Can I Afford to Buy that Dream Lake House (or Some Other Big-Ticket Item)?

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 homeA camper vanA boatAn automobileAn updated kitchenA rental propertyA 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, andThe
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 exampleExampleJohn
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 AmountDeferral PeriodPayment PeriodAnnual Rate of Increase% Upside (assets) or%Essential (Liabilities)$10,0000103%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 $81,541Number 3—Using the AFP, John and Mary enter the following amounts in one of the other asset rows.Annual AmountDeferral PeriodPayment PeriodAnnual Rate of Increase% Upside (assets) or%Essential (Liabilities)$400,0001010%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.SummaryOne
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.