In many of our prior posts, including our post of March 8, 2025, we have strongly encouraged readers to estimate the potential impact on their Funded Status before making a significant financial decision. In the March 8 post, we looked at how easy it was for a hypothetical couple to crunch the numbers on whether they could afford to go on a dream world cruise.
In this post, we will look at a slightly more complicated financial decision—Can I afford to buy something that involves not just an upfront cash outlay, but also involves ongoing annual costs and may also involve some future income during the period of ownership or when the item is eventually sold.
Such items could include, for example, purchase of:
- A vacation home
- A camper van
- A boat
- An automobile
- An updated kitchen
- A rental property
- A business,
To estimate the impact on your Funded Status of the possible purchase of one of these items, you will need to estimate:
- The upfront purchase cost of the item,
- The present value of additional annual expenses associated with the item, and
- The present value of any additional income expected from the item during the expected period of ownership and/or upon sale of the item.
Once these items are estimated, you will need to decrease your total assets in the Actuarial Financial Planner (AFP) by the result of Number 1, increase your total assets by the result of Number 3, and increase your spending liabilities by the result of Number 2 to develop a post-purchase Funded Status.
Let’s look at an example
Example
John and Mary’s Funded Status as of January 1, 2025 was 140% consisting of a total present value of assets of $2,100,000 and total spending liabilities of $1,500,000. They would like to know whether they can afford to buy a lake house about 2 hours away for $400,000 in addition to their current home. They agree that they would like to own the property for ten years, not rent it out and sell it after 10 years. They estimate that the additional annual costs of owning the property (property tax, gas and electricity charges, insurance, upkeep, transportation back and forth from their current home, etc.) will be about $10,000 per annum in 2025 dollars and will increase with inflation each year. They also assume that they will be able to sell this property after 10 years for the same price they paid for it (i.e., no increase due to inflation).
Number 1—cash outlay of $400,000. Note that if they take out a mortgage on the property, item Number 1 would be the amount of the down payment and item Number 2 would include annual mortgage payments.
Number 2—Using the AFP, John and Mary enter the following amounts in one of the non-recurring expense rows.
Annual Amount | Deferral Period | Payment Period | Annual Rate of Increase | % Upside (assets) or |
$10,000 | 0 | 10 | 3% | 0% |
The PV Calcs tab of the AFP shows that the present value of this stream of non-recurring expenses (determined using a discount rate of 8% per annum consistent with 100% discretionary expenses) is $81,541
Number 3—Using the AFP, John and Mary enter the following amounts in one of the other asset rows.
Annual Amount | Deferral Period | Payment Period | Annual Rate of Increase | % Upside (assets) or |
$400,000 | 10 | 1 | 0% | 0% |
The PV Calc tab of the AFP shows that the present value of this $400,000 payment ten years from now using a discount rate of 8% is $185,277.
John and Mary recalculate their beginning of year Funded Status by subtracting the purchase price of the lake house ($400,000) from their beginning of year asset value and adding the present value of the expected sale price ten years from now ($185,277) to obtain estimated post-purchase assets of $1,885,277. They then add the present value of the additional annual costs of $81,541 to their beginning of year spending liabilities of $1,500,000 to obtain an estimate of post-purchase liabilities of $1,581,541, and an estimated post-purchase Funded Status of 119% ($1,885,277/$1,581,541).
By crunching these numbers, John and Mary now have important information they can use to answer the question of whether they can afford to purchase their dream lake house. Based on the assumptions used in the calculations, their 2025 Funded Status is expected to decrease from 140% to 119% as a result of this purchase. Of course, they can easily vary the assumptions used to perform these calculations to further assess their financial risk. While they are still above 100%, their Funded Status is not quite as robust as the pre-purchase level.
Each future year, John and Mary plan to revisit this calculation as part of their annual Funded Status valuation. If actual experience differs from their assumptions about the future, relative to this purchase or any other part of their financial plan, they may have to increase their assets (by selling the lake house earlier than planned for example) or decrease their discretionary spending if their Funded Status drops below 100% in the future.
Summary
One of the most important financial questions households encounter in life is “how much can I afford to spend?” The name of our website is “How Much Can I Afford to Spend in Retirement?”, so this question is our primary focus. And while most of our attention is concentrated on spending by retirees and near retirees, the same concepts (and spreadsheets) can be used by younger, non-retired households. We will discuss how younger, non-retired households can use our spreadsheets for financial planning purposes in a future post.
Would John and Mary in our example above be able to rely on the 4% Rule (or its many variations) or most Monte Carlo models that tell you that you have a 97% probability of being able to spend $X per year to answer the question posed in this post? We don’t think so, and certainly not as easily. This is one of many reasons why we believe that you and/or your financial advisor should be using the Actuarial Approach that we recommend in your financial planning.
