What to do with All that Extra Money? Dr. Alex White Dept. of Ag. & Applied Economics

Uses of “Excess Cash” Build your savings account Pay down your debts Invest in farm/business assets Invest in yourself/family Invest for retirement

Build Your Savings Financial safety net 2-6 months of living expenses  Housing, food, utilities, medicines, travel,... Improves your Current Ratio  Lenders like this! Emergency funds No/few income tax implications

Pay Down Your Debts Start with the high-interest debt  Credit cards, consumer loans  Operating lines Will reduce life of loan, interest expense  Lowers your tax-deductible interest Builds equity faster Adverse income tax implications

Invest in Farm/Business Assets Productive assets!! Increase efficiency, profitability Expand size/scope Build for future generations Sizable income tax implications  Depreciation vs Section 179

Invest in Yourself/Family Reward yourself!  Vacation, new car  Impact on business? Education for kids (529 plans)  Some tax benefits Get recharged Few income tax implications

Invest for Retirement Aw, Social Security will take care of me  Replaces up to 40% of pre-tax income  Tax-minimizing strategies? Invest in land, farm assets  Gotta sell them to generate cash Sizable income tax benefits Helps in succession planning

Retirement Examples $10,000 “excess cash” Option 1 – buy a 4-wheeler  Check fences, cows, haul stuff, etc.  Write off Depreciation Expense (or 179) Lower your income taxes Option 2 – invest in retirement plan  Prepare for your “golden years”  Reduce your income taxes

Option 1 – 4-Wheeler Section 179  Reduces SE Taxes by $1,400  Reduces Income Taxes by $1,900  Total tax savings = $3,300 Does it increase profitability? What about next year?  Buy another 4-wheeler?

Option 2 – Retirement Plan IRA, SEP, SIMPLE, 401(k), etc.  Reduces SE Tax by $0  Reduces Income Tax by $2,000  Total tax savings = $2,000 $1,200 less than Sec 179 option Account grows tax-deferred  vs dep. of 4-wheeler Can invest again next year

10 Years Later Option 1  You own 10 4-wheelers  You’ve saved $33,000 in income taxes Option 2  You’ve saved $20,000 in taxes  Account is worth $156,500 (8%) On $100,000 of principal  No taxes on the growth until withdrawal

30 Years Later Option 1  You’ve bought 30 4-wheelers  Saved $99,000 in income taxes Option 2  Saved $60,000 in income taxes  Account is worth $1.2 million On $300,000 principal After tax, that’s only $890,000 (20% MTB)

Basics of Retirement Plans “Traditional” Plans vs “Roth” Plans Traditional  Must have earned income  Contributions are tax deductible  Earnings are not taxed until withdrawal When in a lower MTB?  Early withdrawal penalty of 10% (age 59 ½)  Required distributions at age 70 ½

Traditional Plans Traditional IRA  Up to $4,000/year $1,000 “catch-up” provision if over age 50 SIMPLE-IRA  Up to $10,000/year $2,500 catch-up provision SEP  Up to 25% of salary, $44,000/year max

Roth IRA Must have earned income Contributions are NOT tax deductible  $4,000/year + $1,000/year catch-up Earnings are TAX FREE Much more flexible  Can get to principal before age 59 ½  No required distributions

Other Retirement Plans 401(k), 403(b), 457  Employer-sponsored plans  Up to $15,000/year + $5,000 catch-up  Same basic rules as Trad-IRA Roth 401(k)  Same basic rules as Roth IRA Except for contribution limits

Other “Retirement” Investments Real Estate  Not liquid  Must sell to realize the gains Farm Assets  Need to continue farming or sell/lease Annuities  Wide variety  Not as much income tax benefits

Where to Open a Retirement Account Banks, credit unions (usually) Insurance agencies, brokers Financial planners On-line  Only if you know what’s going on! Annual fees?  $25-100/year maintenance fee

What are My Options? CDs – not good for long-term Stocks – riskiest, highest return Bonds – safest, lowest return Mutual funds – combo of stocks & bonds

How to Invest Know your risk tolerance!! Know your time frame Asset Allocation  Spreading funds between “stocks & bonds”  100 – Age = % in “stocks”  Remainder in “bonds” (safer inv.) Reallocate every 3-5 years (or so)

Start Early!! Age 25-65, $5,000/year  4%  $494,000  8%  $1.4 million  12%  $4.3 million Age 55-65, $5,000/year  4%  $62,400  12%  $98,000 Procrastination kills!

Retirement Planning Worksheet Excel spreadsheet Estimate your annual contributions  To meet your retirement goals Will be posted on website within 2 months  Can it to you before then

Uh, what if there’s no extra $$? Pay Yourself First!!  Then, live off the remainder  Build a monthly budget Save 5-10% of your income (first!)  Build savings account  Pay down high-interest debt  Then invest for retirement You can always put a few dollars aside!

Bottom Line Think about how you use your money Build your savings account Pay down your high-interest debt Reward yourself occasionally Start investing for retirement early!  Save on taxes at the same time!  Helps in transfer of farm