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Living on a Budget
AARP The Magazine, May 2010
Judy and Hiro have nine kids.
Their retirement savings are lagging.
And they've made some costly investments.
Judy and Hiro Seki will tell you that raising nine kids is not as hard as it looks. "Actually," says Judy, 58, "it got easier as we went along, because our kids took care of one another, and they always had companions to keep them busy." Togetherness was also a plus when it came to the family business, a photography studio that the couple started in their San Gabriel, California, home almost 30 years ago. "We did weddings on weekends and portraits in our den, and we taught the kids to hush when the phone rang so we would sound professional to prospective customers."
Hiro, 62, who studied photography in his native Japan before he came to the U.S. at age 24, was the camera artist. Judy—who met Hiro in 1973, when she was helping Japanese students in Los Angeles practice their English—managed the venture, as well as family finances. In 1989 the prospering business moved to a storefront, but family solidarity continued. "The little ones took out the trash or stuffed envelopes. The older ones answered the phone or greeted customers. Sometimes people mistook us for a day-care center," says Judy.
But times have changed. The Seki nest is emptying. Seven offspring—Taichi, 30; Yamato, 29; Miriam, 27; Taiyo, 26; Angela, 23; Kenta, 22; and Masato, 20—have moved out. The photography business has changed as well. Judy and Hiro gradually realized that, to compete in the digital age, they would have to upgrade with expensive new equipment. That idea didn't appeal to them, so in 2007 they closed the studio, though they maintain the corporation, and Hiro expects to earn about $5,000 this year from occasional jobs for loyal customers.
A man who loves drawing even more than photography, Hiro turned to creating children's books. He has written and illustrated two on traditional themes in Japanese culture. The first, The Tale of the Lucky Cat, for which he received a flat $5,000 for publishing rights, is based on a folk tale about a toy maker who cares for a dying cat. For the second book, The Last Kappa of Old Japan, due out next year, he received a $1,000 advance on royalties. "I always wanted to be a painter," says Hiro, "but my father thought it was risky and that photography would give me a steady income. Now I'm doing what I love, but I don't know if it will ever really pay."
Judy had already embarked on a second career. Since 2005 she has been teaching math, English, drama, and entrepreneurship at Soledad Enrichment Action Girls Academy, a charter high school for at-risk kids. She earns $72,000 a year plus generous health and pension benefits from the job. She also picks up a little extra as an on-demand notary and church organist.
With a net worth of about $600,000—most of it in their home—the Sekis can achieve a reasonably secure retirement, says Rick Mayes of Mayes Financial Planning in Carlsbad, California, but they need to save as much as possible over the next eight years and, after a few investing missteps, they should watch out for any new potholes on the road to success.
They're Behind on Saving
Hiro and Judy have some IRA accounts (see details under "Their annuity is a drag"), but Judy's tax-deferred 403(b) retirement savings plan holds only $27,000. She has begun contributing a sturdy $20,500 a year to get the maximum tax benefit. A tax-deferred college saving plan for Mario, 11, has just $320.
There's No Money for College
The Sekis want to help with college expenses for Masato and Tomio, 17, and save for future educational expenses for Mario. But as things stand there's no cash for any of that. Without spending a dime for college, "this year they will spend all the money they take in," says Mayes, who'd also like the couple to find a way to save several hundred dollars a month to fund their next car purchase. The Sekis do have some cash cushions: about $15,000 in a taxable mutual fund account, plus $23,000 on deposit in banks.
Their Annuity Is a Drag
A bigger challenge to the Sekis’ retirement security, says Mayes, is a pair of costly investment decisions. Late last year the couple bought variable annuities from an in-law, reinvesting the $180,000 in their IRAs in insurance products whose main investment advantage is tax-deferral—superfluous within IRAs, which are already tax-deferred. The annuities deduct 3 percent annually for expenses, a factor that considerably hinders investment growth, yet moving the money again would be costly, too. To cash out of the annuities during the first two years, the Sekis would have to pay a "surrender fee" of 7 percent of current value—or more than $10,000. The surrender fee declines to zero only after seven years.
A Real Estate Gamble Went Sour
A second costly move was made on behalf of one of their sons. The Sekis owe just $24,000 on the mortgage on their 3.5-bedroom home, which is valued at about $400,000. But three years ago the couple took out a $52,000 home equity line of credit to cover the down payment on the son's condo. All three were confident that the money could be repaid quickly—that rising values would make the condo easy to refinance. "That didn't happen, of course," sighs Judy.
Hiro has a term life insurance policy that would pay Judy just $12,500 if he died. Judy, now the main breadwinner, is insured for more than $200,000 from various policies, including a $141,000 variable universal life policy—another complex hybrid of insurance and investment that she purchased for $30,000 in 2007 from the same in-law who sold the annuities. It has a current cash value of just under $10,000 and it, too, carries surrender fees.
The $400,000 Seki home is insured for $198,200, and the liability limit on the policy is a meager $100,000. Liability limits are similarly low on their auto insurance coverage, maxing out at $50,000 for claims against persons or property.
Their Will Is Dated
The Sekis' estate plan dates back to 1988, when their finances and family were both smaller. In terms of beneficiaries alone, it's out of date.
Financial planner Rick Mayes outlined a strategy that would let Judy and Hiro retire in eight years.
Keep earning and saving.
Hold the annuities ... for now.
Ditch the corporation.
Let others pay for college.
Settle the home equity loan.
Get more insurance.
Put affairs in order.
Under the projections prepared by Rick Mayes, Hiro can stop taking photographic assignments in two years, Judy can stop teaching in eight years—and if the plan runs true they can expect to have accumulated savings and pensions that will see them through to the year 2050, when Judy would be 100.
Keep Earning and Saving
Because of their limited savings, the couple needs to work eight to 10 years before retiring, says Mayes. That's fine with Judy, who may work still longer. "Working keeps me stimulated, active, and healthy," she notes. Hiro may or may not earn income from his books, but he will collect $1,387 a month from Social Security if he applies at his full retirement age of 66, or $1,830 if he waits until age 70, as Mayes suggests.
Judy has a steady income now but her teaching job is not covered by Social Security, so she would receive only about $236 a month at age 66, based on her previous work record.
At that age, though, after roughly 13 years of teaching, Judy would also be entitled to a state pension of more than $1,800 a month, with the same benefit continuing to Hiro if he survives her.
Investments will supplement this income. Judy’s 403(b) plan, which Mayes estimates may grow to $256,000 over the next eight years, will play a large part.
Hold the Annuities ... for Now
Mayes expects that in eight years the two variable annuities combined would grow to approximately $238,000. He has not recommended cashing out of them because of the high surrender fees. The Sekis could reconsider at a later date. However, "we had a long talk about focusing on simple, low-cost, transparent investment products," Mayes says, and he urges them to rebalance their current investment mix of 60 percent in stocks and 40 percent in bonds or cash. Mayes suggests that the Sekis reduce their stock holdings to 50 percent, allocating their investments among mutual funds in this way:
50 percent U.S. bonds
25 percent U.S. large-cap stocks
7 percent U.S. small-cap stocks
14 percent international dividend stocks, and
4 percent emerging market stocks.
Ditch the Corporation
The couple can trim expenses a bit by dissolving the S corporation that sheltered their photography business, says Mayes. That would save $800 in yearly fees plus the cost of a CPA to file a business return. "That's much too expensive for the $5,000 that Hiro now earns from photography each year," says Mayes. "File a final business return for 2009, then report future income on a Schedule C on your personal return."
Let Others Pay for College
Loving parents though they are, Mayes suggests that the Sekis put their own retirement needs ahead of their concerns about paying for college for their three youngest kids. “College can be funded in many ways,” says Mayes, "but retirement security is all up to you.” He strongly cautions against cutting back on retirement savings, such as Judy’s 403(b), to pay college costs.
What's more, he says, education expenses may not be onerous. The Sekis expect to pay $2,500 this year and another $2,500 in 2010 for community college for Masato and Tomio. Yet this year and next, the new American Opportunity Tax Credit for college included in the recent federal stimulus package will cover 85 percent of the cost, Mayes reports, and the subsidy may be extended to later years. Scholarships and other financial aid may well materialize for all three boys' education.
Settle the Home Equity Loan
The adjustable mortgage interest rate on the condo one of the Sekis' sons bought has already risen sharply, more than doubling his monthly payment, from $460 to $1,000. While faithfully paying interest on his parents' equity loan, he has been unable to pay back any principal. The condo, purchased for $160,000, is now worth no more than $115,000. Foreclosure is likely.
Mayes is concerned that the interest rate on the home equity line of credit may also rise sharply, or the lender may simply close out the loan and demand full repayment. "If the son just can't keep up, paying back the loan themselves will curtail the Sekis' retirement prospects," he says. He suggests that the parents convene a family meeting to solicit suggestions from the tight-knit group.
Get More Insurance
Mayes urges the couple to check with their homeowner's insurance carrier to see whether their under-$200,000 in insurance coverage would pay for rebuilding their $400,000 home. "It might be enough, depending on the land value," says Mayes, "but it would be a financial catastrophe if their home were destroyed and they got too little to replace it."
Just as important, says Mayes, the Sekis need more liability protection on their home and auto policies. The very low limits would not be much of a buffer in a lawsuit. "They need protection that exceeds their net worth."
Mayes suggests $1 million worth of coverage. "They can do this two ways. They can increase liability limits on their auto and home policies separately—raising the deductibles from $500 to $1,000 will help bring down the extra cost—or they can just buy a separate $1 million umbrella policy, which picks up liability costs where their other policies leave off." Because of their underlying insurance, the new policy shouldn't cost more than a few hundred dollars a year, he adds.
Mayes also suggests that, to protect Hiro's standard of living should she die, Judy increase her life insurance coverage from the current $200,000 to $300,000. The best way: buy additional term life coverage, which can be canceled when she retires.
Put Affairs in Order
The costs and delays of probate in California are great, so Mayes suggests the couple contact an attorney specializing in estate planning to discuss updating their revocable living trust. Its advantages are numerous, says Mayes, including avoidance of delays in probating the will, and the ability to make changes in the trust arrangements at any time.
At the same time, he says, the attorney can provide other vital documents such as advance health care directives and durable powers of attorney.
To follow the Sekis' progress in their Money Makeover, read updates on the Payoff.
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