Most of us seem to be pretty good at spending. Whether paying for necessities or buying something we want to have or think we should have, we will spend what it takes to get the item. If we are awash in cash and liquid assets, then maybe there will not be any real problem unless we get to the point that we are actually running out of money.
Working in financial planning, one comes to find out that many forms of spending (without regard to the amount or rightness of that spending) can get clients into serious financial trouble. This may be so even when a client seemingly has plenty of money and a high net worth. There are the obvious problems such as losing one’s high-paying job and being unable to find equivalent employment or becoming disabled and unable to work or even suffering a significant financial loss such as the failure of a business or investment. Most of us are aware of these potential problems and have created an emergency fund or purchased disability insurance or taken other steps to mitigate the possible problems at least to some extent.
There are other, less obvious but still serious problems that may arise in funding our spending that are tied to the source of that funding. One example is the early withdrawal penalty applied to withdrawals from qualified retirement plans or annuities prior to reaching age 59½, which, in addition to the income taxes due on these sources of funds, greatly reduces the amount actually available to cover the spending. Another example is the application of surrender charges to certain annuity withdrawals, reducing the amount available to you to fund that spending goal.
A different category of friction involves the cost of professional services required to handle a financial transaction, such as an attorney or realtor or the like. If the source funding your spending is not liquid, there are often costs associated with accessing those funds along with the potential for delay in receiving the proceeds and, of course, those ever present taxes (income, sales, gift, and more). Taking out a loan or using a credit card or line to fund an expense – something often done for larger purchases but also for other less expensive items– means encountering not only the ongoing interest to service the loan but also the possibility of assorted closing costs, the payment of points, commissions, fees and more.
The bottom line is for you to be aware of where the money is coming from to pay the expense you are considering making or have just “paid”. If it comes from a source that may be interrupted (income) or a source that carries additional costs (retirement plans, annuities, loans, sale of property etc.), you need to know what those potential costs are, how they will affect your available proceeds and how your financial plan may be impacted going forward. Remember, think first.