Money Makeover

A savings deficit

Gallagher has some savings, but not enough for the future she's imagining. She has accumulated about $55,000 in three 403(b) plans, two from previous employers and one from her current job; another $4,500 in a Roth IRA; and a little more than $5,500 in a bank account.

Yet rather than saving more, she's been spending almost every dollar that comes in. With her $60,000 salary and $3,000 per year that her ex- husband pays her, Gallagher's income after taxes is nearly $50,000. Her monthly payment for her three-bedroom, one-bath home in Geneva is a thrifty $550. Her debts are few, just the $53,800 balance on her mortgage, $16,000 in car loans, and about $2,000 on credit cards. Altogether, she guesses that her yearly expenses for necessities—groceries, clothing, the house, two cars, insurance—are about $40,000. Of the rest of her money, she consistently saves just $600 in her 403(b) plan at work. She often deposits about $300 a month in her bank savings account but admits that she also draws out cash from that account to pay for "quick trips and things." Other income goes to "restaurants, entertainment, charities, and gifts," she says.

Pension perils

If her job at the Girl Scouts lasts, Gallagher expects to receive an annual pension at age 62 of about $31,000. Her Social Security benefit will add a projected $16,080 per year.

That $47,080 in combined pensions may sound substantial. However, nine years from now, at 4.5 percent annual inflation (the average since 1970), Gallagher's $31,000 pension will be worth about $21,000 in today's dollars; her Social Security payment, about $11,000.

From then on, her Social Security benefits will be indexed to rise with inflation but the Girl Scout pension won't. Its buying power will continue to erode over time, requiring an ever-increasing share of Gallagher's income to come from personal savings to maintain a lifestyle that includes travel and charitable giving.

Worse, her Girl Scout retirement benefits don't include subsidized health coverage, just the right to purchase group coverage at full cost. That could amount to a four- or even five-figure annual expense if Gallagher retires before she's eligible for Medicare at 65.

The college debt dilemma

Both of her daughters took out loans to pay for college, and Gallagher likes to help them out with money. "I want them to have a debt-free start in life," she says.

Allyson, 23, a recent graduate, owes $20,000, which she is paying off herself. She earns a good living monitoring vendor compliance—keeping merchandisers on track —for the Walt Disney Company in Florida. "She just bought her own home," her mother says proudly. Still, Judy would love to pay Allyson's loans for her.

Nineteen-year-old Kelsey's situation raises more concern. She and her mother put together an impressive package of grants, part-time work, and government loans to help cover her first year's $32,000 in expenses at Philadelphia University. Still, it wasn't quite enough, and her mother took a $10,000 federal loan at 8.5 percent interest. She expects to do the same for the next three years. The monthly cost of the initial ten-year loan is $120.

Save a lot more

Fortunately, Gallagher still has the time and means to transform her retirement prospects. "A satisfying retirement is within Judy's reach, but she has to make the effort," says Kennedy. "To fund the kind of retirement she wants, she really needs to step up the pace."

He recommends that she start saving $12,600 a year—almost a quarter of her income. It may be a startling recommendation, but the planner insists it's a realistic one. "We're not talking about deprivation, we're talking about reordering your choices," he says. "When you make financial security your top priority, it gets easier to save because other needs just move further down the list."

To get started, Kennedy suggests Gallagher keep track of all expenditures, no matter how small, over a one-month period. "Then mull over each one and decide whether you value it more than you value peace of mind about your future."

Once the new budget starts producing extra cash, Kennedy recommends Gallagher make the $6,000 maximum yearly contribution to a Roth IRA and put the rest into her 403(b) account at work. Gallagher's current investment portfolio holds a very conservative mix of 36 percent stocks, 47 percent bonds and 17 percent cash. To increase her potential for higher returns, Kennedy suggests a portfolio that's 63 percent stocks and about 7 percent REITS (real estate investment trusts, a kind of mutual fund), with the remainder in bonds and cash.

Work longer

Based on her family history, Gallagher is understandably reluctant to postpone retirement too long. However, says Kennedy, she needs to weigh that concern against the near certainty that, even with stepped-up savings, she will not have accumulated enough money by age 62 to keep supporting the lifestyle she wants, especially if she has to buy health insurance. Kennedy calculates that, if she saves as much as he recommends but still chooses not to work past 62, all her savings will be gone by her early 80s.

To prolong her financial security, the planner recommends that Gallagher continue full-time work and saving until age 66, when she'll be eligible for full retirement benefits from Social Security. "That will allow her to build her assets, increase her pensions, plus get her covered by Medicare."

At that point, Kennedy suggests, she could retire from full-time work and take a job for $12,000 a year or so at something she enjoys—like a bookstore, since she loves to read—to avoid tapping her savings until age 70, when she can quit work for good. Under this scenario Gallagher's portfolio should be worth close to $500,000, enough to support her retirement expectations into her 90s, he says.

Let the kids cover college

Much as Gallagher would love to free her daughters from college debt, she simply cannot afford to pay Allyson's loans or continue borrowing for Kelsey, says Kennedy. Fortunately, Allyson is already well positioned to pay her own loans, and Kelsey, a fashion merchandising major, has her whole career ahead of her. He recommends that Kelsey assume all future loans, repaying herself with future proceeds of a life insurance policy on Judy that names Kelsey as beneficiary.

If Kelsey does take extra loans, her total debt may be more manageable than Gallagher expects. As of July 1, 2009, federal loans—though not parental loans like the one Gallagher took out—are eligible for a revised and more-generous income-based repayment plan that keeps installments from ballooning beyond a borrower's ability to pay. If a balance still remains after 25 years of payments— sooner if a borrower enters public service—the remainder is forgiven.

Make your wishes known

Gallagher has a will but not long-term care insurance and doesn't consider it a priority right now. However, with no spouse to lean on, she needs to let her daughters know her wishes for her later years. Kennedy suggests she stipulate her preferences for care and outline a general plan in writing.

She also needs to provide the girls with her power-of-attorney and health care proxy, which will allow them to make financial and medical decisions for their mother if she is unable to make them herself. For $500 or so, an attorney specializing in estate planning can draw up both documents. —Lani Luciano

To follow Judy Gallagher's progress in her Money Makeover, read updates at the Payoff.