The following is a guest post from Marc C. Shaffer, CFP®, AIF®, EA, of Searcy Financial Services, Inc.
When it comes time to make a major purchase, the funds sitting in your retirement plan may start to look very attractive. You may be tempted to borrow from your retirement plan to fund a new home, vehicle, a child’s wedding or their education. To avoid the temptation, develop a strategy now to prepare for these purchases and help you remain debt free.
One effective strategy is prefunding major purchases. From vehicles to vacations, there is a simple formula that can help you make these purchases without incurring any additional debt. Determine the total amount you will need for your purchase and the number of months you have before the money is needed. By dividing the total needed by the number of months available before the purchase, you will know the amount you must save each month.
Total $$$ Needed / (divided by) Number of Months Before $$$ Needed = $$$ to Save Each Month
To pre-fund for major expenses for which the purchase date is not concrete, you can decide upon an assumed date so these purchases don’t catch you unprepared. This will allow you to plan for future imminent purchases such as a new water heater for your home or computer system for your business. Consider this vehicle example, where a new purchase is inevitable, but no exact purchase date has been set:
Vehicle Purchase Example
Vehicles rarely last forever, so you can safely assume you will need to purchase a vehicle in the future. Let’s also assume you would take out a loan when the need arose in order to finance the vehicle. Consider using the prefunding strategy instead:
Let’s assume that you generally drive a vehicle for 10 years before replacing it. This gives you 10 years, or 120 months, until you plan on purchasing a replacement vehicle. Likewise, if there are two drivers in your family, and each plan on driving their vehicle for 10 years, you would essentially be replacing a vehicle every 5 years, or 60 months. Let’s also assume that the replacement vehicle will cost approximately $30,000 and you plan to get $5,000 for your trade in. This leaves you with approximately $25,000 for each replacement vehicle. So, you have 60 months to save for each purchase that will cost you $25,000. If you divide $25,000 by 60 months, that works out to $416.66 per month. If you deposit $416.66 each month into a money market savings account specifically earmarked for vehicle purchases, you will be able to purchase your next car and your partner’s next car with cash.
Your retirement funds are set aside for the purpose of retirement, not major purchases. Don’t set yourself back by chipping away at those funds throughout the course of your life. By prefunding and reducing your amount of loans, you will be more financially stable should an emergency hit and won’t have to borrow from the nest egg you’re working hard to build. Remember, taking a loan from your plan also means a loss in compounding investment returns! Do you have a purchase on the horizon? Start counting the months now and save, save, save!
Marc C. Shaffer, CFP®, AIF®, EA, is a principal of Searcy Financial Services, Inc., a registered investment advisory firm in Overland Park, Kan. For more information, visit www.SearcyFinancial.com. Follow us on Twitter at @SearcyFinancial.
* Guest bloggers sometimes endorse specific investments, general investing strategies or other products/services/ institutions that we do not recommend or have not analyzed. Reviews and endorsements in this post should not be interpreted as a recommendation/endorsement by Smart401k.
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Smart401k is a web-based investment advisory service providing unbiased recommendations to help people invest in employer-sponsored retirement plans. Smart401k provides service to nearly 11,000 clients who collectively have more than $2 billion in assets. Plan participants receive personalized, fund-specific investment recommendations and the support of professional investment advisers available to discuss all investment questions. Based in Overland Park, KS, Smart401k is online at www.Smart401k.com.