Will college bills ruin couple’s retirement?

Money Makeover

  • Photo: alvimann/morguefile.com

    Michelle and Troy are in tough financial times.

    They have three children. The two younger ones are in college, and the couple has been struggling to pay the tuition.

    “They both receive some financial aid but we are borrowing for most of their tuition,” said Michelle, 58.

    That means money is tight.

    Property taxes have been painful recently. To make ends meet, the couple has had to use their home equity line of credit (HELOC) to cover property tax bills for the past two quarters.

    They do plan to sell their home to buy something with lower taxes, but for now, they’re looking for options.

    “Right now my husband wants to take money out of his 401(k) to cover our property tax bills,” Michelle said.

    Troy, 62, has used his retirement accounts as a resource before, Michelle said. Last year he withdrew a big chunk from an IRA to pay for college expenses.

    That move lowered their net worth, sure, but it also put them in a higher tax bracket.

    There’s $32,000 in the 401(k) plans, IRAs worth $22,500, mutual funds worth $135,000 and a 529 plan with $18,000 remaining. Their debt includes $60,000 in college loans, $177,000 for the mortgage and $25,600 for the HELOC.

    Michelle does expect a monthly pension worth $1,400 and change at age 65, but she thinks she’ll have to work until at least age 70.

    The couple asked for help, so we turned to Michael Cocco, a certified financial planner with AXA Advisors in Nutley, to show this couple how to make the most of their financial situation.

    Cocco said it’s important to note that most families have limited resources.

    “Where and how to use these resources to help accomplish your goals often has trade-offs,” he said.

    AVOID COSTLY MISTAKES

    While the couple wants to pay for college without going into too much debt, they also have to balance retirement plan needs, too.

    Cocco said they should to examine how the decisions they make today will affect them in the future.

    For example, pulling money from Troy’s IRA to pay for college was very costly because the entire amount became taxable in one year, Cocco said.

    “There are strategies that one can use to avoid the immediate taxation of these type of funds,” he said. “I always recommend that individuals seek counsel of a tax advisor before making a large move like this so that they can be informed of the potential tax ramifications.”

    He recommends they not make similar moves without fully understanding all the consequences.

    With money so tight, the couple’s primary focus should be making their normal month-to-month bills, such as the mortgage and property taxes, as the top priority. They want to make sure they don’t get behind on any bills or incur credit card debt at high interest rates.

    “This should go before saving additional monies for retirement and before paying for college,” Cocco said.

    A large portion of their net worth is in their home, with nearly $500,000 in equity.

    Using some of that home equity to help pay for college should certainly be on the table, he said.

    The couple said they are considering downsizing to reign in expenses, and it could help with college funding.

    “Your target purchase price should be in the $400,000 range so you can buy this home without having to take another mortgage, helping to control your expenses in retirement,” Cocco said.

    ASSET ALLOCATION

    The couple said they plan to use their non-retirement assets for college costs. With those expenses being so near-term, the couple needs to take care with the funds.

    “I would recommend they keep it very conservative since their time horizon is short term,” Cocco said. “I would suggest leaving most of it in cash, and having some in shorter duration bonds and bond funds to try to earn some interest, but principal protection being key.”

    For the retirement accounts, the couple can have a different outlook.

    Because they’re not planning to use these funds until retirement, Cocco said, it’s okay to be more aggressive by having mostly equities in the portfolio.

    “Being more aggressive with a focus on growth will help grow these assets so they can use them in retirement to supplement the pension and Social Security,” he said.

    This will also help them to keep ahead of inflation, which over time will eat away at their future purchasing power.

    THE COLLEGE DILEMMA

    There are several different ways that Michelle and Troy can help their children pay for college.

    First, he recommends they start by using the 529 plan.

    “The distributions from a 529 plan are income tax free — principal and earnings — if used for qualified educational expenses under current law,” Cocco said.

    They already took a distribution from Troy’s IRA and paid the taxes on it, and the funds are now sitting in a non-IRA account.

    Taking withdrawals from that account to help pay for college will likely have little tax impact at this point, Cocco said, and it certainly can be used as a second option once the 529 plan is depleted.

    They can then use their other non-retirement accounts to pay for tuition over time.

    The couple already started taking Stafford and Parent Plus loans to help secure additional funds for college, and they could continue to take more loans for college bills as needed.

    But they do have approximately $96,000 in available credit on their home equity line, and that rate is only 3.5 percent.

    “Before taking out more Parent Plus loans at a 6 percent-plus interest rate, I would recommend that they use the available balance in the home equity line of credit to pay for college costs, and paying just interest only — if possible with the lender — to help control their current cash flow,” he said.

    Also, home equity line interest is tax-deductible in many situations, so they should check with their tax advisor.

    When they do finally sell their home and downsize, the home equity line balance and the mortgage would be paid off from the proceeds, eliminating this debt, Cocco said.

    NJMoneyHelp.com wants to remind everyone that while you can borrow for college, you can’t borrow for retirement, so if money is tight, consider having your students take out the college debt. If you can afford to help them pay it off, have at it. And yes, we get that you probably don’t want to saddle your children with debt, but you don’t want them to have to support you in retirement, either.

    RETIREMENT INCOME PLANNING

    When forecasting future retirement income planning, it is important to first identify how to maximize your guaranteed sources of retirement income, Cocco said.

    So he started with Social Security.

    As much as the couple might want to tap this resource early, he recommends they wait as long as possible.

    “Each year you defer taking your Social Security, your projected monthly benefit will increase by approximately 8 percent per year,” Cocco said.

    If the couple plans to work 10 more years, that would put Troy at 72 and Michelle at 68.

    “I would recommend that Troy wait to take Social Security until age 70 — you no longer receive increases in benefits due to deferring Social Security past age 70,” Cocco said.

    This would give him approximately $3,196 per month.

    If Michelle could work until her age 70, her projected benefit would be maxed out at approximately $2,593 per month.

    Working longer would also increase her expected monthly pension to about $2,683 per month.

    “Using these three guaranteed income sources would give them a total of $8,472 per month before taxes in guaranteed income, or in excess of $100,000 per year before taxes, which is a very strong amount to get them started in meeting their expenses throughout retirement,” Cocco said.

    The couple figured their current expenses not counting college are approximately $7,000 per month.

    “Even with inflation, by downsizing their home and lowering their expenses, this should give them the ability to meet their expenses through these sources of income,” he said. “Waiting to take pension and Social Security to age 70 will allow them to use some of their assets at the present time to assist their children for college to the best of their ability.”

    That’s great news for the couple.

    They also said they’d consider working part-time in retirement, which would help provide additional cash flow.

    So while things are tight now, there’s a shiny light a little further down that tunnel.

    Please be advised that this response is not intended as legal or tax advice and is for informational purposes only.  Accordingly, any tax information provided in this response is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.  The tax information was written to support the promotion or marketing of the transaction(s) or matter(s) addressed and you should seek advice based on your particular circumstances from an independent tax advisor. 

    Michael Cocco offers securities through AXA Advisors, LLC (NY, NY 212-314-4600), member FINRA, SIPC. Investment advisory products and services offered through AXA Advisors, LLC, an investment advisor registered with the SEC.  Annuity and insurance products offered through AXA Network, LLC.

    Money makeovers offered by NJMoneyHelp.com should be treated as general advice about personal finance and money decisions. Before you make any changes to your personal financial plan, see a professional who can consider your entire financial situation. If you’d like a free money makeover, email moc.p1513545652leHye1513545652noMJN1513545652@ksA1513545652.
  • Net Worth:

    Assets:

    • Checking: $100
    • 401(k) plans: $32,000
    • IRAs: $22,500
    • 529 Plan: $18,000
    • Mutual Funds: $135,000
    • Primary Home: $700,000
    • Personal Property: $10,000
    • Autos: $5,000
    Total Assets: $922,600

    Liabilities:

    • Mortgage: $177,000
    • HELOC: $25,600
    • College debt: $60,000
    • Medical bill: $1,000
    Total Liabilities: $263,600
    Total Net Worth: $659,000

    Budget:

    Annual Income:

    • Michelle: $75,000
    • Troy: $72,000

    Monthly Expenses:

    • Income Taxes: $993
    • Housing: $929
    • Utilities: $748
    • Credit card: $5,300
    • Personal Care: $5
    • Transportation: $441
    • Medical: $249
    • Entertainment: $10
    • Vacations: $200
    • Charity: $25
    • Gifts: $50
    • Pet Care: $125