Retire Debt or RetireMent

**disneysteve** · 12-22-2007, 07:22 AM

Is your "nest egg" in retirement accounts or in regular taxable accounts? If it is in taxable accounts, keep in mind that you are paying taxes on your gains each year. When you take that into account, are you still doing much better than 7.5%? If so, then I'd stick with it. If not, or if it is fairly close, it might be worth reducing some debt.

As for the IRAs, I guess that also comes down to investment return. If you can put the IRA money somewhere with a return considerably better than 7.5%, that's worth considering, but 7.5% is pretty high.

I assume you are earning a pretty substantial income since you anticipate paying off $400,000 in debt in 8 years. That's over $50,000/year including interest.

Kind of a tough call because the 7.5% rate on the debt is higher than you can earn with any lower risk investments. If the market takes a slide, your equity funds may not outperform that 7.5%.

**jIM_Ohio** · 12-22-2007, 01:11 PM

I think the magnitude's of the nest egg (how large is it) and the debt (how much is it), relative to current income... is the issue to look at.

As you present it, I see some good things:

1) you have a plan (based on rates of returns)
2) the plan is working (out of debt in 8 years)

I see some gaps
1) how much do you need to retire on?
2) how much is in retirement accounts now?
3) when will you retire?
4) what will you do when business loan is paid off?

**Fern** · 12-22-2007, 02:13 PM

I would fully fund the IRAs each year as they enjoy extra tax advantages and you need that retirement nest egg to grow over the years.

**Scanner** · 12-22-2007, 03:22 PM

Being in business myself, I would humbly suggest to you that "it depends."

Everyone likes to think their business would and will last forever but every small business goes through 4 phases:

1. Start-up
2. Growth
3. Profit
4. Leisure/decline

The best time to sell is #3. The best time to retire debt is #3 if you are just going to stick with it through the years.

I'll give an example. My friend upstarted a small Internet Service Provider circa 1996, before the real internet boom. Circa 1999, a lot of big ones swallowed up the small ones (AOL tookoff like gangbusters. . .so did Verizon).

He tried to convince his partners that that was the time to "cash his chips in" - time to sell it. They didn't beleive them. Now. . .he's kinda stuck in it (he's since expanded another "division" - computuer repair which is the more profitable now, the ISP barely holds it own).

I guess my point is you should have a 10 year vision of where you are going to be. If it's possible your industry could go through a decline/retraction, I would go with some debt reduction. I don't necessarily see people never needing insurance again but I don't know how that works with big guys swallowing up small guys and the trend with "skipping agents" (GEICO, etc.). I don't know your business; you do.

Your accountant can be instructive here too, as business debt interest is a 100% write-off, from what I understand. It's probably not best to totally retire your debt but maybe you'd want to work it down to something a little more comfortable.

**InDebtInDC** · 12-22-2007, 06:00 PM

I would advise small business owners to stash money elsewhere as much as possible beofre phase 4 comes.

**Scanner** · 12-23-2007, 01:32 PM

I think if you also take instruction from some of the big companies, they go through phases of debt reduction and debt accumulation (vs. our gov't, which just constantly accumulates debt)

I may set a goal of reducing it to $200,000.

If you had to liquidate your business today, what would you get for it?

That's a good start for getting a grip on what you should do personally.

**boog** · 12-26-2007, 07:03 AM

Hey guys! Thanks for the responses. Sorry for the delay in my reply, I thought I had the email notification on. Got that fixed. Ok, on to your quesitons/responses:

Originally posted by disneysteve View Post

Is your "nest egg" in retirement accounts or in regular taxable accounts? If it is in taxable accounts, keep in mind that you are paying taxes on your gains each year. When you take that into account, are you still doing much better than 7.5%? If so, then I'd stick with it. If not, or if it is fairly close, it might be worth reducing some debt...

Sorry for leaving out that tidbit. Yes, the nest egg is in a regular taxable account. And yes, I pay a pretty penny in taxes every year due to capital gains pay outs. Even so, I am still pretty sure I come out ahead. On 01/01/2007, I had $231k. Today, I have $265k (13%). It looks like I am going to have somewhere in the neighborhood of $15k in capital gains/dividends, so at a 15% tax that's just $2250.

....I assume you are earning a pretty substantial income since you anticipate paying off $400,000 in debt in 8 years. That's over $50,000/year including interest...

We are fortunate that we were making diddly-squat up to this year, so we are used to living on less than $30k a year. Therefore, when we started making more money this year, we continued to live as though we made $30k and put the rest of the money toward debt and taxes.

Originally posted by jIM_Ohio

I see some gaps
1) how much do you need to retire on?
2) how much is in retirement accounts now?
3) when will you retire?
4) what will you do when business loan is paid off?

1. Good question. I'd like to have grown my assets enough at retirement to live more than comfortably. I have done a bunch of calculations and it all depends on inflation and how the market does and, of course, when I retire.

2.) Right now, my retirement accounts add up to around $71k. At retirement, I will be pulling from those accounts, as well as the nest egg that is mentioned above, as well as the money received from the sale of my share of the business (currently $400k).

3.) That is a question I can't answer right now. I'd like to retire as soon as I know I can afford to. Somewhere in the 55-65 range. At that point, I'm not sure if I will stop working completely or pick up a part time position.

4.) Probably BEFORE the loan is paid off I will be adding to it. I have 2 other partners. One will be retiring in the next 5 years or so, and my other partner and I plan to buy him out. That will increase the debt another $200k (assuming no business growth between now and then). Additionally, my faimily is expanding and the small house we have is losing its practicality. In the next 5 years, we will probably be buying some land and building a house. Don't know how much we'll want to spend on it, but since it is going to be THE house, we'll probably be looking to spend $500k or so. After all that is paid for, there will be kids college tuition to pay for, nest eggs to create for them, etc..

Originally posted by Scanner

Everyone likes to think their business would and will last forever but every small business goes through 4 phases:

1. Start-up
2. Growth
3. Profit
4. Leisure/decline

This agency has been in business since 1889. Even with that much time, I'd say we are still definately in phase 2. Last year (before I became partner) was a record year, and this year the other partners were able to bring me in as partner, cut me in on 1/3rd of the profits and still take home as much as they did last year. So yeah, still in the growth phase.

...I guess my point is you should have a 10 year vision of where you are going to be. If it's possible your industry could go through a decline/retraction, I would go with some debt reduction. I don't necessarily see people never needing insurance again but I don't know how that works with big guys swallowing up small guys and the trend with "skipping agents" (GEICO, etc.). I don't know your business; you do...

With insurance, there is all sorts for expansions and contractions. We call them Hard and Soft Markets. We are in the middle of a soft (contraction) market right now. A pretty tough one. So far we haven't had much trouble with it. However, that's not to say that we take a hit this next year and see a decline in income by 1/3rd.

The pros/cons as I see it are this:

Use "nest egg" money for IRA
PRO
Moves money from taxable account to Tax Free account
Allows all available money to go to debt reduction
CON
Shrinks "useable" money (if something came up that I needed "nest egg")
No new money is going to higher interest returns
Creates a taxable event when I sell positions where I have high gains

**jIM_Ohio** · 12-26-2007, 09:21 AM

Originally posted by boog View Post

Originally Posted by jIM_Ohio
I see some gaps
1) how much do you need to retire on?
2) how much is in retirement accounts now?
3) when will you retire?
4) what will you do when business loan is paid off?

1. Good question. I'd like to have grown my assets enough at retirement to live more than comfortably. I have done a bunch of calculations and it all depends on inflation and how the market does and, of course, when I retire.

The number is usually something to effect of 25X income or 25X expenses, which implies 4% of assets are drawn down per year in retirement. I think you should analyze based on this assumption. For example if you are used to living on 30k, 25X this number is $750,000. When you have 750k in retirement accounts, you could retire with current spending patterns.

Originally posted by boog View Post

2.) Right now, my retirement accounts add up to around $71k. At retirement, I will be pulling from those accounts, as well as the nest egg that is mentioned above, as well as the money received from the sale of my share of the business (currently $400k).

My doubling math: (assumes 9% return)
71k at age 30
142k at age 38
284k at age 46
568k ag age 54
1136k at age 62

This shows you can probably retire before age 62 without adding much to the 71k currently in taxable accounts.

Originally posted by boog View Post

3.) That is a question I can't answer right now. I'd like to retire as soon as I know I can afford to. Somewhere in the 55-65 range. At that point, I'm not sure if I will stop working completely or pick up a part time position.

I would suggest coming up with a more clear goal. As I outlined above, you could retire at 62 with current spending patters based on the 71k invested already. Assuming you can find an investment with a 9% return each year.

Originally posted by boog View Post

4.) Probably BEFORE the loan is paid off I will be adding to it. I have 2 other partners. One will be retiring in the next 5 years or so, and my other partner and I plan to buy him out. That will increase the debt another $200k (assuming no business growth between now and then). Additionally, my faimily is expanding and the small house we have is losing its practicality. In the next 5 years, we will probably be buying some land and building a house. Don't know how much we'll want to spend on it, but since it is going to be THE house, we'll probably be looking to spend $500k or so. After all that is paid for, there will be kids college tuition to pay for, nest eggs to create for them, etc..

[/QUOTE]This does muddy the problem. Two reasons.

1) debt is increased
2) 30k income being used to set goals is probably not realistic for you.

I would NOT touch the 71k already set aside. There is a lot to be said for having money in the bank. What I would do is

a) continue with 8 year payoff schedule of the loan
b) add to this debt when you buy partner out
**consider this loan a cost of doing business**
c) set aside some money in tax favored accounts (IRAs, 401ks) for retirement now.
**the issue with this money is if spending increases beyond 30k per year, you will need more in retirement than my comments above**
d) set aside some money for a house down payment. Not sure of current equity in house, but my suggestion is put down only 20% (of 500k), which is 100k. Then finance the rest (probably at a rate of around 5-6%). This assumes the current taxable accounts grow at 9%+ and debt only costs you around 5.5%.
e) try to stay debt free outside of the business loan(s) and mortgage.

**boog** · 12-26-2007, 09:44 AM

jIM_Ohio, thanks for the reply.

Just to clarify, $71k is what is in the retirement accounts (IRA's). I have no intentions of touching that, for any reason, until retirement age or beyond. I have $265k in a taxable, joint account. That is what I am calling my nest egg. Maybe I should not have called it that.

Do you think a 10-year retirement period is too vague for a 30 year old?

I agree with your a,b,c, & d., but my question is HOW to do that.

In other words, I need to make IRA contributions to my and my wife's IRA. This would equal $8k. Where does that $8k come from? Does it come from money that I made this year, and reduce the money I would pay to debt reduction, or do I go ahead and put all my earned money to debt reduction, and move $8k from my "Nest Egg"?

**disneysteve** · 12-26-2007, 09:53 AM

Originally posted by boog View Post

I need to make IRA contributions to my and my wife's IRA. This would equal $8k. Where does that $8k come from? Does it come from money that I made this year, and reduce the money I would pay to debt reduction, or do I go ahead and put all my earned money to debt reduction, and move $8k from my "Nest Egg"?

I think your annual IRA contributions should be a line item in your budget each year. If you shift money from your "nest egg" to your IRA, you've gotten a tax advantage, but otherwise haven't actually saved anything. You've just repositioned it.

Think of your IRA the same way you think of your mortgage or electric bill or any other bill. Do you pay your mortgage out of current income or do draw down your savings to pay it? I'm guessing you pay it out of current income. I would treat the IRA the same way.

**jIM_Ohio** · 12-26-2007, 12:25 PM

Originally posted by boog View Post

jIM_Ohio, thanks for the reply.

Just to clarify, $71k is what is in the retirement accounts (IRA's). I have no intentions of touching that, for any reason, until retirement age or beyond. I have $265k in a taxable, joint account. That is what I am calling my nest egg. Maybe I should not have called it that.

Do you think a 10-year retirement period is too vague for a 30 year old?

I agree with your a,b,c, & d., but my question is HOW to do that.

In other words, I need to make IRA contributions to my and my wife's IRA. This would equal $8k. Where does that $8k come from? Does it come from money that I made this year, and reduce the money I would pay to debt reduction, or do I go ahead and put all my earned money to debt reduction, and move $8k from my "Nest Egg"?

I would NOT move money from a taxable account to an IRA. It is just shifting savings (re charactorizing if you will). This increases your current tax bill, and would make subsequent gains on the investments taxed at higher rates than if you left them in their current format.

I would
a) pay down the business loan
while
b) saving for retirement out of current income
while
c) saving for down payment on the house which costs 500k
while
d) staying out of credit card debt

If this means you pay less to the business loan, then that makes sense to me. If this means it takes 12 years to pay off business loan instead of 8, I think that makes sense, but you would need to compare interest rates to investment returns to opportunity costs of the additional 4 years of loan payments.

**Scanner** · 12-26-2007, 01:12 PM

I think debt reduction (not necessarily elimination) should be a priority also because even if #-wise, it's better to leverage the stock market against your debt, being self-employed and riding market contractions and expansions is very stressful.

I would reduce the debt to a level where it's easily retired.

My business loan balance is $7800. I know if there was an emergency I could pay it off. I don't worry about it too much.

I know with a $400,000 loan sitting out there. . .that's a very big matza ball hanging out there as my Jewish friends would say.

You've got $265,000 to work with?

I may put a big chunk down on it . . .maybe 100 to 150K.

**boog** · 12-26-2007, 01:33 PM

Thanks for the replies.

Scanner,

Ok. Here comes a curve ball. Does it change your thoughts if I told you that only $164k was financed at the bank? I started with $200k+, but have paid a lot off this year. The rest is financed through my parents, who don't care how long it takes me to pay it off. They are charging me 7% (to be fair to my sister), but I can pay them back whenever.

Yes, I have approx $265k to work with. If you combine all my taxable accounts its somewhere in the neighborhood of $230k. Additionally, I have a duplex that I rent out, and I have about $50k in equity there. I have about $40k in equity in my house.

All in all, I have a net worth of approx $425K, when you factor in the value of my retirement assets and the value I would get out of the business if I were to sell back to my partners (legally agreed upon formula). I realize I might not get that amount if times got tough and I had to sell to a competitor.

**disneysteve** · 12-26-2007, 02:11 PM

Originally posted by boog View Post

Does it change your thoughts if I told you that only $164k was financed at the bank? I started with $200k+, but have paid a lot off this year. The rest is financed through my parents, who don't care how long it takes me to pay it off. They are charging me 7% (to be fair to my sister), but I can pay them back whenever.

Well, from a strictly dollars and cents standpoint, it doesn't matter who the lender is. It only matters what the interest rate is. Of course, in your case, your parents aren't going to come reposess your belongings or put you in collections if you miss a payment and you don't have your credit report to worry about.

I'd still stick with my previous post and say you should fund your IRA out of current income and use what's left to repay debt, even if that means taking a little longer to repay the debt.

Retire Debt or RetireMent