Case Study

Saving for Early Retirement

Saving for Early Retirement, Paying for College, and Paying Off the Mortgage Early

The following is a hypothetical financial planning scenario presented for illustrative purposes only. It should not be construed as an investment recommendation or solicitation. Please consult an advisor to discuss your individual situation prior to making any investment decision. The rates of return do not represent any actual investment and cannot be guaranteed. Any investment involves potential loss of principal.

Saving for early retirement was always in the back of his mind. At 42, Andrew worked in manufacturing earning a decent income. His first prudent financial decision was beginning his saving 20 years ago, taking advantage of the 410(k) plan offered by his employer. Consistently saving each month for that length of time netted him a respectable balance as he worked toward his ultimate goal of financial security for his family.

It was a valuable lesson after the loss of his father 2 years ago. His parents had exemplified the importance of saving. They prepared an inheritance for him when his father passed, knowing that it would help with their grandchildren’s college education.

Sarah also started with wise decisions. At 41, she forged a successful career in engineering, earning a respectable income for her family. She worked smart from the beginning, earning college scholarships while her parents paid for the remainder. She was fortunate to avoid the student loan debt that many are familiar with today.

Her dedication in her field resulted in promotions, recently earning a 15% raise – the second one in the last three years. This enabled her to contribute the maximum annual amount to her 401(k), albeit starting later than Andrew, still growing it to a respectable balance. Not to mention building up her Roth IRA and maxing out on those yearly contributions.

All in all, they were doing well. They had a sizeable checking and savings balance, and living all but mortgage debt-free left them with some financial freedom. When their children, Ethan and Mathew were born, they took the same prudent savings principles they grew up with and began a tax-advantaged savings account for education. They wanted the same financial self-sufficiency for their children.

Paying for College
The economy has changed and the cost of education has dramatically increased. 20 years ago Sarah only paid $6,000 a year for in-state tuition with room & board. Now those same expenses have risen to $16,000. In nine years when Ethan is ready to start college, it may cost them $25,000 to provide him with the same financial flexibility that Sarah was provided by her parents. It was important that they start working toward achieving their education funding goals.

Andrew and Sarah also had a lot of other goals for their future. They wanted to retire when Sarah turned 55, and didn’t want to count on Social Security as an income source. They also wanted to enjoy their golden years by traveling, taking a major trip every two years that would provide them every opportunity to explore the world around them. They estimated this would cost $20,000 per trip.

Finally, they wanted to have their mortgage paid off before they retired. Even with decades of wise decisions, prudent savings, and dedication to self-reliance, it was going to take some reprioritization to achieve their long-term financial goals.

When they reach retirement in 2030 they will need just over $2 million ($2,003,045) in retirement savings, including their travel budget. Currently, they are on track to have just over $1.5 million (assuming no increases in savings) at their assumed long-term annual rate of return of 7.5%.

They had only one goal purposefully covered – Ethan’s education. When Ethan reaches college in 2025 they will need and should have just shy of $94,000 ($93,644). When Mathew reaches college in 2028 they will need an additional $108,000 ($108,407).

Paying Off the Mortgage
It was time they brought in a Certified Financial Planner professional to help guide them. Here’s how their strategy breaks down:

Current Financial Summary:

  • After-tax Income: ~$12,000/month | $143,000/year
  • Living Expenses: ~$7,500/month | $89,500/year – including mortgage
  • Mortgage payment $1,800/month ($260,000 balance, just refinanced to 15-year loan @ 3%)
  • Checking / Savings balance: $135,000
  • Andrew 401(k) balance: $150,000
  • Sarah 401(k) balance: $120,000
  • Sarah Roth IRA balance: $46,000
  • Tax advantaged education savings account balance: $34,000
  • Andrew life insurance: $750,000, 20-year term, 16 years remaining
  • Sarah life insurance: $690,000 (6x annual pay), group term life insurance

After expenses, other saving, and taxes Andrew and Sarah are accumulating $2,000 per month in checking and savings after Sarah’s recent raise. Two years ago Andrew received a $70,000 cash inheritance when his father passed away.

Initial Solutions:

With their new additional income Andrew and Sarah have increased flexibility, but need to begin prioritizing their cash flow and assets according to their goals.

They are more than adequately covered for emergencies. A dual income family generally only needs to have three to six months of expenses available in checking and savings. If we take the conservative view of six months ($45,000), this frees up $90,000 to distribute to other goals (later).

They also appear to have adequate life insurance coverage. If either one of them died prematurely the survivor would be able to pay off the mortgage and fully fund their children’s education. This is their desired purpose of their life insurance.

It’s time for Andrew to commit to making the maximum contribution to his 401(k). The difference between his current annual contribution of $3,600 ($300 per month) and the $18,000 he can contribute amounts to an additional $200,000 in tax deferred savings between now and retirement. At their assumed rate of return this will net them over $335,000 and the contributions will also reduce their current taxable income.

With $2,000 per month / $24,000 per year being added to regular savings previously, this leaves another $9,600 annually that can be directed more effectively.

Andrew should also be taking advantage of a Roth IRA. The current maximum contribution of $5,500 per year will accumulate another $77,000 in tax free savings between now and retirement, adding over $128,000 to their retirement portfolio at their assumed rate of return.

Early Retirement
The remaining additional annual cash flow of $4,100 can then be directed towards their mortgage. This will permit them to apply an additional $342 to principal with every payment – shortening their mortgage to 12 years and 2 months – meeting their goal of paying off their mortgage prior to retirement (in 14 years).

The $90,000 freed up from their checking and savings (earlier), when invested and earning their assumed rate of return would accumulate to $214,360 when Mathew reaches college age. Since they only need $108,000 for Mathew’s education they can add $45,000 to their education account and the remaining $45,000 can be invested as a cushion for all of their goals. Now if they continue adding the $200 per month to their education fund as they do now, both education goals would be covered.

Prior annual cash flow:

In: $175,000 (payroll)
Out: $21,600 (401k)
Out: $32,000 (taxes)
Out: $5,500 (Sarah Roth IRA)
Out: $2,400 (education account)
Out: $24,000 (regular savings)
Out: $21,600 (mortgage)
Out: $67,900 (living expenses)

Initial solution annual cash flow:

In: $175,000 (payroll)
Out: $36,000 (401k)
Out:
$29,000 (taxes)
Out: $11,000 (Andrew and Sarah Roth IRA)
Out: $2,400 (education account)
Out: $3,000 (regular savings – result of tax savings on additional 401k contributions)
Out: $25,700 (mortgage)
Out: $67,900 (living expenses)

With their initial solution in place they are projected to accumulate just over $2 million for retirement and the $200,000 needed for education funding. While this is their bare minimum needed accumulation it does not take increases in savings amounts into account. More importantly however it illustrates the need for ongoing planning, re-analysis and resulting recommendations of ongoing strategies.

With this solution, they are on the right path to:

  • be adequately covered for emergency expenses
  • have adequate life insurance covering their needs and wants
  • be tracking smartly towards their retirement and education funding goals
  • reach their mortgage goal

The preceding is a hypothetical financial planning scenario presented for illustrative purposes only. It should not be construed as an investment recommendation or solicitation. Please consult an advisor to discuss your individual situation prior to making any investment decision. The rates of return do not represent any actual investment and cannot be guaranteed. Any investment involves potential loss of principal.

Jason Speciner
Jason Speciner
jspeciner@gmail.com

Jason Speciner is a CERTIFIED FINANCIAL PLANNER™ professional and an Enrolled Agent. Since 2004 he has served clients of all ages and backgrounds with unique experience working with members of generations X and Y. You can check the background of this investment professional on FINRA’s BrokerCheck and the SEC’s Investment Adviser Public Disclosure website.



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Minimums do not apply to inStream proactive financial planning as a stand-alone service.
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There is a minimum initial investment of $100,000 per Strategy:FOCO client household. This minimum can be met via transfer of existing accounts or with new funds. A client household may generally include accounts for a head of household, a significant other, dependents, and any controlled organizations or entities.

Minimums do not apply to inStream proactive financial planning as a stand-alone service.
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Assets Under ManagementFee as a % of AUM
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$250,000 - $499,9990.90%
$500,000 - $999,9990.80%
$1,000,000 - $1,999,9990.65%
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