We all know that 2020 has been a rough year. Regardless of how well or how poorly your business has fared through the pandemic, there’s been a lot of heaviness this year. Because of this, you might be thinking of treating yourself to that new expensive toy that you’ve had your eye on. I know it’s tempting to go out and buy that new boat so you, your friends, and family can spend your weekends soaking in the sun and pulling the kids around on the tube. Maybe you’re thinking of buying a new car or truck, or even a four-wheeler. But, is now the best time to make extravagant purchases?
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I know that you work hard. Being a business owner is one of the hardest jobs that there is. As a result, we need to blow off some steam from time to time and just be able to enjoy the fruits of our labor. I get it. However, I want you to ask yourself a question when you’re considering splurging and making your next extravagant purchase. Is buying a new toy worth the long-term effects that it will have on your retirement plan? What are the other financial implications that come from buying new toys? In order to help you understand the full potential impact of making extravagant purchases, I’ve created an example case. Now, this is not a real-life case study, but a mock-up to illustrate the severity of this situation.
A 49-year-old business owner and his wife have approximately $500,000 in investment assets which they have designated to support them once they retire at age 67. They live on a modest income of $125,000 per year. So, they’re a pretty average family from a financial perspective. Now, if you’re saying, “Justin, I don’t have a half million dollars just sitting in the bank,” we need to do something to change that situation for you. But I digress.
This family has just 17 years before they retire. That’s 17 years to accumulate enough wealth to sustain them throughout their retirement. And all of a sudden, he wants to buy a boat. He says, “I’ve worked hard and I’ve got the money. I deserve it.” However, they need to have a monthly income of $8,333 beyond their SSI benefits to support their current lifestyle. If they have a 7% growth rate and an average life expectancy of 20 years after retirement and a 4% inflationary rate, how much do you think this couple should be saving each month to reach their goals?
Taking inflation out of the equation, they need to be saving roughly $1,200 each month. At that rate, they would have around $1,074,000 when they reach their retirement. However, if we factor inflation into their retirement plans, they would need to save $5,777 per month to reach their goals. That means we would need a balance of $3,050,000 in order to provide an inflationary income of $100,000 per year in today’s dollar value. So, if he takes $50,000 from his retirement assets to buy his new boat, he would then need to put back $5,906 every month. By making this one purchase, they increase the amount that they need to save each month to meet their retirement goals.
Now, there’s a certain national radio celebrity who claims that you should be able to get a 10% + return in the market. However, I disagree, strongly, with him on this topic. I agree that, over a long period of time, the market has done well historically. But past performance is not indicative of future results. So, we don’t know what’s going to happen with the market in the future.
For the sake of argument, let’s assume an average return of 10% between now and our retirement. If that were to happen, our couple would still need to save $2,500 each month to meet their retirement needs. Now, I want to say, once again, that I understand the desire to buy a new toy. I’ve been cruising around on the same pre-owned pontoon boat for the past fifteen years. I desperately want to buy a new boat! However, in doing so, I could be robbing my future self for immediate pleasure. So, before you make an impulsive decision, ask yourself, is now the time to make extravagant purchases?
You never want to take money from your accounts when they are down because of market contraction. Instead, you want to take money from them when they are up. Regardless, there are going to be taxes involved. If you do cash in on your investments, you might face capital gains taxes. One of the most common questions that I’ve received over the past few weeks is what will happen if you take money from your IRA or 401k because there’s no 10% penalty under the CARES Act.
It’s true. You don’t have the penalty but you do have an ordinary income. For business owners, especially those who’ve received money under the Paycheck Protection Program, there will be some phantom taxes involved with that. What about your business? Are you one of the business owners who have recorded banner years? And now you really want to pull money from your IRA and be taxed at the highest possible tax rate within your particular margin? Think about it. If you’re in a 24% tax bracket, the money that you withdraw from your IRA or 401k may not be subject to a 10% penalty but it is going to be taxed at 24%. Is it worth it?
Regardless of whether or not you have the cash flow to buy yourself that fancy new toy, you need to be smart about it. Speak with your tax planner or financial advisor first. You don’t need to sacrifice your retirement in order to enjoy life now. Likewise, funding your retirement in a responsible manner doesn’t mean that you can’t enjoy your money in the present. You might actually be better off taking out a loan to make that extravagant purchase than you would if you pulled the money from your retirement assets. I definitely prefer paying 3-7% in loan interest than giving 25-40% of my money to the government.
Folks, this has been a difficult year. I understand the need to splurge and treat yourself sometimes. But take this information into consideration and speak to your financial advisor before making a decision that could be very expensive in the long-term. Hey, life is good. Life is hard. But with a little planning, enjoying our money can be at least financially simple. Let’s go out and make it a great day!
If you have questions about the long-term effects of cashing in on your retirement assets or just need the help of a competent financial advisor, contact us. The team at Financially Simple is ready to help!