Budgeting: Considering Retirement Accounts in Your Cash Flow

When you are calculating your personal cash flow position, the income that you use is your current actual liquid income.  This means that retirement plan contributions are to be considered an expense, not an income.  Though companies include pension plans in their cash flow computations, this is not something that an individual should do.

In general, until you reach the age mandated by your plan, most retirement plans are effectively off limits to most people. This is true of formal pensions and qualified plans as well as most 401(k)s, 403(b)s, and Individual Retirement Arrangements (IRAs). Many of these plans do allow their owners to borrow from them, but these borrowings have to be paid back and this is frequently done through increased payroll deduction, meaning the borrower has no option of defaulting. Further, there are “triggering events” that allow the owners of such plans to cash them out, but to do so involves penalties and dramatic tax consequences, meaning that a lot of money is lost by cashing out early.

The funds in your retirement plan does constitute and asset, and it should be  counted as such in your Net Worth Statement.  However, when calculating your cash flow, the amount you are currently contributing should be considered an expense.  You must do this because the funds you contribute are not readily accessible, nor are any profits you make inside the plan.  While the funds may be available in the case of emergency, they should not be considered regularly available cash.

There is an exception to this rule.  Roth IRAs are treated differently than other accounts.  This is because unlike most retirement accounts, the funds that are placed inside a Roth IRA are taxed at the time of deposit.  The invested funds are then allowed to grow without taxation.  Because of this, the funds placed directly into a Roth IRA may be deposited at any time without penalty.  Because these funds are readily available, they should be considered liquid cash.  It is important to not that profits from investments, rollovers and conversations can not be withdrawn at any time and as such they should not be used in this calculation.

Failing to properly allocate the amounts contributed to, or held in, retirement plans can radically affect your cash flow calculations. Treating payments into most plans, or the holdings therein, as part of your income; or failing to add these contributions to your expenses can lead to misleading and incorrect cash flow assessments. Similarly, not counting direct deposits into a Roth IRA as income may create an unduly pessimistic determination. The anomalous role of retirement accounts in calculating your cash flow deserves special consideration.