Agent for Change
Carl Garvin has helped thousands of his insurance clients prepare for unforeseen setbacks. But while helping to secure the financial futures of others, Garvin has, ironically, failed to do much emergency planning of his own.
Inadequate life insurance and a lack of disability insurance could endanger the financial security of Garvin’s family, said Delia Fernandez, a Los Alamitos-based fee-only financial planner who reviewed the Garvins’ finances for The Times.
“When it comes to making financial plans, you’ve got to consider the worst-case scenario and protect yourself,” Fernandez warned. “The way it is now, if something happens to Carl, the whole family is at risk.”
Before meeting with Fernandez, Carl and Lynne Garvin were focused on other financial issues--paying off their mortgage early on their Thousand Oaks home, saving for their children’s education and arranging an early retirement.
“I’ve seen people who have retired only when they become sick and can’t really enjoy their retirement,” said Carl, who just turned 40. “I don’t want that to happen to me.”
Fernandez said the Garvins have a good start toward their goals. The couple expect to earn about $88,000 this year. They have a net worth of about $130,000, spread among savings, retirement accounts and equity in their home.
But the first order of business is insurance.
Carl has $250,000 worth of life insurance, but Fernandez says that’s too little for someone who earns more than 90% of the income for a five-member family.
How much more they need depends on “many personal things, such as if Lynne would be expected to return to full-time work if something happened to Carl,” the planner said. But $1 million worth of life insurance would not be an unreasonable amount for someone like Carl.
Although he has no disability insurance, Carl says he has an understanding with his brother, with whom he runs the insurance agency. “If one of us gets sick, the other could pick up the slack for a while,” allowing both to draw a regular salary.
Fernandez questioned that arrangement. She said it probably would work fine if Carl is off work for a few weeks with a broken leg. But, she asked, is it fair to his brother, even if he were willing, to require him to pick up the slack for a disability that might last years? And could he support Carl’s family indefinitely if Carl had a lifetime disability?
Although such a grim scenario is unlikely, it does happen. “You might be healthy and careful, but you never know about that idiot driving the other car,” Fernandez said.
In addition to increasing their insurance, Fernandez urged the Garvins to prepare a will naming guardians for their children.
After handling those immediate issues, Fernandez said, the couple should turn their focus to their savings. She believes they can achieve at least two of their three goals, as long as they save aggressively and don’t change their spending habits.
The couple have never devoted much time to planning their finances--they are more likely to be reading “Goodnight Moon” to their three young sons than leafing through the financial pages.
“Up to now, we’ve just been sitting on our money,” said Lynne. The Garvins have about $70,000 saved, but half of that earns very little return in a low-interest checking account. Simply moving most of that money to a higher-interest-bearing account could boost the return by $1,000 a year or more.
“I think we’re more unaware about where to put our money than we are cautious,” explained Lynne, who earns about $4,000 a year as an aerobics instructor. “Now we know it’s time to do some serious planning and become more aggressive. I know our goals are very high, but we’re willing to do almost anything to attain them.”
Actually, the Garvins have already made two key wise moves:
* They reduced their housing costs by converting first and second home mortgages, with interest rates of 8.25% and 11%, into a single 30-year fixed loan with a 7.5% interest rate. The couple owe $194,000 on their home, which they estimate is worth about $250,000.
* They have already saved $33,000 in their retirement plans, even as they’ve had the expenses of starting a family.
Carl has about $20,000 in a simplified employee pension (SEP) plan, a tax-deferred account designed for small-business owners. Lynne has a $13,000 individual retirement account created with 401(k) plan money she saved while working as a medical technician before their twins were born.
Fernandez calls Carl’s SEP the key to the Garvins’ retirement planning, because it allows him to set aside up to 15% of his income. Also, a SEP is as easy to set up as an IRA and thus involves much less paperwork than other retirement options.
To calculate their retirement needs, Fernandez estimated that the Garvins will live into their 90s, since many members of both their families have enjoyed long lives.
The Garvins have no exact amount in mind for how much they will need when they retire. But they say they have no expensive hobbies and do not envision a retirement filled with jaunts around the globe. “We’re basically homebodies,” Lynne said.
They estimate that they could live on $45,000 a year, about 90% of last year’s income. (Carl’s income has increased this year because his father has retired from the family insurance business.)
Carl said he’d like to retire in 18 years, at around age 58, but Fernandez said the Garvins would have to set aside about $17,000 annually to save enough to comfortably meet that goal.
A more realistic plan, she suggests, is for Carl to work a few extra years. Just two years more--waiting until he is 60--would reduce the savings required to a more modest $13,000 a year. Plus, Carl would then be closer to the minimum age of 62 to start drawing Social Security, which will make up an important part of his retirement money. Even then, Fernandez is assuming that the Garvins’ savings will grow at an average annual rate of 10%, which of course is not guaranteed.
To get going, Fernandez suggests that the Garvins put the maximum allowable amount into Carl’s SEP, possibly about $13,000 this year.
They should set up a pair of Roth individual retirement accounts and invest at least $1,500 annually in both of them.
Fernandez recommends investing their IRA and SEP retirement funds in a diversified, no-load mutual fund, such as the Vanguard LifeStrategy Growth (three-year average annual return: 20.96%). The fund uses a mix of other Vanguard index funds to achieve long-term capital growth. The fund is designed to reflect the overall performance of the stock and bond markets.
Carl and Lynne knew that an early retirement would not be cheap, but the need to save more than $1,000 a month to do it was a surprise. “The amount is a little higher than we expected,” Carl acknowledges.
The couple could make adjustments in their savings and their plans as time passes. For example, if Carl were to work part time for some years, there would be less financial pressure. And, of course, their retirement savings will depend on how much they contribute to their children’s college funds.
They have established college accounts for each of their three boys, with about $1,500 in each.
The Garvins’ twins, now 5, are 13 years away from college age, so it’s impossible to know if they are bound for technical school, junior college, a state school or a pricey private school.
“I don’t think we’ll be thinking about the most expensive school,” Carl said. “I went to USC for one year, but I think I got a better education when I transferred to Cal Poly San Luis Obispo, which was much cheaper.”
As a rough estimate, Fernandez budgets an $8,000 contribution, in today’s dollars, for each child for each year they are in school. Although probably not enough by itself, grants, part-time jobs, scholarships and loans can be expected to add to that.
Her estimate would require the couple to start saving about $4,000 a year for college. Fernandez suggests investing the maximum $500 per year per child in education IRAs, which allow funds to grow and be withdrawn tax-free. She suggests using the Scudder Growth & Income Fund (three-year average annual return: 26.45%). Scudder is among the companies that do not charge maintenance fees on such accounts.
The rest of the college savings should be invested--in the parents’ names--in a growth-oriented mutual fund, possibly the Vanguard LifeStrategy Growth fund.
With those things out of the way, Fernandez addresses another goal of the Garvins, one that she thinks is a bad idea: paying off the mortgage early.
“You are only paying 7.5% on that loan, and when you factor in the tax deductions, the money is only costing you around 5%, which is pretty cheap,” she said. To pay the mortgage off a decade early, the Garvins would have to add another $200 to their $1,356 monthly payment.
“Psychologically, the thought of paying the mortgage off early is very appealing,” Carl said.
Nevertheless, Fernandez said, it needs to be weighed against other needs.
By paying for the extra insurance, the will, this year’s SEP and IRAs, the Garvins would spend about $20,000 of their savings. That leaves about $15,000--an appropriate sum, Fernandez suggests--for an “emergency fund.” But rather than parking that money in a checking account, she suggests putting all but $2,000 in a money market account, most of which are currently paying about 5% interest.
Naturally, the Garvins are concerned about being able to afford both college for the children and their own retirement plans, even with Carl’s higher income. “We’ll have to see how much we can do,” Carl said. “Even if we’re not able to do it all, we’ll do some.”
Fernandez understands. “The important thing is to get in the savings mode and do what you can,” she told the couple. “You’ve got a good start and a good income to work with. Don’t give up if you can’t do everything. Just do as much as you can.”
Graham Witherall is a regular contributor to The Times. To participate in a published Money Make-Over, send your name, age, phone number, income, assets and financial goals to Money Make-Over, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053. We cannot respond to all inquiries.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Meet the Planner
Delia Fernandez is a fee-only planner and owner of Fernandez Financial Advisory in Los Alamitos. She has 21 years of experience in the financial services industry and teaches in the UC Irvine Extension personal financial planning certificate program.
* Investors: Carl and Lynne Garvin
* Income: About $88,000
* Goals: Early retirement, contributions toward children’s college education
* The problem: Unfamiliar with investment options and unsure how to reach goals
* The plan: Use all expected additional income for tax-deferred and regular savings -- but first buy more life and disability insurance.
This Week’s Make-Over
* Investors: Carl and Lynne Garvin
* Income: About $88,000
* Goals: Early retirement, save for children’s college education, pay off mortgage early.
* Home equity: $56,000
* Checking account: $35,000
* Retirement accounts: For Lynne, $13,000 IRA invested in Putnam New Opportunities stock fund; Carl’s $20,000 SEP retirement fund is divided among American Mutual Fund, American World Growth and Income Fund and American U.S. Government Securities Fund.
*Children’s college accounts: $4,500
* Prepare a will.
* Buy more life and disability insurance.
* Put most--or all--of any increase in income toward retirement and college goals.
* Don’t pay off mortgage early.
Recommended Mutual Fund Purchases
* Scudder Growth and Income (800) 225-2470
* Vanguard LifeStrategy Growth (800) 662-7447