What to do with All that Extra Money?

1. What to do with All that Extra Money? Dr. Alex White Dept. of Ag. & Applied Economics 540-231-3132 axwhite@vt.edu http://faculty.agecon.vt.edu/alexwhite/

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

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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?

10. 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

11. 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

12. 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)

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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

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

20. 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)

21. 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!

22. Retirement Planning Worksheet • Excel spreadsheet • Estimate your annual contributions • To meet your retirement goals • Will be posted on website within 2 months • Can e-mail it to you before then

23. 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!

24. 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