Adam and Aileen, both 45, say they live paycheck to paycheck, but they actually save the max to Adam’s 401(k) before they touch any cash. They would like to downsize to a 55-and-older community, but first, they want to pay for college for their two kids, 14 and 12.
But there’s a more immediate concern. Adam fears he could lose his job.
“We keep saving for retirement, saving for the kids’ college, saving in case I lose my job,” he says. “We would like to retire as soon as we are financially set.”
The couple, whose names have been changed, have saved $238,800 in a 401(k), $81,400 in IRAs, $22,200 in a brokerage account. $6,000 in savings and $22,000 in checking. There’s also $56,800 remaining in 529 Plans for college costs.
The Star-Ledger asked Ronald Garutti, a certified financial planner with Newroads Financial Group in Clinton, to help the couple balance their goals.
“Any time a client tells me they are worried about job security I immediately focus on the immediate future,” Garutti says. “When planning for the immediate future, it is best to review cash and liquid assets as well as to understand what expenditures are mandatory and what are discretionary.”
Too often, he says, in low interest rate times like we are currently experiencing, investors skip over an emergency because a 0.5 percent return on cash assets is not sexy — especially when the market is at or near all-time highs.
Garutti says he’s rather focus first on the emergency fund. Typically, he says, an emergency fund should be three to six months of future expenditures, minus most discretionary expenditures.
But what’s typical for one family is not typical for another.
“For instance, if a family has long-term consistent employment, and hopes of the same to continue, maybe they need less than the family where one of the earners is a contractor, a small business owner or maybe works for commissions and never knows exactly what the next paycheck will be,” he says. “The later family will need considerably more assets in an emergency fund — maybe 18 to 24 months may be a better starting point for them.”
Then there are the specifics for Adam and Aileen. They paid off their mortgage very early, so if their income change was to change, their immediate bills might be smaller than other families.
They also could dip into home equity lines if necessary, he says, strongly recommending they open a line of credit now while they have income to show.
“If the husband loses his job tomorrow, it will certainly be harder to open a home equity line,” Garutti says. “They should open a line, not take any money out and throw all of the forms into a drawer and ignore it unless they absolutely need the money. It’s better to be prepared than scrambling.”
Right now, the couple has approximately $28,000 in cash, but most of this is in checking and may fluctuate from paying bills.
Garutti says it is best to separate savings and active checking dollars, however, the accounts should be linked in case someone needs to transfer funds in a pinch.
Without making changes, they are approximately $10,000 of net after-tax positive each year, Garutti says. This money could be added to liquid savings to continue to build those reserves.
On to college.
The couple would like to pay all college expenses for their children, but Garutti says this would set back their retirement plans. Today, they’re maxing out Adam’s 401(k) but they are not saving into other accounts.
“If they end up paying for their kids’ college expenses in full, it might be hard for them to retire early,” he says. “The heart and the math often tug at this decision. The heart wants to pay all education expenses and have the house paid off. However if they do that will they have enough to retire? Or will they be able to retire early as they indicate?
Maybe, and maybe not, Garutti says.
Based on current assets, he says an early retirement is not on the horizon. They could choose to work a few more years to reach the education goal, but only they can decide if that is the path they wish to choose.
“With approximately $57,000 dedicated to education funds, that would not fund eight years of New Jersey state school expenses,” Garutti says. “Rutgers costs approximately $28,000, including room and board, per year. That means they only have about 25 percent of the possible goal funded with existing investments.”
Garutti looked at other areas of their finances, and he says they are underinsured in the event of a death. Right now Aileen has no life insurance, and Adam has only $150,000 of coverage.
“Provided they are healthy, inexpensive term insurance should be added to their plans,” he says. “Even though they do not have home debt, they would face significant asset depletion if either were to die prematurely.”
Garutti says he doesn’t like to recommend rules of thumb, but there are a few ways to back into a starting point of the discussion.
He says often, people will assume 4 percent as an achievable long term yield of assets. That means if someone had $1 million of insurance, they could potentially expect $40,000 of yield without touching the principal. If they were to dip into principal, they would be able to “spend” more than $40,000, but then next year they would need to earn more than 4 percenet to be back to even.
“Considering that the wife has no insurance and the husband only has $150,000, they should look to change this immediately,” he says. “I would recommend implementing some 10-year term insurance and some 20-year term insurance.”
He recommends they could layer the coverage amounts to expire at different times based on various milestones such as funding college. And because term prices would be guaranteed for the length of the contract, it would be a fixed expense.
Taking a close look at their portfolio, Garutti says they’re invested pretty aggressively.
Almost all of their investable assets are invested in stocks and stock mutual funds, and they have little in the way of bonds.
“Adam’s 401(k) has 20 percent in cash, but he says that’s because he is looking for new stocks to buy, and not because he is hedging his portfolio,” Garutti says.
They need to complete a risk tolerance exercise immediately and should be making diversification changes in line with the finding, he says.
“It is okay to be aggressive if they understand the ramifications, but they are overweighted in tech stocks and some foreign holdings and should have some bonds to cushion them during periods of increased volatility,” he says.
Get With the Plan is designed to illuminate personal finance concepts and isn’t a substitute for actual financial planning or dedicated professional advice. Contact Karin Price Mueller at Bamboozled@NJAdvanceMedia.com.