Financial Makeover

"Why are we struggling on an income like ours?"

To cut child care costs, this doctor's husband stays home with the kids. If he returns to work, will their finances improve? We asked the experts.

By Doreen Mangan
Senior Editor

Although she's earning more than ever, pediatric rheumatologist Gail M. Cawkwell and her husband feel financially strapped. "We don't go to movies, we don't take fancy vacations," says the 37-year-old doctor.

Cawkwell earned $135,000 in 1999, her first year at a pediatric multispecialty practice in Las Vegas, where the family, including four kids, moved last February. That was quite a bump-up from her $91,000 salary at an academic practice in St. Petersburg, FL, where she spent five years. Her husband, Roger, 38, was earning about $36,000 as an engineer for the state of Florida.

Though Gail's income will rise even higher this year—to $150,000—the couple expect their finances to remain tight. The costs of living in Las Vegas, particularly housing and child care expenses, are higher than they anticipated. The six-bedroom stucco house they built cost $330,000—$30,000 more than they expected. Gail has more than $6,000 of annual professional expenses, such as CME travel, hospital fees, and subscriptions. Her Florida employer picked up those costs, but her current one doesn't. The couple owe $17,000 in educational debt and $12,000 on their 1998 Ford Windstar. For the first time in their 12-year marriage, moreover, the Cawkwells have credit card debt—$8,500, which they accrued while decorating and landscaping their home.

To cut their costs, Roger Cawkwell stays home to take care of the younger children, ages 3 and 1, which saves them an estimated $13,000 annually. Still, they can sock away very little money. They save only the $100 a month Roger adds to his IRA and the $200 they invest monthly in a mutual fund. Because the Cawkwells abhor debt, they're trying to pay theirs off as quickly as possible. Their 15-year, fixed-rate mortgage costs $3,100 a month, or $37,200 a year. And they're making large payments on their other loans. They're fortunate, though, to have a $163,000 retirement stash—mostly in equities—from savings plans in previous jobs, because Gail's new practice has no retirement plan.

The Cawkwells have only about $11,000 set aside for college costs. Roger says they'll pay for their kids' education with home-equity loans. The 15-year mortgage will be paid off when Sam, their third child, starts college in 2014; they then plan to direct that money toward college costs for him and their youngest child, Rebecca.

All that will take nifty financial footwork. In the meantime, they feel a bit overwhelmed.

"My husband is frustrated, because we live from paycheck to paycheck. He thinks it will be years before we can save anything substantial, and we'll be in our mid-40s," says Gail.

She's frustrated by their financially restricted life. "We might hire a babysitter two or three times a year, so we can go out. We don't spend much on clothes. My parents buy clothes for the kids as presents. Grocery expenses go on a credit card that gives us coupons to use at T.J. Maxx." Their only vacations are visits to family members who live in New Jersey and Calgary, in Alberta.

"We don't really feel deprived," Gail says. "We'd just like a bit more flexibility." The two often debate these questions:

• Is the 15-year mortgage a bad idea?

• Should Roger go back to work, even though a big chunk of his income would be spent on child care?

• Should they concentrate on saving for college and forget about adding to retirement savings? Won't the money they have grow into a large enough nest egg by the time Gail is 65?

• Could their present savings be better invested?

• Should Gail buy into the practice when she has an opportunity, in another year?

To help Gail and Roger answer such questions and get a better grip on their finances, we introduced them to Bethesda, MD, financial planner Mary A. Malgoire and her associate, Everette B. Orr. We asked these experts to analyze the Cawkwells' situation and develop a strategy that would allow the couple to live comfortably now, while also saving for important goals.

What the planners told the Cawkwells

"First, let's look at your current financial status. You have assets of $589,000 and liabilities of $334,500, for a net worth of $254,500. Your principal assets are your home, valued at $330,000, and your retirement accounts, worth $163,000. Your liabilities are your $297,000 mortgage balance and short-term debts totaling $37,500. Those include education loans, car and orthodontist payments, and credit card debt.

"Your asset mix is fairly typical for a couple at your stage in life. A good chunk is in fixed assets—home, furnishings, and cars. You have more in retirement savings than is typical for people your age, though, which is commendable. Your liquid assets of $29,000 are low. While that's not unusual, it's the reason for the month-to-month financial insecurity you feel.

"Your core living expenses are $95,000 a year. That's high, but your housing costs are a big part of that. Last year, mainly because of those expenses, you had a negative net cash flow of $9,200. This year, though, with your salary going up and some of the house-related expenses disappearing, you'll free up $11,600, which you can put away for college and retirement.

"You'll have even more to put away—as much as $18,000 in all—if you refinance your mortgage to a 30-year loan, which we strongly recommend. True, you'd pay more in the long run, but you'd have more interest to deduct, and an ongoing tax shelter will be important as your income grows over your next 28 working years. Current 30-year mortgage rates in your area are 8.5 percent or so, with no points, so your after-tax cost could be 6 percent or less.

"Another way to improve your cash flow is to melt down your other loans as quickly as possible. Transfer your $8,500 credit card balance, on which you're paying 14 percent, to a lower-interest card. You can get one with a fixed rate under 10 percent. For example, Fleet Platinum MasterCard has a fixed annual percentage rate of 7.99 for purchases and balance transfers. If you cut your rate that low and increase your monthly payments from $150 to about $265, you'll erase that debt by the end of 2002.

"Here are our recommendations on how you should redirect this newfound money and manage your financial decisions:"

Rainy-day fund. "Put aside about $6,000 annually for emergencies or heavy expenses such as major home repairs and cars. Many people never get out of debt, because they don't have a rainy-day fund. Instead, they take out large loans, believing that their financial situations will improve once the debt is paid off. But, typically, a new expense arises, and they replace old debt with new.

"Since you drive your cars 'until they fall apart,' figure on buying two new ones at 10-year intervals, for about $25,000 per car. The next purchases will be in 2004 and 2009. Since your home is newly built, you shouldn't need hefty repairs or improvements for quite a while. Still, we estimate that those expenses will cost about $5,000 every 10 years—at the very least.

For your rainy-day savings, consider fixed-income investments such as certificates of deposit or a short-term bond fund. Vanguard's Short-Term Corporate is a good example.

College costs. "Funding this expense will compete with retirement savings. For four kids, you should save about $12,000 annually to cover four years at a state school such as the University of Nevada.

"We suggest that you open an account for each child in American Century's College Investment Program. The money will be invested in American Century's Select fund, a no-load, low-expense, large-company stock growth fund that returned an average of almost 26 percent annually over the last five years. The funds will be shifted to a money-market account automatically every other month, beginning within four, five, or six years of the date the child will start college.

"Open the college investment accounts with your current college savings, which are now in a variety of funds. Direct your bank to automatically transfer to American Century $325 a month for an account for Philip's education, $275 for Rachel's, $225 for Samuel's, and $175 for Rebecca's. The older children should get more now, because they'll need the money sooner.

"As each child graduates from college, reallocate the funds to the remaining children. If you invest $12,000 annually and earn an after-tax rate of 6 percent on that money, you'll have about $135,000 when Philip, who's 10, heads for college in 2007. By 2010, when Rachel, now 7, begins college, you'll be able to trim your annual college savings gradually, putting away just $2,700 for Rebecca's senior year. Since none of your kids is older than 10, you have many years of saving ahead.

"The accounts should be in your names. If they're in the children's names, the kids will have full rights to all of the money upon reaching age 18, and they may not be able to responsibly manage large sums. Yes, custodial accounts have tax benefits, but those aren't significant."

Retirement. "After you take care of expenses and college savings, you should funnel all of your residual net income into retirement savings. Until either of you can again participate in a pension plan, you should each invest $2,000 annually in Individual Retirement Accounts. Roger is already investing $1,200 a year. He should boost that to $2,000, to take full advantage of the tax-deferred earnings potential.

"Save as much as you can this year. Next year, when more of your debts are reduced and Gail's income rises, aim to save at least $11,000, and increase the amount annually to match inflation. If you continue saving in proportion to the boosts in Gail's income, you'll accumulate about $5 million by the time she turns 65, assuming a 4 percent inflation rate and 8 percent average annual investment return. From that, you could withdraw about $126,000 a year (pre-tax excluding Social Security) to start, and the annual withdrawal would increase with inflation.

"These projections assume you don't contribute another dime to your employer-sponsored tax-deferred retirement accounts. The numbers are okay, if you can harness your expenses now to maintain the same standard of living as your income grows. Most people can't do that. And you may find, when you're, say, 55, that you're thinking, 'I can't wait to get out of here.' So you may want to have an even more substantial nest egg to fall back on.

"You'll need to practice tight financial management to meet those goals. Here are a few strategies to consider:"

Rethink Roger's status. "Roger may want to return to work as the children get older. This move would generate cash that you could invest or use for mortgage prepayments or for occasional splurges such as a fancy vacation. But the strategy has hidden costs. Roger would have to earn pre-tax income of about $21,400 just to break even, because you'll still need some child care for the younger kids, and you'll hire household help to do what Roger does now. You've got to factor in commuting, clothing, dry-cleaning, and eating-out expenses, too. A $40,000 salary would allow you to take home about $11,400, after those expenses and taxes; $50,000 would generate $17,575.

"You need to weigh this decision carefully. No doubt, you'd get satisfaction from resuming your career, Roger, and you'd be staying up to date with developments in your field. But you're doing a lot of good things right now for the family that you can't put a price on. Going back to work could create pressure and stress for everyone. This isn't a move to be taken lightly."

Boost your insurance. "Gail has $570,000 in life insurance, and Roger has $430,000. As the breadwinner, Gail needs an additional $1.2 million to sustain the family's current lifestyle, if you don't want Roger to have to return to work. The extra cost—about $800 more a year—is justified, considering the risk of losing an income the size of Gail's. "Roger needs more insurance, because household expenses will rise significantly if Gail has to pay someone to do his work in the home for all those years before the kids go to college.

"Similarly, both of you are underinsured for disability. Gail's policy provides a monthly benefit of $6,398. She'd need $1,600 more monthly to maintain the family's current lifestyle if she were to become unable to work. Roger can't get additional insurance while he's unemployed, but if he gets a job outside the home, you should then increase his monthly benefit of $853."

Tinker with your retirement investments. "An all-equity portfolio makes sense for your retirement money. You still have plenty of time before you turn 70 1/2 and must begin withdrawals from your IRAs and other tax-deferred plans. Overall, your money is wisely invested in no-load funds such as T. Rowe Price Blue Chip Growth, and in tax-free municipal bonds. We'd suggest only slight rearranging. For example, Gail could move some of her assets from her TIAA-CREF Stock Account to beef up her holdings in TIAA-CREF's Growth and Equity Index Accounts. Roger should de-emphasize the large-stock holdings in his Florida state plan and assign some of those dollars to future growth areas such as technology and mid-size stocks.

"As your overall portfolio grows, you should diversify a small portion into inflation hedges such as energy and real estate. We recommend Vanguard's Energy Fund and its REIT Index Fund.

"One investment of yours that we don't like is Templeton Capital Accumulator, the global stock fund Roger's using for his IRA contributions. Its average annual return of 16.5 percent over the last five years may sound good at first, but it's mediocre compared with what the current bull market has achieved. In addition, the fund's yearly sales charges can be very high. This fund is a contractual obligation, meaning you're committed to a monthly investment for 15 years. Since you save $1,200 a year in this fund, we suggest you contribute $800 annually to another IRA, to reach the $2,000 maximum for such accounts.

"When your investable assets reach $500,000, consider hiring a money manager."

Don't neglect estate planning. "You're not too young to think about how best to pass on your wealth. Avoid onerous estate taxes by creating a bypass trust and by assigning life insurance to an irrevocable life insurance trust. Designate the insurance trust the owner and beneficiary of the policies. As long as both trusts are set up properly, the surviving spouse will still be able to use the funds in them for health, education, and support. When the second spouse dies, the trust assets will pass to your heirs, free of estate taxes.

"Also, you should each replace your Florida wills with Nevada ones. In addition to appointing a guardian to care for your children should you both die prematurely, you can bequeath any property that might fall outside the trusts as you see fit.

What to consider when buying a practice

"Next year, I may have the opportunity to buy into my medical group. Should I do it?" pediatric rheumatologist Gail Cawkwell asked Bethesda, MD, financial planners Mary Malgoire and Everette Orr.

"Such a move would likely boost your income, but you have to examine the buy-in critically from several angles," replied the planners. Here's how their advice breaks down:

Finally, realize that owning a practice is a little like getting married: It's a long-term relationship. How well do you and the other doctors and staff work together? Is there a natural harmony, or is there tension? As in your home, you should have joy and happiness in your practice.

Mary A. Malgoire, a fee-only planner, founded The Family Firm, in Bethesda, MD, of which she is president, in 1984. She was listed in Medical Economics' "The 120 best financial advisers for doctors." (July 27, 1998, available at www.memag.com.) Her associate, Everette B. Orr, CPA, is former head of auditing for the US Agency for International Development, which dispenses foreign aid.

. "Why are we struggling on an income like ours?".

Medical Economics

2000;5:125.