Letter Carrier Who Loves Investing Needs to Address His Debts First

As a letter carrier for the U.S. Postal Service, Charles Reed walks about five miles a day in Inglewood, where he delivers mail. Sometimes there are obstacles in his path, such as uneven pavement, hidden sprinkler heads, slippery porches, locked gates and--yes, even a few snarling dogs.

His job gives him a comfortable annual income of about $42,000, free life insurance and access to retirement benefits. Reed has worked for the Postal Service for 13 years and will be eligible to receive payments from Social Security as well as a pension.

In addition, Reed, 35, wants to have money for early retirement and contributes the maximum allowed--10% of his pretax income--to his employer’s tax-deferred savings plan. Reed now has about $62,000 in a plan mutual fund that mimics the performance of the Standard & Poor’s 500 index.

Earlier, he invested in much more conservative choices of cash and government bond funds.

“I toggled with it over the years,” said Reed, who relishes learning about investments in hopes that he can retire at age 56. However, he finds the road to prudent money management much more circuitous than his daily mail route. A few poor choices created detours, the worst of which occurred in 1988, when he filed for personal bankruptcy to shed $15,000 of debt.

Reed has turned around his personal finances since then and become a disciplined saver, but the lifelong bachelor still faces a few hurdles.

Lisa A. Chapman, a certified financial planner in Long Beach who reviewed Reed’s finances at The Times’ request, said the letter carrier has great instincts. However, Reed is not paying enough attention to some immediate money matters, particularly credit card debt and a pending increase in mortgage payments.

His credit card bills have crept up to $4,800, or nearly one-third of what landed Reed in bankruptcy court 12 years ago. Yet at the same time, he is contributing nearly $500 a month to his various retirement accounts and $150 a month to other stock and stock mutual fund investments.

“It’s better to get your debt paid off and get money in the bank. If you’re paying 21% in interest on those credit cards, you need to earn more than that from your investments,” Chapman said. “I’d like to see you have cash saved for emergencies.”

Reed acknowledged that such advice might have kept him out of trouble in 1994, the year he bought a house and rented out his condominium. When his tenant couldn’t pay the rent, Reed had no cash cushion to take the hit and he lost both properties to foreclosure. “I’ve heard I should keep cash on hand for emergencies, but doing it is the hard part,” Reed said. “I’d rather invest.”

Chapman agreed that investing is more fun and glamorous than paying bills and establishing a cash reserve, but she urged Reed to retrain his thinking and start recording his routine expenses. “Money tends to evaporate,” Chapman said. “It will take you a year or two to pay off that debt. Cash is power.” She also alerted Reed to the risk of a third foreclosure--on his current home: a three-bedroom, one-bath house in Long Beach.

Reed’s first mortgage, now totaling $103,900, is scheduled to jump next year from a fixed, 8.125% interest rate to an adjustable rate of 11.125%. Chapman is concerned that Reed may not be able to afford an increase in his monthly payment from $771 to $991. There’s also a smaller second mortgage, charging 12.125%, that costs $290 a month.

“I knew the mortgage could possibly go up. I didn’t know I would have such a hit,” Reed said. “This is one of life’s lessons.”

Chapman referred Reed to a mortgage broker and consultant, Cecil J. Session of Rowland Heights, who is helping research the possibility of refinancing the two loans. By combining the first and second mortgages, Reed could reduce his monthly payments and perhaps avoid next year’s costly rate increase in the first mortgage.

However, there are some complications. Reed must wait until next year to refinance to dodge a prepayment penalty on the second mortgage, which totals $25,250. Moreover, his two foreclosures might make Reed ineligible for low-interest refinancing, Session said. She said Reed may have to wait until late 2002 for his record to clear because foreclosures typically stay on a credit record for at least four years. Finally, the rules of his two mortgages may make refinancing difficult.

If refinancing were to prove impossible or next year’s mortgage payment were to increase too much, Chapman said, Reed would need to take steps to avoid losing the house. But he is determined to keep it: “I have my savings that I can tap if needed; and if push comes to shove, I’ll just get a second job.”

Making higher mortgage payments would delay his other goals of paying off debt and saving for retirement, so Reed might consider getting a roommate temporarily to cover the mortgage increase, Session said.

“This happens a lot more than you think,” Chapman said, noting that many buyers do not completely understand that certain mortgage loan terms can raise the risk of foreclosure.

Another misstep Chapman noticed while reviewing Reed’s financial documents was that he had failed to report the conversion of his traditional individual retirement account to a Roth--a taxable event.

So Chapman referred Reed to Mark G. Maughan, a certified public accountant in Fountain Valley, to help correct that omission. Fortunately, the amended returns Maughan filed do not require Reed to pay substantially more tax.

Although Reed had hired a tax preparer to file his 1998 return, that preparer may not have specifically asked about Roth conversions, Maughan said. And many individuals “may not know how to report the transaction properly on their tax returns,” he said.

Other than the reporting problem, rolling over the retirement savings from a traditional IRA to a Roth was a smart move, Chapman said.

In traditional IRAs, contributions may be tax deductible, but withdrawals at retirement are taxed as ordinary income. In contrast, contributions to Roths are not tax deductible, but withdrawals are not taxed. Funds rolled from a traditional IRA to a Roth IRA must be reported as income.

Although there is some debate about Roth conversions, Chapman says she is convinced that investors will come out ahead with Roths in the long run. “I’m all behind the conversions--100%,” she said, stressing that the tax-free status of Roth withdrawals in retirement provides more income to retirees. “One myth about retirement is you spend less money after you retire. Another myth is you’re in a lower tax bracket.”

Finally, Chapman noted that Reed should evaluate whether he needs his $250,000 term life policy, which costs $390 a year. He already has $80,000 in free coverage from work. Given that he has no dependents, Chapman said, Reed may want to drop the extra policy so he can apply the premium to his credit card bills. “The sooner you pay your debt off, the sooner you can invest” more, Chapman said.

Reed agreed to focus on removing the roadblocks of extra expenses to pave the way toward his ultimate goal--early retirement.

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Suzy Hagstrom is a regular contributor to The Times. To be considered for 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 or to money@latimes.com. You can save a step and print or download the questionnaire at https://www.latimes.com/makeoverform.

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Information on choosing a financial planner is available at The Times’ Web site at https://www.latimes.com/finplan. The site offers stories, phone numbers, addresses and links to related sites.

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This Week’s Make-Over

* Investor: Charles Reed, 35, postal worker

* Gross annual income: About $42,000

* Goals: Retire at age 56 and learn more about investments and money management

Current Portfolio

* Checking account: About $1,800

* Retirement accounts: About $62,000 in employer retirement savings plan, invested in the Vanguard 500 index fund. Two Roth individual retirement accounts, with $4,300 invested in Janus Worldwide Fund and $3,200 in Vanguard Total Stock Market Index

* Other investments: $1,420 in Munder NetNet fund, $450 in T. Rowe Price Science & Technology fund and $1,000 in General Electric Co. stock

* Real estate: A three-bedroom home with no equity

* Debt: A first mortgage loan of $103,900, a second mortgage loan of $25,250 and about $4,800 in credit card bills

Recommendations

* Temporarily stop investing in mutual funds that are in non-retirement accounts until the credit card debt is paid.

* Refinance the mortgages when possible.

* Establish an emergency savings account representing three to six months of routine expenses--$7,000 to $13,000.

* Consider canceling $250,000, 20-year term life policy. Reed is single and already has $80,000 in such coverage provided free by his employer.

* Diversify retirement account in October, when the U.S. Postal Service adds international and small stock mutual funds as choices.

* Continue contributing $2,000 a year to the Roth IRAs and maximizing contributions to employer plan.

* Draft a will and medical and financial powers of attorney.

Meet the Experts

Lisa A. Chapman, right, is a certified financial planner for PaineWebber Inc. in Long Beach, paid generally by commissions. As a senior vice president of investments and a retirement planning consultant, Chapman trains stockbrokers and conducts workshops at Fortune 500 companies.

Mark G. Maughan is a certified public accountant. He is a partner of Brown & Maughan, which has offices in Rolling Hills Estates and Fountain Valley.

Cecil J. Session is president of Loans Et Cetera in Rowland Heights, a mortgage brokerage she helped start in 1989.