The first order of business is to get organized. Although it appears that Marilyn and Ron have a financial cushion every month in their budget, Marilyn is not sure about the accuracy of that number, and is uncomfortable with their recordkeeping.
The couple should consider using one of the many financial software packages available to track their finances. I recommend they subscribe to either Quicken or Finicity.com and start using one of these online tools to monitor and plan their monthly income and expenditures. Commit to doing this for at least a year (and maybe forever). They will immediately feel better about their finances when they start tracking things regularly.
Next, the couple should see an attorney to draft the appropriate estate planning documents. These should include wills, living wills and powers of attorney. They also may want to consider trusts for the children and guardianships in the event something happens to both parents. These provisions may have added importance in post-divorce families as Marilyn and Ron may have some strong opinions about finances and guardianships if they predecease their children.
Insurance for worst-case scenariosLife insurance is primarily for income replacement and the most reasonable approach would be to buy level term coverage. Marilyn and Ron each currently have $50,000 of life insurance from their employers. Based on the number of years’ income they would like to protect, the value of their current investment portfolios and their future cash flow needs, the following amounts of additional coverage would not be unsuitable:
|•||Ron: $500,000||•||Marilyn: $300,000|
Also important: They should check the beneficiary provisions on all of their insurance and retirement plans and make sure that they are amended to reflect their current marriage. They certainly don’t want an ex-spouse named where they shouldn’t be!
Another important consideration is disability insurance. They should make sure they each have appropriate levels of disability income insurance, particularly long-term disability, which should kick in after a 30-day to 180-day waiting period. The amount of coverage should be at least 60 percent of their monthly income and continue to retirement age.
Establish a rainy day fund
As a rule of thumb, the couple should establish a cash reserve of $12,000 and an emergency fund of $24,000. The cash reserve should be in a checking, savings or money market account. The emergency fund should be invested in cash, CDs or short-term bond funds. The idea is for the cash reserve to be in easily accessible funds while the emergency reserve earns a little higher return in relatively safe investments (not stocks or stock funds), and yet be accessible if necessary. It’s OK if it takes six months to a year to build up the emergency funds — just get started on it now.
Prioritize and tackle debts
Marilyn ad Ron have three credit cards with interest rates that range from 3.9 percent to 9.9 percent. These relatively low rates reflect their disciplined approach to paying bills.
If the 3.9 percent rate is fixed, they should transfer the balances on the other two cards to the card with the lowest rate. At the very least, they should work on paying the balance off on the highest rate card first, and then work their way down to the card with the lowest rate. They should try to pay off this credit card debt within the next 15 months, as Marilyn’s school loan payments will start at that time.
The good news is that there is some discretionary cash flow in their monthly budget, so they should be able to accomplish this while building a cash reserve as recommended earlier. One of the auto loans will be paid off shortly thereafter, so the extra cash flow at that point will help with her student loan repayments.
Marilyn’s student loans will amount to approximately $35,000 and she will begin paying on these loans when she finishes her master’s degree. It appears that she is already participating in the federal Stafford and Perkins loan programs, which offer the best rates among student loans. In addition, she may qualify for having some or all of the loans forgiven under new guidelines issued by the federal government for persons employed by public or nonprofit children- or family-service agencies. If she does not qualify for these programs, she will want to make sure she consolidates her loans to the program with the lowest interest rate.
The couple also faces a decision about housing; Marilyn is concerned about owning two homes. They currently have their marital home as well as her previous home, which is in an area where she could experience a serious loss in value if she sells now. They think they can rent this home for the time being and at least break even. There is a small line of credit on the home at 7.5 percent interest. They should work with their lender to see if they can lock in at a lower rate on the home equity loan, but it doesn’t appear to be significant debt as long as the home doesn’t stay vacant.
Plan for retirement
Marilyn and Ron have pretty aggressive retirement goals, as they want to be able to retire in 12 to 15 years. Since they each currently contribute 10 percent of their pay to their (Public Employee Pension) retirement plans, they should each evaluate the following:
- What their expected annual pension benefit will be at their anticipated retirement age.
- The difference in this benefit if they elect a Single Life pension or a Joint Life pension.
- Estimate what their desired income is in today’s dollars.
- Determine the funding gap, if any.
If there is a gap between their anticipated pension income and their budgetary needs, a plan should be developed to fund that gap. My rough analysis shows that there may indeed be a need to save and invest more for retirement.
That said, their immediate concern should be their credit card debt, followed by auto loans, the home equity loan and then the educational loans. The educational loan debt should be the least concern based on the potential for loan forgiveness and the preferential interest rate on the debt.
Education for the children
Marilyn expressed interest in assisting some of their children through college. Based on their ages, this could begin in three years and last for 10 years. I would take a “wait-and-see” approach on the college funding for the children, as Marilyn and Ron should focus on their own short-term finances first and then make sure they have fully funded their retirements. Then they can consider additional expenditures for college educations. It won’t be a tragedy for the children to carry some college loans themselves, as education is a worthy investment and they’ll have youth on their side when paying off the loans. It’s not possible to borrow for retirement, but it is more practical to borrow for education.
- See an attorney to draft will, living wills, powers of attorney.
- Consider setting up trusts for the children.
- Appoint guardianships for the children.
- Check beneficiary provisions on retirement plans.
- Check beneficiary provisions on life insurance.
Tip: As a preventive measure, read about the 7 ways you can accidentally disinherit your children.
2) Assess risk exposure
- Get adequate life insurance protection.
- Select a level term policy to contain costs.
- Purchase long-term disability insurance.
- Disability coverage should extend to retirement.
- Recommended cash reserve: $12,000.
- Start saving in $24,000 emergency fund.
- Invest emergency fund in CDs, short-term bonds.
Tip: Not sure why you need an emergency fund? Check out our guide on Creating an emergency fund.4) Prioritize debts
- Transfer balances from higher-interest credit cards.
- Pay off credit cards within 15 months.
- Next, pay off auto loans.
- Charge rent for second home that covers equity loan.
- Student loans may qualify for loan forgiveness.
- If student loans don’t qualify, consolidate.
Tools: Eradicate debt with Bankrate’s Debt-tackling tool kit.5) Implement long-term savings
- Calculate future retirement income needs.
- Determine funding gap, if any.
- Save more for retirement if necessary.
- College funding may have to wait.
Tip: Bankrate’s Retirement road map offers some direction.