this but it’s the only place we can grab some money,” said Jill. “We want to get back into the 401(k)s as soon as possible.”

Jill and Brent, whose names have been changed, saved $364,325 in 401(k)s and $29,667 in IRAs before stopping contributions. They also have $5,000 in bonds and $16,637 in money market accounts. They’ve also earmarked $24,068 for college for their two children, ages 15 and 13, invested in a combination of 529 plans and taxable mutual funds.

The Star-Ledger asked James Ciprich, a certified financial planner with RegentAtlantic Capital in Morristown, to help to couple dig their way out of debt.

“Their total credit card debt is excessive, totaling over $93,000 with an average
rate of 6.85 percent,” Ciprich says. “Current monthly payments total $1,830, which is not enough if the goal is to be free of credit card debt prior to children starting college.”

The couple’s first task is to pay off the credit card debt as aggressively as possible. The sooner they can pay down the debt, the more interest they will save.

If the couple can pay it all off within a three- to five-year time frame, they will be able to redirect cash flow back to their 401(k) savings and towards college tuition. He suggests they start with the highest interest rate card first to reduce the overall interest expense.

A better look at the couple’s expenses will help them pay off debt faster. When Jill and Brent submitted their budget to Get With The Plan, there were several expense items they admit were guesses. Budgeting is the best antidote to credit card debt, Ciprich said.

“They need to get a clear picture of where they are spending their money and move all of their purchases to cash or a debit card,” he said. “By using a debit card they can track their spending through online banking services or software such as Quicken or Money, as opposed to seeing ATM withdrawals and continuing to wonder where the cash has gone.”

The couple would like to help their children with college costs, and their savings so far would fund about half of the national average for public school costs, Ciprich says. To make their dollars go farther, he recommends they should invest conservatively if they plan to use the money for their oldest child, who is college-bound in three years.

The 529 plan assets should be set aside for their younger child so they have more time to benefit from tax-deferred growth.

“They could elect a 529 plan with a lower expense ratio, such as Michigan, which offers a plan with an expense ratio of .45 percent,” Ciprich says. “Their New Jersey plan costs between .85 and 1.21 percent.”

Jill and Brent have stopped their retirement savings so they can pay down debt more quickly. Once the debt is paid, they should resume contributions and save as much as possible.

Their current allocation is 80 percent in equities, 15 percent in bonds and 5 percent cash.

Ciprich says they could reduce their equity exposure without significantly impacting their ability to retire at age 65 while maintaining their current spending levels.

He recommends diversifying equities to include more global exposure, and they should diversify their fixed-income holdings to include Treasury inflation-protected bonds,international bonds and high-yield bonds.

Finally, they should add some alterative asset classes such as commodities, real estate and hedging strategies to further reduce risk and enhance return.

“They can also roll over old 401(k)s into an IRA with better investment options,” he says.