Heavy debt, baby diapers drain money
bostonherald.com
Money Manager/by Karin Price Mueller
Sunday, May 18, 2003
Problem
Gil and Maryann have a 6-month-old child, and they're trying to give their financial lives a fresh start. Their main goal is to dig themselves out from under a mound of debt.
``We can generate a pretty decent income, but we have a lot of debt,'' says Gil, 40, who works in the financial services industry. ``When we bought our home we used the credit cards to create cash to improve our debt ratios.''
Gil and Maryann, 26, a recruiter, accumulated $43,500 of credit card debt, partly to make themselves look like better candidates for a mortgage, partly for home-related expenses. They keep moving the debt to low- or no-interest rate cards, but Gil and Maryann want to get rid of the debt as soon as they can. Still, the house is a tempting drain on their money.
``After the house, all of a sudden I got wrapped into new furniture,'' Gil says. ``I'm not a luxury person but we're spending on things that we need to do, and it's a huge expense.''
Also working against the couple financially this year is that Maryann took some time off from work when she had their son, so she didn't earn as much as she normally does. She should be back to her annual salary of $75,000 soon, and Gil also earns $75,000 a year. He believes that once the debt is paid, their salaries should be plenty to support their lifestyle.
They have a $280,800 mortgage on their home near New Hampshire, with an extra $34,639 owed to a home equity line of credit. Additionally, they owe $5,570 on college loans and $6,000 on a time-share loan.
They own four weeks at another timeshare, worth $40,000, but the one on which they owe $6,000 they'd like to sell off.
``The one that we're paying on, we'd like to get rid of. It's a gorgeous place but we were impulsive. We never should have bought that,'' Gil says.
The couple is also starting anew with retirement planning, after Gil emptied out his 401(k) plan several years ago to help a friend with a business venture that went sour. He withdrew about $60,000 from his retirement plan, without setting money aside to pay the tax bill or penalties. Now the couple also owes $13,000 to the Internal Revenue Service, which they're paying down.
So they not only have the extra debt, they have far less in savings than they could have today. Gil calls the move ``a big mistake.''
Now they're saving again, and Gil has $9,500 in his 401(k) and Maryann, $4,700. They also have $11,000 in a savings account and $1,500 in checking.
Gil knows they have to save more for retirement, and hopes he can retire in about 18 or 20 years - around the same time his son is in college.
Gil and Maryann also want to start saving for that big goal.
``I want to fully pay for college, but I don't want him to know about it so he can learn about money and save, too,'' Gil says. ``I put myself through school and so did my wife, so we want to help our son.''
Solution
Restoring financial order gets family back on track
If Gil and Maryann hunker down, they can get their finances back in order, eliminate debt and start preparing for future goals such as retirement and college for their son.
``The debt is, without a doubt, the thing they need to focus all their energy on,'' says Dan Galli, a certified financial planner with Boston 128 Companies Inc., with offices in Rockland and Waltham. ``The good news is they can do something about it. It will take them four or five years, and they will have to be disciplined.''
Galli, a member of the Financial Planning Association of Massachusetts, says except for the first mortgage, all debt can be eliminated in about five years if they implement a strict debt-reduction program.
First, they should continue payments of $1,000 per month to their credit card debt of $43,500. That debt will be paid off in 4 years if they continue their payments and don't add to the balances.
Next, the couple just finished paying off another bank loan. They can redirect the payments that were going to that debt to their home equity line of credit, for a monthly payment of $804. Even if interest rates increase slightly, that will be sufficient to pay off that note in four years, Galli says.
Both the college loan and the time share loan have five years remaining. If the time share is sold, as the couple is hoping to do, then its monthly payment of $200 can be used to retire the college loans early. If not, after the equity loan is paid in four years, that money can be redirected to these two debts to retire them early.
``A big positive for them is that this repayment schedule is not going to affect cash flow,'' Galli says.
To reach the couple's retirement goals, they need to maximize savings, Galli says. Using their 401(k) plans is the way to go. Right now, the couple is saving 8 percent of their salaries. The maximum annual contribution would be $24,000 for 2003 ($12,000 each) and this would certainly be a desirable goal, Galli says. But the drain on cash flow caused by debt service makes this difficult to achieve.
Galli says they should try to increase their contributions to 9 percent or 10 percent, and work toward increasing the percentage a bit each year until they are able to hit their maximum contribution levels. Once the 401(k) plans are maximized, Roth IRA accounts can be considered.
Both 401(k) accounts today are invested almost completely in stocks, diversified between growth and value, as well as large, mid-sized and smaller companies. Assuming an annualized rate of return of 8 percent, and continued contributions at the current level, they could assume a value in 18 years of $467,897, Galli says. But as their incomes rise and they increase contributions, the values of the accounts could rise significantly.
``For them, the stock market situation couldn't be any better because they don't have a lot in the market,'' he says. ``They're buying low, so now is a good time to start pouring it in.''
For college savings, Galli says a monthly savings program should be started using either a Coverdale Account or a 529 Plan. Because cash flow might be tight at this point because of the debt repayment, Galli says the couple could start slowly and increase contributions as the debt is paid off.
The couple is also seriously underinsured, Galli says. They currently have $50,000 of coverage each, supplied by their employers. Galli says they each need at least $500,000 of term coverage.
Assuming their current health is excellent and no tobacco usage, the monthly premiums for $500,000 of coverage for Gil and Maryann would be about $50 and $27, respectively, Galli says. He also suggests they should check at work to see if they can get group disability insurance.
Gil and Maryann also need to contact an estate planning attorney to draw up wills, durable powers of attorney and health care proxies. And over time, Galli would like to see the couple increase their cash reserves.
``They could have a little more in an emergency fund, but I don't think it's realistic today because of the debt,'' he says. ``They have about one-and-a-half months' worth of cash, and when the debt is paid down they can increase that to at least three months' worth.'' |
