What to do with All that Extra Money

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What to do with All that Extra Money?

• Dr. Alex White
• Dept. of Ag. Applied Economics
• 540-231-3132
• axwhite_at_vt.edu
• http//faculty.agecon.vt.edu/alexwhite/

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Uses of Excess Cash

• Build your savings account
• Pay down your debts
• Invest in farm/business assets
• Invest in yourself/family
• Invest for retirement

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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

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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

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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

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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

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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

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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

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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?

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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

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10 Years Later

• Option 1
• You own 10 4-wheelers
• Youve saved 33,000 in income taxes
• Option 2
• Youve saved 20,000 in taxes
• Account is worth 156,500 (8)
• On 100,000 of principal
• No taxes on the growth until withdrawal

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30 Years Later

• Option 1
• Youve 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, thats only 890,000 (20 MTB)

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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

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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

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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

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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

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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

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Where to Open a Retirement Account

• Banks, credit unions (usually)
• Insurance agencies, brokers
• Financial planners
• On-line
• Only if you know whats going on!
• Annual fees?
• 25-100/year maintenance fee

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What are My Options?

• CDs not good for long-term
• Stocks riskiest, highest return
• Bonds safest, lowest return
• Mutual funds combo of stocks bonds

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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)

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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!

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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

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Uh, what if theres 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!

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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