23 Aug Can divorced dad afford college and retirement?
Bill, 45 and divorced, has a long list of money goals.
“I want to prepare for retirement, maintain my earning power and have a financial cushion,” Bill said.
He’d like to retire in his early 60s, and is willing to consider working part-time during a transition stage. Bill hopes that he can live off his retirement savings with a 4 percent per year annual draw from the accounts.
To get closer to his goal, in 8 to 10 years, he’d like to move to a state with a lower cost of living.
He also wants to provide for his 13-year-old daughter, who he expects would attend college full time at an in-state university.
Laurie Wolfe, a certified financial planner and certified public accountant with Lassus Wherley in New Providence, reviewed Bill’s finances for NJMoneyHelp.com.
“Bill’s consistent discipline for saving, his focus on controlling expenses, and his investment savvy are all important components of a successful financial plan,” Wolfe said. “One of Bill’s biggest challenges will be to manage his cash flow during the college funding years, college education expense years and the years between early retirement and age 70, when minimum required distributions will begin.”
Here’s what he needs to do to stay on track.
To analyze Bill’s plan, Wolfe made several assumptions, including that Bill would live to age 100 and the inflation rate would be 3.5 percent.
She assumed his living expenses wouldn’t decrease until he changes residences in 8 to 10 years.
For Bill’s investments, Wolfe assumed a 6 percent annual rate of return, and that he would max out his 401(k) and Roth IRA each year.
She assumed Bill’s salary would grow annually at a 2.9 percent rate. She only included a $5,000 annual bonus because that money isn’t guaranteed. She also didn’t include any income from part-time work in Bill’s later years.
For Bill’s daughter’s college, Wolfe used the cost of attendance at Rutgers University, which is $29,933 for 2017, and she assumed a 6 percent inflation rate for college costs. The goal would be for Bill to fund half the cost.
While his finances look pretty good, the college funding period will squeeze his cash flow. More on that in a moment.
“One of the most important tasks over the coming years will be to monitor the positive or negative deviations from the assumptions presented in this plan,” Wolfe said. “Significant deviations from such things as inflation, investment returns, and income or expense levels may significantly alter these outcomes.”
Another significant task will be the management of college funding and expenses, she said.
To help all of this, Wolfe recommends Bill monitor and budget his money in order to get a clear understanding of his expenses and where cuts can be made.
Bill’s retirement assets are more than $600,000. He’s done this by contributing the maximum to his 401(k) plan and making an annual Roth IRA contribution.
Beginning in the year he turns 50, Wolfe said, he can save an additional “catch-up” contribution to both accounts. For a 401(k) plan, he will be able to save an additional $6,000 per year, while the IRA can accept an additional $1,000 per year.
It is beneficial to take advantage of this tax-deferred savings opportunity, Wolfe said.
“Although it appears that his cash flow is constricted during the college funding/expense period, it would be prudent to continue saving as much as possible into these retirement vehicles,” she said. “The combination of annual contributions and tax-deferred compounding builds a higher level of assets in both nominal and buying power dollars.”
Bill said his risk tolerance is moderately aggressive and that he wants to invest wisely.
Looking at his current portfolio, 43 percent is invested in large-caps, 20 percent is in small- and mid-caps, 13 percent is in international stocks, 3 percent is in emerging markets, 18 percent is in fixed income and 3 percent is in cash.
Although diversified, Bill’s allocation does not correspond with his moderately aggressive risk tolerance level, Wolfe said.
“His portfolio is overweighted in all U.S. positions,” she said. “Although these funds have experienced tremendous returns in the short-term, he is subject to much higher risk.”
To reduce the risk to the portfolio, Wolfe recommends increasing the allocation to international stocks, international fixed income, emerging markets and REITs, lowing his overall exposure to U.S. large caps to 25 percent of the portfolio and having 12 percent in U.S. small- and mid-cap stocks.
“We recommend the use of low-cost, institutional-class mutual funds and exchange-traded funds (ETFs),” she said.
Besides managing expenses, the investment portfolio is a critical component to achieving Bill’s goals and objectives, Wolfe said. The portfolio will be one of his primary sources of income in retirement, so it will need to be structured so it continues to grow and generate the total return that Bill will need to cover his cash flow while controlling the level of risk exposure.
Overall, Wolfe said, Bill should invest in a geographically diversified portfolio with a net targeted annual rate of return between 6 and 9 percent over the long term.
He also needs to make sure he has enough cash on hand to cover emergencies.
Bill currently has non-retirement assets of about $19,000. His ongoing expenses are about $4,285 a month excluding taxes.
To have about six months of expenses in the bank, Bill needs to increase his emergency fund to about $25,700. Wolfe recommends he put it in highly liquid funds, such as a money market or high yield savings account.
To reach the goal of providing half of his daughter’s expenses for an in-state college, Bill will need to start saving.
Indeed, it’s the most significant challenge that Bill faces.
Wolfe’s projections include savings of $8,000 a year, or $766 a month, starting in 2017, with that amount increasing 10 percent a year.
“This savings causes cash flow deficits during the college attendance years,” she said, noting the shortage would start in 2022 when his daughter starts school because this is also the year Bill is eligible for catch-up contributions to the retirement accounts. “The cash deficits from these years total $46,304 and the shortfall in total college funding is $73,505.”
At this point, Bill will need to make cutbacks and/or borrow to reach the goal, she said.
Here’s how Wolfe came to those numbers.
When Bill’s daughter starts college in 2022, the annual cost, adjusted for inflation, will be more than $40,000. For four years, the total cost would be $175,238.
That’s where savings can come in, but it’s a big nut to swallow. As Wolfe said, Bill would need to start saving $766 per month through 2024.
That’s a lot to save, but saving now is better than raiding other funds later.
Wolfe said in order to avoid using retirement assets to fund college, it will be necessary to reduce personal living expenses, borrow or find some other means of tackling this cost, Wolfe said.
“This may come in the form of scholarships, gifts and/or financial aid,” Wolfe said.
He does have an ace in his back pocket.
His bonus is variable — up to $23,000 per year — but Wolfe only put a bonus amount of $5,000 a year in the plan. So if the bigger bonuses come in, that will make a huge difference.
Bill maintains umbrella liability insurance policy in the amount of $5 million.
Excess liability or umbrella coverage provides protection against large personal liability claims, Wolfe said. The coverage supplements Bill’s underlying auto and homeowner policies.
Wolfe recommends investors have sufficient coverage to protect their personal net worth and pay for the potential costs of litigation to defend against a claim.
Based on his net worth, Wolfe said, Bill really only needs $1 million of umbrella coverage.
Reducing coverage could save him $500 or more a year — money that can be redirected to his other savings goals.
Bill also needs to take a look at his estate planning documents.
He last did his documents in 2010, including a will and a health care directive/living will.
The documents name his sister as his power of attorney, trustee and also as his daughter’s guardian. When his daughter turns age 30, Bill plans to revise his documents to name his daughter.
“It appears that Bill is on top of this very important aspect of his overall financial plan,” Wolfe said. “We recommend that you review your estate planning documents at least every five years, or more often in the event something changes that creates the need to update them.”
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- Checking: $19,000
- Daughter’s checking: $4,000
- Savings: $250
- 401(k) plan: $40,000
- IRAs: $566,000
- Primary Home: $325,000
- Personal Property: $35,000
Total Assets: $989,250
- Mortgage: $197,000
Total Liabilities: $197,000
Total Net Worth: $792,250
- Salary: $103,000
- Bonus: $23,000
- Income Taxes: $1,820
- Housing: $2,516
- Utilities: $321
- Food: $430
- Child Support: $386
- Child care: $70
- Personal Care: $90
- Transportation: $200
- Medical: $412
- Insurances: $52
- Entertainment: $40
- Charity: $40
- Gifts: $30
- Misc.: $50