Moerdler: What difference would a retirement plan make? Do you recommend that instead?
Adams: You should consider setting up a 401(k) plan. Of course, then it would be in your best interest to forget about combining your two salaries into one to reduce your FICA taxes. Only paid employees can participate in a company's retirement plan. Each of you could contribute up to $9,420 -- while deducting it from your taxable incomes. Furthermore, the savings in the 401(k) are bulletproof in the sense that if MDY ever runs into financial trouble, your savings there will not be considered an asset of the company.
Moerdler: We've talked about setting something up for our retirement savings. But, as you see, we haven't done anything yet.
Datskovsky: Part of it is the time. It's not something we have the time to do. We have saved some money in IRAs, though.
Adams: Yes, but your IRAs are all in bank certificates of deposit and scattered in too many accounts. You should consolidate them into a single investment account. It will be easier to make money, in part because your fees will be lower. And in a corporate retirement account, like a 401(k), you could allocate savings among at least three different investment options while keeping the funds in a single place. Meanwhile, stop funding the IRAs, at least for now. IRAs are meaningless from a tax standpoint because you don't get a deduction. You're building assets, but. . . .
Moerdler: We'd be better off putting the same funds into a 401(k)? From what you're saying, it seems as though that's our safest, cleanest bet.
Adams: Absolutely. It's the first way you should save. I'd start your 401(k) with a mutual-fund group mixing your investments -- 60% or 70% in a conservative common-stock fund, 10% to 20% in a more aggressive growth-oriented fund, and the balance in a diversified international fund. Reinvest your dividends. MDY can enhance those savings, too, by matching, at some level, all employees' contributions.
Datskovsky: But what's going to happen to MDY's cash flow if we commit the company to match some portion of 401(k) contributions?
Adams: Your corporation doesn't have to match contributions until you feel it can afford to. But when MDY does begin to match, that will be more tax-free money out of the corporation and into your own retirement savings.
Datskovsky: How much money do you think we should be able to set aside?
Adams: By my calculations, you ought to have about $35,000 that you can direct into savings and investments. Currently, your short-term emergency savings account is too small -- less than one month's living expenses. People generally need three to six months' worth in a cash-reserve money-market fund. I suggest that your immediate priority be to accumulate $25,000 in such an account. Anything you save beyond that should go into your 401(k) plan, up to the $9,420 limit per person per year.
Moerdler: What is the right amount to save for college? Every time we look, the prices are higher than the last time we looked.
Datskovsky: It's very scary.
Adams: You have to estimate your future needs. But the amount you save also depends on what you'll be able to afford. Here's a trick: Zahava will be 18 in the year 2008. So you should check the listings for zero-coupon bonds in the Wall Street Journal. You'll see that a zero-coupon bond that will be worth $1,000 in the year 2008 is currently selling for $381. So, if you figure you're going to need $50,000 to pay for her first year of college in 2008, then you'd need to spend about $19,050 today to buy a bond to cover that.
Moerdler: But what if we can't afford that? What if we can pay just $5,000 a year?
Adams: Then you do that and keep layering on more and more, year after year, until you've got enough to cover your costs. Right now, though, you wouldn't want to buy zeros because their yields aren't high enough. You can still use them as a conservative benchmark. If you'd need to spend $19,050 in zeros, then you could invest somewhat less in a long-term growth-stock mutual fund.
You should try to allot 3% to 4% of your combined income annually for college savings. At your current salaries, that would amount to $5,400 to $7,200. Assuming 9% interest from a good growth-oriented-stock mutual fund, you would achieve your education goals for both your daughters.
Datskovsky: What you've suggested so far -- building cash reserves, establishing a 401(k) plan, and continuing to save for college -- will more than eat up the money you think we could set aside. In fact, I don't think we'd both be able to contribute all the eligible $9,420 to a 401(k). I don't think we should give ourselves raises yet.
Moerdler: We could manage raises in a few years if we maintain MDY's growth rate and profitability. And of course we need to renegotiate the company's credit line. Will we be able to make more aggressive investments soon?
Adams: Once you've accomplished those three immediate goals and have extra funds to invest, I think you should buy municipal bonds. Tax-free bonds and long-term-growth stocks are the only investments that make sense in the current tax environment.
Moerdler: I think we're getting rate-pillaged and plundered in what you call the "current tax environment." So tax-free bonds sound good -- but not really aggressive.
