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By Jeffrey W. Kirshner, CPA*, PFS, MBA
Of the many concerns I hear from the people I work with, two of the most common are: Retirement Planning and College Planning. People are very aware of the need to save money, and if you are like most people, you have genuine concerns about enjoying retirement and paying for kids’ college educations while still having enough to deal with other areas of concern such as caring for elderly parents, the rising cost of living and the increasing tax burden. Therefore, you understand that losing money hurts your balance sheet and jeopardizes your financial security. Unfortunately, what many people do not realize is the potentially devastating effect to which it does. Let’s look at the real costs of losing money.
Cost Number One – The Out-of-Pocket Outlay
When you incur an expense, you usually see what is obvious…dollars leaving your pocket. You pay for dinner out with friends and you leave cash on the table; you lease a car and write a check for that every month, you buy new clothes and household items on your credit card and pay the full bill (hopefully) at the end of each month. These are all simple examples of dollars that you possess that subsequently leave your pocket. Therefore, the total cost of an expense is usually measured in these terms. What most people fail to see is that the real cost is far, far greater. In fact, there are three costs that you incur when money leaves your balance sheet:
There is no one correct definition of a successful retirement. However, what I often hear from clients in some way, shape or form is that a successful retirement can be defined as one that provides sufficient assets and cash flow to achieve income, lifestyle and legacy objectives. While you cannot predict the future, you need to prepare for what is probable and still protect against what is possible. What is probable is that a healthy couple approaching retirement age (let’s assume age 65) has a 50/50 chance that one of them will live to be age 95. Knowing this at age 45 can help you make better cash flow decisions about how much you spend and how much you save.
Let’s take a look at the impact of various cash flow decisions until retirement only (for now); so let’s say 20 years. And, let’s say we are planning for college for you child. Generally, when the topic of planning for college comes up, people generally want to know about and focus on college funding vehicles such as 529 Plans, Coverdell Education Savings Account, Uniform Gift to Minor Accounts, Life Insurance, etc. While this is most certainly a good conversation to have, it is secondary to assessing the true cost of college funding.
For our example, let’s assume that you paid for college for your child at the rate of $50,000/year. You clearly see the first cost: that is, the actual out-of-pocket outlay for the expense (tuition, books, fees, etc.) of $200,000 in total. In this example, there is no return on that money other than perhaps the satisfaction you receive from your child getting a good college education.
Cost Number Two – The Time Value of Money
This is the second cost that many people don’t measure. Every time you lose a dollar, you lose not just that dollar, but everything that dollar could have become for you if you had saved or invested it. That is, if it were earning a rate of return, it would have grown into something far greater than the $200,000 out-of-pocket outlay. This cost is called the Time Value of Money (TVOM).
Loosely described, this is an opportunity cost. It’s a way of measuring the cost not only of money that leaves your wallet, but also the cost of money that never gets the opportunity to get into your wallet. A good way to measure is as follows:
Consider that the rate of return on a dollar that is lost is not 0%. It is way worse than this…it’s -100%. The loss of it is not a risk; it is a guarantee. Therefore, if you can develop a strategy that allows for a reduction or elimination of that expense, and if you can find an asset somewhere else on your balance sheet that carries a rate of return greater than -100%, then you should be able to put those savings into that asset and have more money on your balance sheet. I typically describe the TVOM rate as being the best after-tax return that is available to you.
In our college funding example, it might be that your 401(k) is providing you with a long-term rate of return of 8% pre-tax. If you net that out for taxes, then that might mean an after-tax rate of return of 5%. So, if you could have held on to the $200,000 for 20 years instead of paying for college, then by retirement you’d have not only the assets that you gave away for college but an additional $330,000. Therefore, the payment of tuition, books, fees, etc. really cost you $530,000 that could have been on your balance sheet at retirement.
Cost Number Three – The loss of potential retirement income
And that brings us to the THIRD COST. At 65, by not having $530,000 on your balance sheet and not being able to earn a decent return during retirement (let’s say 5%), you forego potentially as much as $26,500/year in retirement income if you spent income only and over $40,000/year if you consumed principal and interest over 20 years.
This is all just the cost of college! When you begin to compile ALL of the areas where you incur costs, the numbers can become astounding. Of course, not all costs can be avoided. Some costs such as certain taxes and insurance premiums are ones that need to be paid in order to avoid negative consequences, financial or otherwise. However, it is imperative to think differently about how to mitigate the impact of costs you incur.
There has been an entire industry that has risen out of the need to help parents plan and save for college, yet very few people are talking about how to help you not just save for college, but also how measure the true cost of it and then devise a strategy to recover that cost during retirement. If you could devise a strategy that allows you to both pay for college AND not suffer from the potential loss of retirement income, then it is a win for everybody. Your child wins because he/she completes college with no debt, and you enjoy the fact that you provided this invaluable benefit for your child with little to no impact on your retirement income.
Jeffrey W. Kirshner, CPA*, PFS, MBA
The Illuminated Wealth Solution ™
Jeffrey W. Kirshner is a Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). OSJ: 5080 40th Street, Suite 400, Phoenix, AZ 85018, (602)957-7155. Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is an indirect, wholly-owned subsidiary of Guardian. KIRSHNER & KLARFELD FINANCIAL GROUP, LLC is not an affiliate or subsidiary of PAS or Guardian.
*Not Practicing for Guardian or any subsidiaries of affiliates thereof
The views and opinions expressed herein are solely that of the author and do not represent the views or opinions of The Guardian Life Insurance Company of America, or its subsidiaries or affiliates thereof
California Insurance License #: 0D63609
Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation 2020-92739 Exp 1/22