Get With The Plan: October 31, 2010

103110Bobby, 55, and Katrina, 54, have had big expenses in the past few years. They took home equity loans to pay for college for two of their children, and for their third child — a sophomore — they’re paying tuition from cash flow.

They’d like to wipe out the college debt and focus on retirement.

“We’d like to retire somewhere between 63 and 65,” says Bobby. “Probably relocate to a condo or townhome on the Shore. We are not extravagant people.”

The couple, whose names have been changed, have set aside $330,270 in 401(k) plans, $105,239 in IRAs, $17,800 in mutual funds, $46,000 in money markets, $4,500 in savings and $4,300 in checking. Bobby also qualifies for a pension, estimated to be worth $48,000 a year at age 63 if he chooses the option that will continue to pay Katrina if he dies first.

The Star-Ledger asked Michael Maye, a certified financial planner and certified public accountant with MJM Financial Advisors in Berkeley Heights, to help Bobby and Katrina forecast their financial health for retirement.

“Bobby and Katrina are careful with expenses, which translates into a savings rate of 25 percent of their gross income, which is excellent,” Maye says.

Despite the hefty college expenses, the couple has set themselves up nicely for retirement. Two big helping factors will be Bobby’s pension, and the health credits he’s accumulated through work, which will take the bite out of health care costs prior to their Medicare eligibility.

Bobby is making the maximum contribution to his 401(k), including the extra catch-up contribution for those older than age 50. His contributions go partly to the traditional 401(k) and partly to a Roth 401(k), which Maye says is a tax-smart choice.

“Bobby’s strategy is a good one as it allows some current tax deferral, paying some tax now and creating a tax-free Roth 401(k) account,” Maye says. “This approach makes a lot of sense since no one knows exactly what future long-term tax rates will be. Hedging your tax exposure makes a lot of sense.”

Bobby and Katrina apparently live way under their means. Based on their budget, May says they have excess cash flow of roughly $18,500 per year, and when their youngest child graduates from college, that will almost double.

When college ends, May says they can put that new free cash flow to work.

First, he recommends paying down any remaining balance on their home equity loan.

Next, they should increase their cash cushion. They currently have about six months of expenses in a liquid account, but he recommends they increase that to one year’s worth of expenses.

Katrina is currently contributing 20 percent of her salary, or $8,600, to her employer-sponsored retirement plan. Maye says they should consider increasing her contribution because they appear to have extra cash flow.


Given their cash flow and savings rate, Bobby and Katrina should be able to retire at Bobby’s age 63 with a living expense of $83,400 — their current living expenses less college tuition.

Bobby’s pension of $48,000 will provide a great foundation, Maye says, and will equal almost 50 percent of their projected living expenses. But over time, the pension will cover less, Maye says, because the pension is not inflation-adjusted.

“Typically, I like the mortgage to be paid off at retirement, but the couple is projected to be able to cover the mortgage,” Maye says. “In addition, the couple is likely to sell their home and use the proceeds to purchase a condo down the Shore once retired.”

Bobby and Katrina have an asset allocation of 60 percent equities and 40 percent fixed income, but Maye says they can afford to dial down the risk in their portfolio now. He recommends they consider 30 percent equities, 60 percent fixed income and 10 percent alternative investments.

“The couple should reallocate a portion of their intermediate-term bond portfolio to short-term bonds,” Maye says. “The couple should allocate a portion of their fixed income portfolio to international bonds, which can provide a hedge against a depreciating dollar.”

He also recommends the couple make an allocation to natural resources/commodities as an inflation hedge.