An Addition To Our Edible Equity

My employer takes its fiduciary responsibility to its employees via the 401K pretty seriously for a relatively small business.  One of the perks of this is that we have free access to quarterly meetings with a fee-only financial planner, with my employer picking up the tab.  This is an awesome perk that I’ve only recently started taking advantage of.  

Last week was my 2nd ever meeting with FP (the financial planner), and my goal was to try and figure out what his thoughts were on us putting more money into non-retirement accounts (at the expense of 401K contributions) if we want to break out of the 9-5 grind before the retirement accounts get “unlocked” at age 59.5.

You see, I don’t tend to think of our net worth as a single number that when we hit, we’re set.  I tend to focus on what I call our “edible equity”.

 

What’s Edible Equity[1]?

Basically, when I think about our equity classes within our net worth, there’s equity that we can covert pretty readily into food (and other living expenses), and equity that comes with big penalties or sacrifices for doing so.  The first pile is edible, the second inedible.


For me, the concept of edible equity hit me when I was listening to the audio-book of Seven Years to Seven Figures by Michael Masterson while running a while back.  In the book, it felt like Masterson was saying that if you had $1 million in real estate that appreciated at 10% per year, you could live off of the $100K per year in appreciation pretty comfortably.  And that struck me as odd.  I’m pretty sure I got some funny looks that morning as I huffed out the words, “But you can’t eat your house!”[2] while running down the beach.  Real estate just isn’t edible in that way.  You can’t sell part of your house each year to take out the capital gains the way you can with other more liquid investments.[3]

 

How Edible Is Our Equity?

I’m using rounded numbers from our January 2013 Balance Sheet here, but things have changed slightly since then.

Edible

  • Cash – $42K – all very edible, yum!
  • Cars – $14K equity, call $8K edible since we could sell a car without too much issue
  • Duplex – $97K – very edible, though best consumed (for now) in small bites via the cash flow from renting
  • Investment Lot – $30K equity (netting out the $50K loan to Mr. PoP’s folks here), but we’ll call it $25K edible to account for 6% realtor’s commissions if/when we sell
  • Edible Total – $172K  

 

Inedible

  • Our House – $66K equity, all inedible.  We see selling and renting as a wash at the current market value/rents.
  • Roth IRAs – $97K all inedible until 59.5, right?
  • 401Ks – $101K also inedible until 59.5, right?
  • Inedible Total – $264K

Puts things in a bit of perspective to think of more than half of our equity as being “inedible” or “not yet ripe”.   But is this 100% correct?  That’s why I wanted to talk to PF.

 

Retirement Accounts Aren’t Entirely Inedible

Back to my meeting with PF last week.  I said:

“I’m trying to figure out at what point we should stop (or slow) contributions to our 401Ks and IRAs in favor of accounts that we could access sometime in the next 29.5 years.  Any advice?”

And here’s where PF surprised me.  “Well, think about your retirement accounts as locked jars, but with very small well-defined spouts built in.”  And then PF told me two things that I had not realized.

  1. Roth IRAS have big penalties if you pull out the gains early, but you can pull out your contributions at any time without penalty.  Good to know, but I don’t think this changes our long-term view of the edibility of our Roth accounts since contributions will end up being such a small chunk if we just let it grow a while.
  2. Our 401Ks (after we leave our jobs) can be rolled into a “stretch IRA” that we could pull money out of following the 72(t) early distribution rules – basically yearly small government-defined bites as required distributions.  This definitely changes how we look at the 401K’s edibility over the medium term (ie the next 10-29.5 years).

So of course, now I have a spreadsheet (geek time!) that I built that lets me play around with “eating” from different piles of equity starting at different times.  Our finances haven’t changed in the last week, but finding out that a fairly large chunk of our assets that I thought were completely inedible aren’t, definitely changed how I viewed our 5-10 year plan.

 

Do you tend to think about all of your assets in one big pile, or split them out into separate parts the way we do?  What do you think about my “edible equity” term?  Think we can get it defined in investopedia?

 

[1]  This is my own definition here, so feel free to disagree.
[2]  Unless you are the witch from Hansel and Gretel, in which case you have other problems.
[3]  I do concede there are ways to tap equity in real estate, but the oversimplified version in the book didn’t address it.

47 comments to An Addition To Our Edible Equity

  • It took me a minute to figure out what you meant!

    We seperate our assets out….cause like you said….some are easily accessible and others aren’t.
    Holly@ClubThrifty recently posted..Debt: 4 Reasons to Leave Debt Behind TodayMy Profile

  • I separate out my IRA and 401k accounts on my spreadsheet for this reason. It’s extremely satisfying to see my retirement balance grow, but separating them from my other savings reminds me that I can’t access them for decades to come!
    Tina recently posted..It’s Okay to Stick Out Like a Sore ThumbMy Profile

    • Exactly! It’s one of the reasons that I don’t get super excited when the market value of our house goes up, too. It doesn’t change that it’s still the place I live, so the increase in value doesn’t do anything except raise taxes =)

  • This is one of those topics I’ve always wondered about since I’ve never seen a post quite like this. I too have a wonderfully complicated spreadsheet, and I ran into issues when I factored in dispersments once I retire (early). Because its at least 10 yrs off for me, I haven’t worried about it too much. Id be nervous to take the roth principle out when im young… but maybe that’d the best way to go. Im sure your spreadsheet has showed you the answer.

  • trudy

    I don’t even think of my house and cars as equity, because I plan to keep them and use them until I croak.

    Since I’m retired I keep three piles of assets: non-IRAs, which is what I live off first (and could live off for much longer if the Fed didn’t have it in for savers), Traditional IRAs which I would live off next and will have to start taking required distributions from shortly, and, last to touch, Roth IRAs.

    I crunch numbers each year to see how much I can convert from a Traditional IRA to a Roth IRA without a significant impact on my taxes. I started doing this some years ago, but I should have been more aggressive about it. Not only does it put money in a place that has tax free earnings even when you take them out, it reduces the required minimum distributions from the Traditional IRAs.

    It’s really quite amazing if you crunch numbers about how much you will owe in taxes if your income changes a bit, as I learned when factoring in the conversions. My state socks it to even low income people whereas the federal taxes are decently low for low income people but then really go up fast as income goes up.

    • I tend to look at one of the cars as edible since if/when we stop working, we plan on becoming a one car household.
      Sounds like you have a similar set of piles to what we’re looking at. We’d touch taxable investment accounts first, then start 72T distributions from a stretch IRA, and touch the Roth IRA money last.

      What state do you live in that taxes low income popele so much? We’re lucky to not have state income taxes.

      • trudy

        Rhode Island. I think it’s because they do not let you use the federal deductions. Everyone gets a flat deduction.

  • I think of it as liquid vs. not. There are ways to turn illiquid investments into more liquid investments, for example, re-amortizing your mortgage (or taking out a home equity loan).

    http://nicoleandmaggie.wordpress.com/2012/11/05/november-mortgage-update-under-100k-and-playing-with-amortization/
    nicoleandmaggie recently posted..I had a midlife crisis in class todayMy Profile

    • I guess I look at home equity loans as different from taking capital gains from a stock account since you’d have to pay them back – and with interest. So while it frees up some equity for a time, it doesn’t really let you consume it wholeheartedly in my eyes. (And don’t get me started on reverse mortgages…) That’s why I put the footnote with the caveat in there. =)

      • But, if you have an equivalent amount in an illiquid asset that becomes liquid later, it is a way to bridge to that retirement savings, say, for example, in the case of an emergency. That way you can feel free to put more money in the tax-advantaged illiquid assets rather than keeping more in the liquid assets than you really need “just in case”. You might still be better off maxing out those tax advantaged illiquid funds if you have a way to increase liquidity in an emergency.
        nicoleandmaggie recently posted..I had a midlife crisis in class todayMy Profile

        • You’re definitely right about using RE as collateral for a bridge loan, and I like the way you look at it “in case of emergency”. I don’t think I’d be comfortable building that into the “best case scenario” of our plan, but I can see it being a back up scenario if we hit bumps along the way.

  • I think anyone trying to retire early should try to position their funds to be more liquid, or edible in your terms. Dividend income would be almost useless to the early retiree if they were earned in retirement accounts. I intend to rely on rental income and stock dividends and appreciation in taxable accounts to fund my early retirement life. All edible sources as you say.

    • That’s what we’re counting on for a lot – rental income, taxable accounts, and probably the 72(t) distributions… but this isn’t set in stone. =)

  • Even though you can access your Roth contributions and 401(k) if needed, I still like to treat those as untouchable. No matter what age you plan to retired you’ll (hopefully) still need money after the age of 60 & having a fully intact Roth & 401(k) at that point would be a huge bonus.
    The First Million is the Hardest recently posted..The Case For A Higher Minimum WageMy Profile

    • I think there’s a balance, which is what I’m trying to calculate with my spreadsheet. We’d leave the Roth IRA intact as long as possible, but even if we can’t don’t anything to it after we turn 35, at 6% growth, it’d be almost $1m when we’re 60 on its own. I don’t think we’d be sacrificing the health of any of those accounts even if we did the 72(t) distributions.

  • What a brilliantly perceptive way to look at it!

    Never thought about it that way, but you’re absolutely right. And, without being able to articulate it this way, that’s why we decided to have the bulk of our net worth in stock. First, the dividends keep you fed every month. And, if you need throw a big party or go visit folks, you’re only a week or so from eating.

    Brilliant!

  • I definitely am aware that some of my assets are accessible while others aren’t but at this point it isn’t a big deal for me. Once I get into my 30s I think I will be paying a bit more attention but for now I am very comfortable with our asset allocation choices for edible vs inedible.
    Lance @ Money Life and More recently posted..How Disability Insurance Helped UsMy Profile

  • Ivy

    But you can withdraw penalty-free from your 401k once you turn 55, didn’t your FP mention that? The catch is that you can’t leave that employer before you turn 55 (IRS Notice 87-13). That is, if you retire at 55 your 401k is edible. If you want to retire at 53, then the 401k becomes inedible again, save for the 72(t) SEPP distributions you described above.

    Not sure if it makes a difference for you. For us it does, as I do plan to stay with my employer until I am 55, at which point I will qualify for medical benefits in retirement and can start withdrawing 401k. The kids will have just hit college, and we can go and see the world (again) :-)

    • If he did, I was not paying attention – so thanks for bringing it to my attention! (I told him to assume that we were leaving our employers at 40.) That definitely adds another variable to the mix that I’ll have to incorporate to the spreadsheet, but seems to go with the overall trend that shoring up the 401K is not a bad plan since we’ll be able to take the 72(t).

      Medical benefits are definitely a factor that I’m not 100% sure how to account for yet. I’m hoping within the next few years we’ll have a good idea as to where individual health insurance policies settle down cost-wise.

  • That’s a very appropriate term for what you describe.
    I can feel the squeeze that inedible assets are putting on our finances. Our 401(k) and house are the major assets we own ATM. The edible assets are something that we’re going to be working on once the debt is paid off.
    Would you consider the equity in a business that you own 100% edible or inedible? I could see the equity being inedible, but the dividends/profit you pocket as edible.
    Justin@TheFrugalPath recently posted..Are Drug Companies Buying Your Doctor’s Opinion?My Profile

    • I think I’d look at business equity the same way that I look at our rental duplex. It’s edible, but we get the most out of it right now if we bite it a little at a time rather than selling it. I think the same would go for a business that has a relatively steady stream of dividends or profit.

  • Have you heard of the 5 year Roth IRA rollover trick? This allows you access to chunks of your non-roth accounts without using the 72t rule. If you know the amount you need from your 401k or Traditional IRA 5 years before you need it, you can roll over that amount into your Roth IRA, wait 5 years, and then withdraw the principal (the rolled over amount from 5 years ago) penalty free! This method takes some forecasting and 5 years worth of pre-planning before starting the “pipeline”, but it’s a great way to access those locked away funds.

    • Hadn’t heard of that one – but it sounds like you’d definitely pay a premium on the taxes during the year you rolled into the Roth for doing so.

  • My hopeful is to have enough rental income to cover expenses until the magic 59.5 number. It is hard to decided whether to max out the tax deferred account vs put money into something you can withdraw at any time. I’m not sure if you’ll make investopedia, but that is certainly an easy way to understand retirement accounts.
    Kim@Eyesonthedollar recently posted..Credit Cards Are Giving Me a Free VacationMy Profile

  • Jim

    Great analogy Mrs PoP, Since I am a fan of food, I love the way you organized your investments into those which are edible and those that aren’t! You seem to be on a fiscally responsible path toward a young retirement!
    Jim recently posted..How Much Should I Have Saved for Retirement by Age 30?My Profile

  • This is super interesting. My husband and I have been throwing the word retirement by age 45. Basically at age 45, we want to have investments making money for us.

    This information is good to know!
    SavvyFinancialLatina recently posted..Are there cliches at your company?My Profile

  • Oh I also separate money into financial buckets. I don’t see the point in having most of my assets tied up in a house because I need a roof over my head, and the house isn’t producing cash. It’s not a liquid asset.

    I don’t see cars as a liquid asset because we need them.

    Retirement accounts are locked until I’m old, so I can’t even access that money.

    It’s all about the cash, or investments that return cash.
    SavvyFinancialLatina recently posted..Are there cliches at your company?My Profile

  • In our financial plans we were always building “buckets” of money.

    Although your real estate isn’t liquid, if it’s income producing property that may have been liquid. Couldn’t that income stream been part of your “edible” portfolio?
    Joe Saul-Sehy recently posted..Behind on Your Bills? 5 Easy Steps to SanityMy Profile

  • Interesting way to look at it, I like it! I don’t think I’ve really had too much thought about it but it has crossed my mind. You are right, you can’t eat your house so no matter what it’s worth, it is what it is. Although we could sell our home once paid for and move to a smaller home or a city where homes are cheaper. My parents have homes that are paid for and they live off the rent.. well not even that as their pensions are more than enough to keep them going. The rental money is just a perk for them I guess. Once we get rid of this mortgage I think we will start filling our buckets… as Joe says. Time to build up that “all very edible cash” as you put it lol..
    Canadian Budget Binder recently posted..Income Tax Is Like A Four Letter WordMy Profile

    • You’re right, we could move to a smaller house (though ours is pretty darned small for this area already!) or a less expensive area, and rent the house – though being remote landlords might be a wash by the time we pay rent/mortgage elsewhere.

  • Wow, Mrs. PoP. I’ve never thought about it that way before! We will now be re-thinking our investment plan – thank you!
    Laurie @ The Frugal Farmer recently posted..“Ya See, That’s What I Wanna Talk to You About”My Profile

  • I love picturing someone running down the beach huffing out “BUT YOU CAN’T EAT YOUR HOUSE.” lol.

    It’s awesome that your employer provides access to a free fee-only advisor. I’ve been thinking about investing in seeing one but I can’t bring myself to spend money on advice when it’s available for free online, on blogs like this one.

    The edible vs inedible savings is an ideal way of looking at one’s networth. It seems like you need $1M in edible networth, plus $1M in inedible networth to be able to retire. Maybe less where COL is cheaper, but not by much.
    Her Every Cent Counts recently posted..How Much Does It Cost To Learn How to Breathe?My Profile

    • Yeah, it’s pretty awesome that my company does it. It’s a smallish company with a 401K program, so they consider a CYA kindof thing that it’s worth providing the independent advisor to protect themselves as fiduciaries.

      I think $1M edible and $1M inedible would be more than enough. I think our levels are a bit lower than that, but we’re not in a super high cost of living area.

  • I find this article very interesting. I learned a lot. Nice topic to tackle.
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