Politico’s Set-Aside Plan Balances Budget

Conrado Terrazas knows penny-pinching can bring a payoff.

Through frugal living, the professional community organizer has managed to pay off $45,000 in school and credit card debt in just a few years. Now, at age 42, he’s putting aside almost 30% of his net pay for his next goal: retiring to the culturally rich capital of Mexico, a place he loves for its vibrancy and already considers a second home.

“Even though I was born here and my career and family are here, I’m Mexican American and I feel drawn to the people and history of Mexico,” he said.

But Terrazas, whose annual income is $41,000, wanted advice on how to manage his money so that in 25 years or so, he’ll be able to settle comfortably in Mexico City. So far, his nest egg is modest--$5,700 in a certificate of deposit and $10,000 in his city of Los Angeles pension program.

Terrazas is on the right path, with his biggest asset being his willingness to live simply, said Dale A. Walters, a fee-only certified financial planner in Phoenix whose firm specializes in cross-border planning.

But Terrazas will continue to need to make choices. He’s been mulling the idea of buying a house in his neighborhood, Echo Park, within a few years, but he’ll probably have to forgo that plan to see his retirement dream come true, Walters said.

By sticking to a strict budget, Terrazas has begun saving at least $680 of the $2,524 he takes home each month working for City Councilwoman Jackie Goldberg.

The words “strict budget” may be synonymous with “painful sacrifice” to a lot of folks, but not to Terrazas, who has devised a nine-page plan listing a weekly breakdown of expected expenditures and savings through 2000. He’s just never been a big spender, he says.

“There aren’t too many people I’ve seen who have a budget like this,” Walters said. The planner added that he’s had many clients who, like Terrazas, “weren’t great income producers, but scrimped on certain areas and now have the same amount of money as people who made a lot of money but lived extravagantly.”

Personal Satisfaction, Not the Big Bucks

Each month, Terrazas spends $585 on rent, $240 on food, $135 on phone and other utility bills, $240 on entertainment, $5 toward paying off a $3,400 no-interest school loan and $275 on miscellaneous purchases. He also puts aside something every month for the $3,000 he spends each year on two Mexican vacations. Everything else goes into the bank.

“I’ve always been pretty frugal,” he said, “but I still take vacations, buy clothes and go out and enjoy myself, so I don’t feel deprived.”

But that’s now. Terrazas had pared his standard of living to the bare minimum, as he eliminated his interest-accruing debts as quickly as possible. For four years, he treated himself to only one vacation, rarely bought clothes, lived in small places or with roommates and hardly ever went out for entertainment. In that time, he paid off $32,000 borrowed to pursue master’s programs at Yale’s School of Organization and Management, which he completed in 1988, and USC’s School of Cinema-Television, which he completed in 1991. He also paid off the $13,000 he had racked up on his credit cards to cover his living expenses while he was in school.

Now free of all debt that charges interest, he’s turning his attention to, first, building a retirement fund, and second, possibly buying a home in Echo Park. He also will need a car when his job ends in 2001, when Goldberg completes her final term. (The city now provides him with a car and pays for its upkeep and insurance.)

If Terrazas continues his high level of savings and invests his money well, he should have enough to take care of his highest priorities--buying a car and being on track for a comfortable retirement. And if that means staying a renter, Terrazas doesn’t mind.

“Personally, I think you have your goals in the right order,” Walters said.

Indeed, Terrazas is willing to make the trade-offs that come with pursuing a career path that may not be particularly remunerative but that he is passionate about.

“I would like to make more money, but my sole goal is not to make lots of money,” said Terrazas, who in the ‘70s and ‘80s organized farm workers, rent-control and crime-prevention programs. He also has served as co-chair of Gay and Lesbian Latinos Unidos since 1994.

“I’m looking for personal satisfaction,” he emphasized.

After receiving his master’s from USC, Terrazas worked in entertainment development for Fox Broadcasting and Disney, but he was drawn back to politics in 1993, when he ran unsuccessfully for the Los Angeles City Council. He then worked on various political campaigns before joining Goldberg’s staff in July 1994.

After Goldberg’s term ends, Terrazas may pursue one of three options: going into business for himself as a political consultant, running for Goldberg’s seat or returning to the entertainment industry.

Given the uncertainty of Terrazas’ employment situation--and also the fact that it typically takes some time for a consultant to build a full clientele--the first order of business is to set up an easily accessible emergency fund.

His certificate of deposit matures next month. Walters recommended setting aside at least $4,500 of that, or three months’ living expenses, as an emergency fund and putting it in a money market account.

Because emergency money is for unexpected expenses, the planner explained, it would be better to have it in an instrument that’s more liquid than a CD.

Building a Nest Egg for Mexico City

Next, Walters turned to the matter of investing for retirement. For most younger people, planning for so distant an event involves some degree of guesswork, and that’s especially true for Terrazas. But Walters sketched out a scenario that Terrazas could work from based on their best estimates of the savings and income Terrazas might have in 25 years’ time.

First, there’s the issue of living expenses. Here Terrazas might get a break.

U.S. expatriate Loujean LaMalfa, who owns a real estate development company in Puerto Vallarta and for a time put out a publication for people who are interested in retiring in Mexico, says Mexico City’s cost of living is far lower than that of Los Angeles. Housing, food, health care, entertainment, transportation, services such as housekeeping and gardening--all are cheaper, some much more so. She noted, though, that the large influx of Americans has made the cost difference less dramatic than it was, say, a decade ago.

Walters warned Terrazas that Mexico City is known for its high crime, but it would take more than that to dissuade Terrazas--such as a partner who doesn’t share his golden-years dream. “If I do fall in love, obviously that could affect my retirement plans,” he said.

In laying out a retirement-investment strategy for Terrazas, the planner noted that given Terrazas’ bent for thrift, he’d estimate that Terrazas would need a retirement income of about 70% of his current gross pay, or about $2,400 a month in today’s dollars. Assuming inflation will average about 4% a year, Terrazas would need a retirement income of $6,400 a month in 25 years.

Thus Terrazas should aim to have roughly $436,000 in retirement savings by age 67. On that amount, he could expect to draw about $2,900 a month in income without substantially affecting the principal, again assuming an 8% return, the planner said. Terrazas can expect to draw Social Security, so that and investment income combined would bring him close to his retirement income target.

Now to how he would get there. Assuming he’ll leave city employment in three years and reinvests pension savings of $17,500 at an 8% annualized return, that pot would be worth roughly $120,000 by the time Terrazas plans to retire.

Weighing Retirement Against Real Estate

If Terrazas starts his own business, the planner encouraged him to contribute to a Simplified Employee Pension plan, a tax-deferred retirement account for the self-employed commonly known as a SEP-IRA. On contributions of $2,300 a year returning 8%, Terrazas could expect to have more than $168,000 saved in 25 years, Walters said. And if Terrazas gets another job, he should contribute at least that much each year to that employer’s tax-deferred retirement savings plan.

Walters also suggested that Terrazas open a Roth IRA and contribute the maximum $2,000 a year to that. A Roth, besides allowing savings to grow tax-deferred, as other IRAs do, has the added benefit of being exempt from taxes on distributions taken in retirement.

Walters suggested that Terrazas’ Roth funds be directed at least initially to Vanguard STAR (five-year average annual return: 12.16%), a balanced mutual fund that invests in other Vanguard domestic stock and bond funds. Again assuming an 8% annualized return, that account would be expected to grow to $146,000 by 2023.

Normally, Walters would recommend that a client take advantage of his current workplace retirement savings plan. Terrazas is eligible to contribute to a Section 457 plan through the city of Los Angeles, but he has been thinking that he might be better off saving on his own since he expects to leave his job in three years.

Walters agreed that for Terrazas, this is the right course.

“The plan would very much tie you down and restrict your choices,” Walters said. Unlike a 401(k), investors can’t roll the money over into an IRA after leaving their jobs. “The money is stuck in the plan until you retire.”

After leaving city employment, Terrazas’ only other options would be to transfer the funds to another 457 plan (assuming he’d have a 457 in a subsequent employment situation--a big assumption) or to begin taking distributions, which would be taxable.

Also arguing against a 457 now, the planner said, is that many of the investment choices offered through Terrazas’ plan have high expenses, and Terrazas would be subject to surrender charges. (It should be noted that Terrazas can roll his pension money over into an IRA if and when he leaves city employment. If Terrazas does that, the planner advises splitting the money between a large-cap stock fund with a value investing style and a bond fund.)

In more immediate matters, Walters recommended that Terrazas start saving about $300 a month for a car. Assuming he can earn returns of 5% annually here, Terrazas would have more than $11,000 to buy a used vehicle in three years, Walters said.

He added that savings not intended for retirement--earmarked for the car, insurance, business start-up costs or campaign expenses--be kept in a money market account rather than invested in the stock market because Terrazas knows he will need the money within three years.

“If you jump into the stock market, you may not have enough money when it comes time to buy a car, considering the volatility of the stock and bond market,” Walters said. “If you were looking to buy a car in five years or more, it would probably be different.”

What about buying a home, then?

Based on his current income, Terrazas would qualify for a mortgage of about $100,000, Walters said. As of July, however, the median sales price for homes in Echo Park was $175,000, according to Acxiom/Dataquick Information Systems. Clearly, buying a home would mean saving much less for retirement--not a sacrifice Terrazas would be willing to make for something he’s not entirely sure he wants.

“I would like to have a home because I’ve been told it would benefit me tax-wise and would also build equity,” he said. “But it’s not my main priority, and I’m a little afraid of the responsibility.

“My main concern is retirement, and now I feel I can actually do it.”

*

Diane Seo 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. Questions or comments can be left at (213) 237-7288. We cannot respond to all inquiries.

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(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

The Situation

* Investor: Conrado Terrazas, 42

* Gross annual income: $41,000

* Financial goals: Save for retirement in Mexico, a car and perhaps a down payment on a home

* The problem: Unpredictable work life could make setting priorities difficult.

* In his favor: Fortunately, Terrazas knows what he wants and is comfortable making choices.

This Week’s Make-Over

* Investor: Conrado Terrazas, 42

* Occupation: Community organizer

* Gross annual income: $41,000

* Financial goals: Save for retirement in Mexico, a car and perhaps a down payment on a home

Current Portfolio

* Retirement account: $10,000 in employer pension program

* Cash: $5,700 in certificate of deposit

* Debt: $3,400 in interest-free education loan

Recommendations

* When CD matures next month, set aside $4,500 in a money market mutual fund to be kept as an emergency fund.

* Because so much of Terrazas’ life is up in the air, new non-retirement savings, such as for a car, should be kept easily available in a money market account.

* Open a Roth IRA and contribute the maximum allowed every year; invest the money in a balanced mutual fund. If Terrazas starts his own business, he should contribute $2,300 annually to a SEP-IRA. If he gets another job, Terrazas should contribute the maximum to that employer’s tax-deferred retirement plan.

* Terrazas can’t stay on track with his retirement savings and save to buy a Los Angeles home at the same time. Therefore, he should not plan to buy real estate soon unless his income increases significantly or he buys with a partner.

Recommended Mutual Fund Purchase

* Vanguard STAR: (800) 992-8845

Meet The Planner

Dale A. Walters is a certified public accountant and a fee-only certified financial planner at Keats, Connelly & Associates in Phoenix. He is president of the Institute of Certified Financial Planners in Phoenix.