Get With The Plan: November 11, 2012

Ozzy and Janis, both 49, are juggling their goals of retirement and college funding for their two kids, 15 and 12. They’re wondering if they’re investing smart, or if there’s a better way to reach their goals.

“Our retirement visions include nothing particularly extravagant,” Ozzy says. “Perhaps we’ll want to travel once or twice a year, if possible, but we won’t be buying boats or anything like that.”

The couple, whose names have changed, have saved $338,700 in 401(k) plans, $172,500 in IRAs, $16,700 in a brokerage account, $53,400 in a money market, $22,500 in checking and $925 in savings. They also have $135,800 set aside for college.

The Star-Ledger asked Michael Pirrello, a certified financial planner with Mill Ridge Wealth Management in Chester, to help the couple assess their financial situation.
“Ozzy and Janis get an A+ for living within their means and getting themselves free of debt and on a road to financial security,” he said, noting that they need refinement more than a complete overhaul.

While the couple has saved money for college, they realize the cost can be huge. Ozzy and Janis say they’d prefer the kids choose an affordable public college so they can pay 100 percent of the costs.

The discrepancy between private and public college costs is significant, Pirrello says.
“For example, for both children to attend Boston College, the total expense is estimated to be approximately $587,000 as opposed to both children attending Rutgers University, which is estimated at approximately $259,000 in total,” he said. “Yes, the numbers seem ridiculous, but this is the reality of college costs for this family of two children ages, 12 and 15.”

Given their savings to date, Pirrello says the goal of affording a quality public education for their children is certainly within reach.

Using Rutgers’ costs as the benchmark, and projecting college cost increases of 5 percent and investment returns of 7 percent, they will need to keep saving.
To fully fund their older child’s education, which will cost approximately $120,000, they will need to set aside $97,819, growing at 7 percent, Pirrello says. The remaining $38,041 should be set aside for their younger child to grow at 7 percent.

Still, they’ll need to save an additional $1,161 per month to meet the projected cost of $139,000 for their younger child.

Pirrello says they can juggle their current savings to accomplish this. Of the $135,860 that is currently saved for college expenses, only $20,494 is in 529 plans, which means Ozzy and Janis will have to pay taxes on the majority of the funds.

“Taxes will ultimately reduce the amount of money available for college costs, so they should consider converting 70 percent of their college savings from traditional investment accounts in their names to 529 accounts to avoid taxation on college-specific savings,” he said. “The remaining 30 percent can continue to be invested in non-529 accounts for flexibility purposes with a focus on a tax-efficient investment strategy, such as tax-favored dividend funds and municipal bonds.”

Turning to retirement, Ozzy and Janis have saved judiciously for retirement and consistently lived below their means with an aggressive focus on paying off debt, Pirrello says. They now find themselves in the enviable position of owning their home with no mortgage and carrying no debt whatsoever.

They will have a three-pronged approach to fund retirement: Social Security, retirement savings accounts and taxable savings accounts.

“Because this couple had such a laser-like focus on paying off debt, they have sacrificed Ozzy’s retirement savings, which is reflected in the balance discrepancy of their retirement accounts — most retirement funds are in Janis’ name. But at age 49 and with no debt, Ozzy still has plenty of time to ramp-up his retirement savings.

Pirrello says retirement planning is very subjective and has many variables, so he made some assumptions to get a baseline.

The couple would potentially like to retire at age 67. Assuming a combined Social Security benefit of $42,000 per year, they will need additional funds to meet their income needs of approximately $119,000, which represents 70 percent of their current earnings, Pirrello says. With inflation, $119,000 in 2012 dollars is equivalent to almost $202,000 in the couple’s first year of retirement in 2030.

To reach that amount, Pirrello says their investments will need to achieve an average annual return of approximately 7 percent, while continuing to save $15,000 together annually in retirement funds.

“Very realistic goals for this disciplined couple,” he says.

The couple’s nest egg could potentially benefit from better investment allocation and diversification of their retirement savings.

Janis is 63 percent in equities in her retirement savings, invested in four mutual funds that have significant overlap of their investments —the mutual funds, though going by different names, actually own many of the same stocks.

By diversifying better, Pirrello says she can lower risk and potentially increase return.
“The same can be said for her bond investments,” he said, noting she has three funds but they’re invested similarly.

The couple also should be aware of their cash emergency fund.

Neither Ozzy nor Janis have significant job security, so they have enough cash to cover them for a year should they both lose their jobs.

“As the economy rebounds and Ozzy and Janis gain more confidence with their job security, the large cash balance in their savings should be reduced to reflect six months of living expenses and the remainder redeployed to a more moderate investment strategy to increase the yield potential on those savings,” he says.