When I am talking to retirement plan participants, a frequent question I get is “should I contribute to my retirement plan?” To answer this question, you must understand the three different types of money.
“Now” Money
This is the money in your checking and savings accounts. You might also consider life insurance cash value or lines of credit, basically anything that you can get to inside of a week. Some folks would say anything you can get to inside of 7 minutes at the ATM, which precludes those last two items. That’s fine, but the point is this is the kind of money that you can get whenever you need it for whatever you need, and you don’t have to ask anyone’s permission – the Department of Labor, your employer, your Trust account – no one.
“Later” Money
This gets into retirement plan balances as well as IRAs and Roth IRAs. But this is also where we would categorize earmarked expenses that aren’t going to happen for a while. Think in terms of the down payment on a house that you plan to buy in three years. It’s not now money, but it is going to be used sometime in the future. You might also categorize a business buyout, a pension income stream or an annuity, or anything else that you stand to receive later in life. Think = not super liquid…yet.
“Never” Money
This is the money that you never planned to use. Most of our clients have more assets than they will ever spend down. This means they will be passing something on to someone. This doesn’t mean necessarily that they will be passing on 100% of everything to their kids. But as many wealthy families might tell you, the same things that mom and dad practiced that created their own wealth, they passed down to their kids and these principles are often helping the kids build their own wealth.
What’s the point of this? A few things:
- First of all, it’s helpful to have clear delineation where necessary. You don’t want to be putting everything that you have into “later” money, and then get caught off guard by a short-term expense that you can no longer cover because you’re 100% illiquid.
- You also don’t want to do the other extreme, which is to save nothing for the future and to have everything in “now” money. This mistake has two major ramifications: Lack of investment growth because you are too conservative, and an inability to fund life down the road, because your cash earning nothing at the bank couldn’t keep pace with inflation.
- Whenever possible, it is helpful to have an asset serve multiple purposes if it can. Let me give you an example: Your Roth IRA is at the very least “Later” money. But if you never spend it, the government never forces it out (yet), and you can pass it on tax free to your heirs. Not bad. Another example would be permanent life insurance: one reason people get it is for the “never” money, just in case their “now” and “later” time frames get cut short by their unexpected passing. That’s fine, but when structured correctly, some life insurance policies can actually provide tax-free cashflow, and you don’t necessarily have to wait until you’re 59.5 years old to get at it (looking at you, ERISA regulations).
Several of these examples bear further explanation on an individual basis, and none of them are a direct recommendation for you personally. But these are some of the things that you maybe should think through as you are setting up for future cash flow.
When you ask yourself if you are going to have enough money to afford something, it sure helps to know which type of money we’re talking about.