PERSONAL FINANCE : DOWN THE ROAD : STAGES
Financial strategies change at various stages of life. To illustrate the differences, here are strategies for five hypothetical families. Financial planners and accountants Thomas Gau of Torrance and Michael Blue of Woodland Hills developed the strategies, assisted by Times staff writer Carla Lazzareschi. Both Gau and Blue work on a fee-only basis, and don’t earn commissions for selling products. The strategies assume that all families live in Southern California, with its high living costs and incomes.
STARTING OUT
Family status: Single worker. Age 28. No children. Renter.
Current income: $25,000.
Future earning prospects: Better than the rate of inflation.
Attitude toward risk: Comfortable with some risk.
Current assets: Automobile worth $5,000; $2,500 in bank account.
Investment goals: Set aside money for future home purchase, possible marriage. A nice vacation.
Recommended Actions:
Open an individual retirement account or join a 401(k) savings program.
Start an austerity program by trimming all unnecessary spending and paying off all consumer credit cards. Put savings into bank account or money market fund.
Start looking for a friend or relative with whom to share a home purchase.
Adviser’s comments:
It would probably kill this person to learn this, Blue says, but he or she is in the maximum possible tax bracket. “He’s in the same boat as the millionaire and has a whole lot less to enjoy,” Blue says.
This person’s primary objective, Blue says, should be to shelter some income from taxation. Because he earns $25,000, this person is eligible to contribute up to $2,000 annually to an IRA and deduct the full contribution from his taxable income. Blue says the $2,000 contribution, which also accumulates earnings on a tax-deferred basis, will save this person $660 in taxes come April 15.
The next step should be a home purchase. Because of income constraints, this person is probably going to need assistance coming up with a down payment, particularly in Southern California. Sharing home ownership with a good friend or relative is often a good approach for the first home purchase.
HAPPY-GO-YUPPIE COUPLE
Family status: Married couple, both full-time professionals. Both aged 32. One child. Renters.
Current income: $80,000
Future earning prospects: Far better than inflation.
Attitude toward risk: Willing to accept some risk, but want balanced portfolio.
Current assets: Automobiles worth $30,000; stocks worth $4,000; savings account of $3,000.
Investment goals: Buy a house and save for college education for one or more children.
Recommended Actions:
Make sure all insurance needs are met. This includes medical, as well as life, auto and disability, if not provided by employer.
Get on a firm budget. Trim spending, pay off credit cards. Start an aggressive savings program.
If stock holdings are not a part of an IRA, sell and put proceeds into a money market account or mutual funds.
Adviser’s comments:
Because they rent and have few deductions, this couple is in the top tax bracket and probably pays close to $27,000 of its $80,000 gross income in taxes. That doesn’t leave much left for savings, especially with high Southern California rents and child-care costs.
This couple’s top priority, Gau says, should be buying a house because it provides physical shelter and a tax shelter. Saving for sending Junior to college should be put on the back burner until the first goal is met.
To buy a house, this couple clearly must try to save more money. That means aggressively cutting spending on discretionary items such as eating out, expensive vacations, clothing and the like.
If possible, this couple should consider asking a family member for a loan to make a down payment. In addition, the couple should consider selling stock holdings and putting the proceeds into a money market fund or short-term certificate of deposit.
“When you’re saving to buy a house, you can’t afford to have your nest egg in something like stocks where the principal is at risk,” Gau says.
MIDDLE-CLASS, MIDDLE AMERICAN
Family status: Married couple, both aged 39. One full-time worker; one part-time worker. Two children, aged 8 and 12. Homeowners.
Current income: $60,000
Future earning prospects: Will keep pace with inflation but unlikely to exceed it.
Attitude toward risk: Not comfortable with much risk.
Current assets: Vested pension rights; $30,000 in mutual funds; $10,000 in money market fund; $10,000 certificate of deposit; $40,000 in home equity.
Investment goals: Save for children’s college education and couple’s retirement.
Recommended actions:
Except for home mortgage, pay off all consumer debt.
Check all insurance needs. As they get older, this is especially important.
Consider buying a universal life insurance policy to save for the children’s education.
Consider putting some assets into the children’s names.
When the certificate of deposit matures, put proceeds into zero coupon municipal bonds, a debt-free real estate limited partnership or even Series EE U.S. savings bonds.
Advisers’ Comments:
Saving has obviously been a priority for this couple, and they have amassed a tidy sum for their children’s college education and their retirement. But it’s time for them to get aggressive about increasing their nest egg, both Blue and Gau say.
Gau recommends buying a universal life insurance policy to help save for the children’s educations. This policy provides insurance coverage and pays a fixed interest rate close to the yield on long-term corporate bonds. The interest is tax deferred until withdrawn.
Gau and Blue recommend that each parent give up to $10,000 a year to each child tax-free. By transferring some assets they can lower their taxes because the rate children under 14 pay on the first $1,000 of investment income is lower than that paid by adults. (Income above $1,000 a year is taxed at the highest rate paid by the parents.)
Gau also recommends investing in a debt-free real estate limited partnership, so called because its properties are owned outright with no mortgage. Gau also recommends, to cut or defer taxes, zero coupon municipal bonds, which accumulate tax-free interest at regular intervals but don’t actually disburse it until maturity.
EMPTY NESTERS
Family status: Married couple, both aged 48. One full-time worker. Children have left home. Homeowners.
Current income: $40,000
Future earning prospects: Unlikely to keep pace with inflation.
Attitude toward risk: Not interested. Want safety.
Current assets: Vested pension rights; home equity of $90,000; savings of $15,000.
Investment goals: Live well for the present and prepare for retirement.
Recommended actions:
Both spouses should have full-time jobs outside the home and the earnings from the returning-to-work spouse should be earmarked exclusively for savings.
Check wills and all insurance policies for maximum coverage.
Consider refinancing the house and investing the proceeds in a small piece of rental real estate.
Leave the $15,000 of savings in the bank or a money market fund for potential emergencies.
Make sure life insurance on the principal wage earner is at least $400,000, enough to generate a monthly benefit of $3,000.
Advisers’ comments:
Gau couldn’t be more emphatic: “This couple is on a dead-end road to ruin unless they are both working full-time. I assume the wife stayed home to raise the children. But now that they’re on their own, she should get a job if they expect to have any money for retirement.”
Initially, Gau says, the wife’s earnings should be set aside in a savings account or money market fund. As the account grows, the couple should consider other, more sophisticated investments such as rental real estate.
Blue recommends that the couple refinance their house, pulling out $30,000 of their accumulated equity to buy the rental property. The refinancing will increase mortgage payments, which can be deducted on income taxes. Blue says a lower-priced “fixer-upper” will generate the fastest appreciation.
Whatever this couple does, Gau says, they must do it quickly. Gau estimates that at their present level of earnings, they would probably be eligible for Social Security and retirement benefits of $1,500 a month, less than half of what they are currently living on. “Unless they win the lottery, this couple is going to be in trouble unless they do something quickly,” Gau says.
THE WIDOW OR WIDOWER
Family status: Single retiree. Age 63. No children at home. Renter.
Current income: $20,000
Future earning prospects: Poor. Retirement benefits may not keep pace with inflation.
Attitude toward risk: Doesn’t want anything risky.
Current assets: Vested pension rights; stocks worth $15,000; savings of $25,000.
Investment goals: Secure retirement life and insulation from potential ravages of inflation.
Recommended actions:
Consider transferring stock holdings and savings to four separate, but equal, investments: $10,000 in an conservative bond and stock mutual fund; $10,000 in a utility stock mutual fund; $10,000 in a debt-free real estate partnership, and $10,000 in a savings account.
Advisers’ comments:
Unless this person pays an outrageously high amount to rent an apartment--a possibility in Southern California--both Blue and Gau believe that he or she is in pretty good shape. However, Gau wonders why the person does not have more in savings and other investments. He or she would have greater assets if the deceased partner had carried sufficient life insurance, he says, underscoring his belief that most Americans lack sufficient coverage.
But the $40,000 nest egg should be sufficient, if handled properly, Gau says. He recommends the conservative mutual fund for income and growth potential; the utility stock mutual fund for their higher-than-average dividends, and the simple savings account for emergencies. Gau says the debt-free real estate limited partnership, can provide an important hedge against inflation without the a great amount of risk.
