Money Makeover: Adopt and adapt

(Money Magazine) -- As a teenager, Lori Smith decided she would someday adopt children. "I promised myself that I would help kids who needed homes," says Lori, now 41 and a mom to three little Smiths - two of whom she and husband Steve, 40, adopted from China. "What I didn't know was that I should have started saving back then."

An exaggeration? Sure, but perhaps not by much. Since they married 12 years ago, the Smiths have managed to repay some $60,000 in combined debts they brought to the marriage (hers from student loans; his from "having fun," says Lori) and finance two $18,000 adoptions.

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But the couple know they've gotten a late start on their goal of retiring at 60, and they have no college savings for 3-year-old Alyssa, 3½-year-old Logan and 14-month-old Teah. Plus, they'd like to have a fourth child.

"When it comes to our money, we're not sure where to start," says Steve. "It seems like everything is a priority."

The Smiths have a couple of things working in their favor: no credit-card debt and a healthy income. Steve, who spent 12 years in the Navy, makes about $100,000 as an engineer at a firm that makes semiconductors. Lori, an occupational therapist, now works sporadically.

But later this year, Lori's mother plans to move into their five-bedroom home, which will provide the couple with child-care help and allow Lori to earn an expected $1,200 a month. The couple also have a big chunk of cash in the bank, thanks to an $18,000 tax refund (they got an $11,000 credit for adopting a child last year).

Retirement is another story. Steve will get a $2,800 monthly Navy pension when he turns 60, but the couple have just $96,000 in retirement accounts. And, of course, they'll be shouldering the cost of iPods, summer camps, clothing and toys for almost two decades to come.

With so many young children and not much saved, "retiring at 60 simply isn't realistic for the Smiths," says Becky Salsburg, a financial planner in Lake Oswego, Ore. But they'll be on track to retire at 65 if they make the following adjustments:

Build a safety net: If Steve lost his job, the couple would be in serious trouble. Having at least three months' worth of living expenses in an emergency fund is essential. Salsburg suggests they put $12,000 of their tax refund, as well as the $7,500 in their savings account, into the Vanguard Prime Money Market fund, which pays 5 percent interest.

Steve also needs $1 million in life insurance, and Lori should get a $250,000 policy to help cover child-care costs if she were to die while the kids were young.

Start college funds: For the most part, the Smiths need to put retirement before college savings. Says Salsburg: "Nobody gives out scholarships to retirees." Still, they can use the remaining $6,000 from their tax refund to open 529 accounts for each kid. "At least they'll feel they've gotten going," she says.

Readjust the portfolio: Steve stows 6 percent of his salary in a 401(k), which his employer matches with an additional 3 percent. The entire $50,000 account is in stock funds, and most of those funds invest primarily in big U.S. companies. Boosting his stake in international funds to 30 percent could add some upside if foreign stocks outpace domestic blue chips, while keeping at least 20 percent in bond funds should prevent steep losses in a stock downturn.

Lori has about $40,000 scattered among traditional and Roth IRAs and an old 401(k). She should combine the 401(k) and traditional IRAs into a single account, and invest the money in Vanguard Total Stock Market Index (Charts) and Dodge & Cox International (Charts).

Pick a realistic retirement date: To quit working at 65, Steve needs to increase his 401(k) contribution to 10 percent a year. Any extra savings should go into their Roth IRAs, where they can stash $4,000 apiece this year. That money can be withdrawn penalty-free for college expenses, too.

"It's a good, flexible place for their money," says Salsburg. "And with so much ahead of them, they have to be ready to adapt."