Freddie, 41, and Marie, 38, are a one-income couple whose financial future is based solely on Freddie’s business. They’re trying to leverage every opportunity to save for their future, and for college for their two children, 4 and 2.
Their concerns are many.
“No pension, crazily escalating health care costs … We have flexibility of benefits and income, but with quite a bit of instability,” Freddie says. “If we are able to grow business and have more income, I assume we would just save most of any extra for retirement and hopefully college, although I am not sure the best way to do that.”
They also want to know how they should reallocate the cash in their portfolio, which came from a Roth IRA conversion.
The couple, whose names have been changed, have saved $124,500 in 401(k)s, $136,000 in IRAs, $100,000 in a brokerage account, $25,000 in a money market and $40,000 in checking.
The Star-Ledger asked Jerry Lynch, a certified financial planner with JFL Total Wealth Management in Fairfield, to help the couple supercharge their savings plan.
Lynch likes that the couple has taken advantage of current tax law.
“By being in a 10 to 15 percent tax bracket, they qualified for tax-free dividend income. They received almost $28,000 in tax-free income last year. Great Job!” Lynch says. “They seem to be very proactive with their CPA. A CPA’s advice is extremely limited after Dec. 31 when the year is over.”
Like any family, Freddie and Marie have multiple priorities, and deciding which goal comes first is one of the hardest things to do. Lynch says this couple’s major priorities are college savings, refinancing their home and retirement savings.
Right now, Lynch says, most of their focus has been on retirement, but Freddie and Marie may want to rethink this.
“Every product or strategy has limitations and the 401(k) has them too,” he says. “For example, there’s very limited liquidity, you can be dead before you access the funds, you do not know your future tax rate and it cannot be used for short-term goals.”
Freddie’s 401(k) is invested expensively: the investments in his plan have advisory fees built in, but he says he has no adviser — that he is aware of — for his plan.
“He is paying on average 25 percent more when he is not getting any advice and more important, he did not know he was paying this fee,” Lynch says. “Financial services is a lot like that ‘chance’ game they play in New York City where they spin three cups real fast, one of which has a peanut inside and you need to know where the peanut is. There is always a peanut inside — you just need to know where.”
Lynch says many investors tell him their accounts have no fees, but that’s not true.
“My response is then who paid for the building, the chairs and everyone’s salary?” he says. “Even no-load mutual funds have fees, so you need to review this in advance and understand what you are paying for.”
Lynch also looked at Freddie’s recent Roth IRA conversion. He said most investors make this move at the wrong time, often converting and paying tax on a higher income bracket.
But Freddie and Marie did it smart, so they converted an amount that would keep them in the 15 percent bracket.
“The general rule is only convert into your tax bracket,” Lynch says.
For others who are considering a conversion, Lynch has some other tips.
If you’re planning to move to a state that doesn’t have income taxes, such as Florida, don’t make a conversion until you move. And if you do convert, don’t convert into an existing Roth account.
“There is a ‘do-over’ provision in the conversion that allows you to go back, turn the account back to a traditional IRA and not pay the tax — called a re-characterization,” Lynch says. “If you convert into an existing account, you do not have the ability to do this as it is all or nothing on the re-characterization.”
Also consider breaking out a Roth conversion into different accounts by sector or investment type for the period of time you can re-characterize your Roth.
“By separating the Roth into different asset classes and accounts, you have the ability to re-characterize only those assets and accounts that have increased in value and not the asset classes that are worth less,” he says. “After Oct. 15 of the following year, you can consolidate the assets and accounts that did well into one account, and get a refund on the assets classes that did not appreciate in value.”
A mortgage refinance would also serve the couple well if they plan to stay in their home.
Freddie and Marie refinanced 30 months ago from 6 percent to 4.875 percent, but Lynch says if they can reduce their interest rate by 1.5 percentage points, they’d save around $4,500 per year — money they can earmark for college savings.
“The problem with the refinance is that they do not have enough equity and do not want to pay private mortgage insurance,” he says.
There are two options. The couple could sell enough stock to pay down the mortgage to an 80 percent ratio, and then refinance. Or, they could consider a 401(k) loan to pay down the equity.
“I generally do not suggest this but here it is a possible option,” Lynch says, because they don’t really need to sell the stocks, they’d pay it back to themselves over the next five years or longer, and it would reduce the stock allocation in their portfolio.