$739,000 in debt—and wanting to start a family

April 23, 2001

Greg and Sheri Rocco, both doctors, both 30, aren't making much fiscal headway. Still, they yearn to wipe their slate clean, have children—and retire at 60. Financial planners show them how.

Greg and Sheri Rocco, both doctors, both 30, aren't making much fiscal headway. Still, they yearn to wipe their slate clean, have children—and retire at 60. Financial planners show them how.

Start with a half-million-dollars-plus of med-school debt. Add a $156,000 home mortgage. That's the burden Sheri and Greg Rocco, each 30, are shouldering as they begin their medical careers. "We went to very expensive schools," says Sheri, a pediatrician in practice for one year.

So far, the suburban Chicago physicians are coping, thanks to self-discipline. They're chipping away at the school loans, adding about $500 to the required $1,750 monthly payments on Sheri's $234,000 medical-school balance. Looming, though, is Greg's $310,000 debt, which they'll start repaying when he finishes his FP residency this July or a fellowship in July 2002.

"I abhor owing all this money," Greg says. Yet the Roccos' wish to pay off their loans as soon as possible conflicts with their desire to have children soon and retire at 60.

Still, if anyone can do it, this couple can. Thanks to Greg's addiction to saving, the Roccos already have a $63,000 stash. Half is in IRAs and their employers' retirement plans; the balance includes a $10,000 emergency fund.

Sheri, who describes herself as a "horrible" saver now reformed, credits Greg as the driving force behind their nest egg in the making: "If I had a dime, I spent it. Greg, on the other hand, has always been a good saver. His mother says she was borrowing money from him when he was 5!" Greg discovered the Putnam Fund for Growth and Income when he was in college. The roughly $5,000 he invested then had grown to $18,000 by last year. The pair used $14,000 of that toward the down payment on their house, purchased for $195,000 in Mundelein, an inexpensive Chicago suburb.

How do they manage to squeeze hefty loan payments and savings out of Sheri's $110,000 salary and Greg's $40,000 residency earnings? By living simply. Of their $10,000 after-tax monthly income, the mortgage accounts for $1,500; transportation, including car insurance, about $650; utilities and phones, about $350; Sheri's education loans, $1,750; disability insurance, $243. Groceries, travel, gifts, and miscellaneous expenses add to the tab.

Their secret is how they handle what's left over. "Each month, we subtract the expenses and loan payments from our take-home income and divide the surplus in half," says Sheri. "One half goes to extra loan payments, the balance to savings."

Their only splurges are trips to visit their families—Greg's in Dix Hills, NY, and Sheri's in San Diego—and to attend friends' weddings. "We had eight or 10 out-of-state weddings in 1999, and we were in six of them," says Sheri. "It was about the same last year. This gets expensive. But our friends and families are important, so we're willing to make do with less, to fulfill those commitments."

Greg admits that although material things have no attraction for him—the 9-year-old Jeep Cherokee he drives belonged to his parents and has 130,000 miles on it—it's killing him that he can't "spoil Sheri and give her everything."

Although they felt they were handling their finances well, the Roccos wondered whether they could do better. That's why they approached Medical Economics about a financial makeover. "Where do we go from here?" Sheri asks. "We're trying to manage loan repayments, plan a family, and save for retirement without stressing out all the time about our finances." And this pediatrician, who loves kids, is "frustrated at not being a parent."

Their questions boil down to these:

  • Can they afford to start a family now, even though Greg may do a one-year fellowship?

  • Given their enormous debt, should they forget about college savings and hope their kids win scholarships?

  • When Greg begins earning an FP's salary, how can they best allocate that money to meet their goals?

  • Could they better manage their investments?

  • Are they adequately insured?

To help the Roccos address these questions, we introduced them to Chicago financial planners Joel M. Blau and Ronald J. Paprocki. We asked those experts to analyze the couple's situation and recommend a strategy that would allow them to meet their family and retirement goals while shrinking their debt.

What the planners told the Roccos

"Procrastination is the No. 1 reason many physicians don't reach their financial goals. They think, 'I'll start saving when my income reaches $200,000.' But by that time, they've built a lavish lifestyle and haven't developed the savings habit you have. Your saving and frugal spending habits will stand you in good stead as you tackle your financial problems.

"Here's how we think you should proceed."

Those onerous loans. "Your joint student debt totals $544,000. When Greg's loans come due, your monthly commitment will be $4,100. You're paying about $500 per month extra on Sheri's school loans, as well as an additional $100 on the $156,000 mortgage and $130 on Sheri's $5,000 car loan. We estimate that without prepayments, the bulk of Sheri's school loans would be paid off in 22 years; prepaying at the current rate will wipe them out in 13 years.

"Normally, when a couple's cash flow is tight and their net worth is low, we recommend that they trim loan prepayments to free up cash, either for investing or for occasional treats. If, instead of making $500 school-loan prepayments, you invested that much every month for 13 years, you'd have nearly $160,000, assuming 10 percent after-tax return. If you then used that to pay off the remaining loan balance, you'd have around $26,000 left.

"But given Greg's extreme aversion to debt, it's better to continue making prepayments until other needs, such as child care, arise. However, we recommend that you not prepay your mortgage, to preserve the tax deduction on the interest and leave a few extra bucks for investing or improving your lifestyle.

"When Greg begins earning a higher salary, you may be able to increase the loan prepayments, but only by putting off some of the other goals we'll discuss. In the meantime, prepay selectively. Although you're paying an average rate of about 7 percent on your consolidated government loans, you have four private loans with variable rates that average about 9 percent. If you can't consolidate or refinance those loans, you should divert prepayments to them first, since you have no control over the interest rates."

Affording kids and college. "Can you afford to have a child if Greg pursues a sports-medicine fellowship instead of beginning to practice in July, when his residency ends? The short answer is Yes.

"Right now, you're using $730 of your monthly surplus for prepayments. Greg would earn the same salary he now receives during his fellowship year, and his loans would be deferred. So you could apply that surplus $730 to child-related expenses.

"You might be surprised to find, though, that your discretionary income won't increase significantly when Greg does start earning a normal salary of about $120,000. Together, you'll bring home around $230,000, and we conservatively estimate that your total after-tax income will be $160,000, or $13,300 a month, compared with your current $10,000. However, Greg will begin to pay $2,349 a month on his loans. After your other expenses and savings, you'll have a surplus of just $984. Fortunately, you'll have savings to dip into, if necessary, should Sheri take a maternity leave.

"This brings us to the question of college costs. Let's assume you'll have two children within the next three years. Average annual college costs now range from about $11,000 for public schools to about $30,000 for Ivy League ones, so you shouldn't postpone saving for the kids' college expenses. Starting this year, you'll need to save about $330 per month to fund four years of public college for each child. Saving for Ivy League educations will run you about $920 per month, or about $11,000 annually. Those calculations assume a college-cost inflation rate of 6 percent.

"We suggest you consider the state-sponsored Section 529 plan, in which contributions grow tax-deferred. Funds invested in the Illinois plan go into a portfolio of no-load mutual funds, fixed-income investments, or a blend, and the annual management fee is 0.99 percent. Upon withdrawal, earnings are taxed federally at the child's rate—currently 15 percent—and are exempt from Illinois state tax.

"If your child decides not to go to college, you may substitute another family member as the beneficiary. If the money is used for noneducational purposes, a 10 percent penalty will apply, in addition to income taxes.

"However, if you prefer to maintain full control of college savings and the right to use them for any other purpose without penalty, we recommend a portfolio of tax-efficient growth funds such as Vanguard 500 Index Fund and White Oak Growth Stock. Such funds provide an appropriate mix of long-term investments."

On track for retirement. "You'd like to retire at 60, with a combined pretax income of $120,000 in today's dollars. To generate that amount through age 90, you'll need a $5.2 million nest egg. Your current savings, assuming an 11 percent pre-tax annual growth rate plus your other assets, will total $2.3 million in 2030, when Sheri would retire.

"To make up the difference, you need to save $1,138 a month, or $13,656 annually, for the next 30 years and get an average annual pre-tax return of 11 percent. You're already saving $16,800 a year in the tax-sheltered accounts. That's good news. However, we can't help but think that, like many young physicians, you're underestimating the amount you'll need during retirement. Right now you're living frugally, but as your income rises you may find yourself saying, 'How did we ever live like that?' It would be a good idea, in a few years, to rethink how much you'll need in retirement and revise the amount you must save.

"In the meantime, continue saving as you are now, using as many tax-advantaged strategies as possible. Continue to contribute to your Roth IRAs for as long as you can. When your joint adjusted gross income reaches $150,000, your allowable contribution will begin phasing out, and it will disappear at $160,000. At that point, you could consider tax-efficient mutual funds, or even variable annuities or variable universal life insurance. They can provide superior benefits, compared with traditional IRAs."

Rebalancing investments. "Your overall portfolio is heavily weighted in large US stocks. Growth is slowing in those, so we recommend reducing them from 68 percent of your holdings to about 50 percent. Given your long investment time frame, we'd like you to emphasize growth segments of the market.

"Take small- and mid-sized US stocks, for example. Right now, they make up about 19 percent of your investments. We think you should boost that portion of your portfolio to roughly 30 percent.

"Only 7 percent of your savings is in international stocks; those should total 20 percent. We know Sheri is nervous about foreign investments. However, overseas companies are changing the ways they do business and focusing more on profits than in the past, and we anticipate significant growth ahead. Also, right now many of those stocks are selling at bargain prices; it's a good time to buy them.

"This is a moderately aggressive portfolio. For a more conservative approach, you could blend some international bonds and real estate funds into the mix.

"Besides rebalancing your portfolio, you can simplify your life by consolidating certain investments. For instance, your portfolio includes four stocks—Rambus, Northfield Laboratories, Genzyme, and TWA—worth a total of roughly $1,200. No matter how well those stocks do, you have too little invested in each to make a meaningful difference. We suggest you liquidate them and invest the money in a fund such as White Oak Growth Stock. This has been an excellent performer; its annualized five-year return is 20.1 percent.* The fund usually focuses on fewer than two dozen companies in technology, health care, and finance.

"To simplify further, we suggest that you move the taxable accounts you have with various brokerage firms and fund companies into a single account with a firm such as Charles Schwab & Co.

"You could also simplify your retirement assets; currently they're composed of 18 holdings. For example, we'd replace Mutual Shares Fund and William Blair Growth Fund, which duplicate other holdings, with one international fund. A good choice would be Artisan International, which has had an average annual return of 19.4 percent over the past five years."

Insurance deficiencies. "Your insurance coverage needs improvement in two areas.

"Each of you each has a disability policy that provides a tax-free monthly benefit of $2,000 to age 65. A future-purchase rider will let you raise that to as much as $5,000 a month, based on your income. However, $60,000 is only half of what Greg is likely to earn in his first year of practice. Furthermore, if you do any kind of work while disabled, your benefit will be reduced if you earn more than 30 percent of your prior income. Ideally, a policy should replace at least 60 percent of your income tax free, without regard to income from another occupation. But such coverage is rare and expensive.

"Even if you keep your present policies, you should add a cost-of-living rider. Inflation would erode your benefits during a prolonged disability.

"Your current life insurance coverage consists of a $150,000 term policy on Greg and a $110,000 group policy on Sheri. For now, either of those benefits, plus the assets you've accumulated, will be sufficient if one of you dies, because Sheri is earning an adequate income and Greg soon will be. The school loans of the deceased would be forgiven.

"However, since you're planning a family, we suggest that you each buy a $500,000 policy with a level 10-year term. Choose one that could later be converted to variable universal life. This is a low-cost way of locking in the ability to get more insurance later."

Final notes. "You've taken an important step in asset protection by using tenancy-by-the-entirety ownership for your home. This differs from joint tenancy in that neither spouse can convey his or her interest or force a partition of the property without the other spouse's consent. This provides important protection from creditors.

"Although you're young and still without children, we strongly suggest that you take estate-planning steps as soon as possible. At the least, you need simple wills. As your net worth increases and you have children, you'll also need to set up some trusts to preserve your assets."

The Roccos were pleased, on the whole, with the planners' advice—and they were particularly relieved to learn that they do have the means to have a family. "I don't think Greg will ever be fully convinced that we can make it, but he's starting to believe it's possible," Sheri says.

*All returns in this article as of March 27, 2001.

Fee-only planners Joel M. Blau and Ronald J. Paprocki co-founded Mediqus Asset Advisors in Chicago. Blau wrote Medical Practice Divorce, published by the AMA earlier this year, and was listed in Medical Economics' "The 150 best financial advisers for doctors," Aug. 7, 2000.