Over the years I’ve added categories of investors to my list. Age, health, and many other factors play a part in naming these categories. I’ve recently spoken with a gaggle of Boomer types in their 60s. Generally speaking they wanna know how they can improve their impending, sometimes imminent retirement. The income they see comin’ their way just doesn’t coincide with the picture they’ve held in their minds for the past 20 years or more. ‘Course, the older they are and the closer retirement is, the more intense the conversation tends to be. Duh, right?
It often angers me as I listen to the advice these boomers have followed, given by folks that, I assume, had their best interest at heart. I habitually assume that’s true, though sometimes that assumption is sorely challenged. A case in point is a 63 year old widow with a couple small rentals, a mortgaged home, about $100,000 in a Roth IRA, and roughly $50,000 in cash savings. Her Social Security payment, according to her, will be about $1,680 a month or so, a couple HappyMeals over $20,000 annually — before taxes. It won’t begin ’til she’s 66, a little over 2.5 years from now. She wanted to know if there was anything she could do to improve her projected retirement income.
Her small rentals are old cottage type homes renting for $800 apiece. They’re free ‘n clear, so she banks the $900 or so she’s been netting. The balance on her home’s loan is now just below $100,000 — $98,350. I told her if she takes the $900/mo. cash flow and applies it to that loan, she’ll have it paid off in approximately 75 months. I don’t like that number, and she likes that I don’t like it. Hhmmm . . .
If she bought a discounted note with her Roth IRA money, and earned 13% cash on cash, her monthly payment would be around $1,083. Coming from her Roth, the income would be tax free. Also add that to her house payment each month, and now the loan is paid off in, give or take a month, 42 months. Still, not soon enough. She has way more than enough to make up the relatively small unpaid balance. That would mean when she turns 66, she’ll not have around $580 a month comin’ out of her bank account for her house payment any more. Add to that the new SS check, the aforementioned $1,680 a month, and she’s already sportin’ a $20,000 income without the nearly $7,000 a year she was forkin’ over for the house loan. She will pay income taxes on the SS money.
The tax free monthly income from her note investment will be the $1,083 she’d previously been using to pay off her home loan. Let’s not forget the two cottage rentals. Though she’s collecting $900 a month or so, let’s say Murphy’s Spreadsheet is in play, and it’s more like $800 a month.
Her income at retirement can now be broken down as follows:
1. $20,000 a year from Social Security. This will be taxed, netting her out a minimum of $16,000, likely more.
2. The entire $9,600 a year cash flow from her cottages is sans depreciation, as she’s used it all. Let’s be conservative and say after taxes that income will boil down to around $7,700.
3. The income from her discounted notes, owned by her Roth IRA, is exactly $13,000 a year. Gross and net. The neat thing about this source of income is that eventually her note or notes will pay off, allowing her to receive the built in profits she bought via the original discounted price. This will, when the smoke clears, result in her enjoying a pay raise in retirement. Instead of $13,000 a year, tax free, she could find herself on the receiving end of over $20,000 a year. Again, completely tax free.
Add this up, and her combined after tax/tax free retirement income is in the neighborhood of over $36,000 a year. This is in excess of $3,000 monthly, hers to spend as she will. Furthermore, she won’t have that pesky house payment to make ever again. Is this a ton of money we’re talkin’ about here? Nope, not even. But life is relative, isn’t it? If she’d listened to the advice from Wall Street, the income from her Roth wouldn’t be in the same universe of $13,000 annually. In fact, my experience is that it’d likely be around 30-35% of that figure. Oh, and it likely wouldn’t go up much over time, if ever or at all.
Furthermore she wouldn’t have come within shoutin’ distance of entering retirement sans her $580 house payment. Her retirement at that point woulda been less than $28,000 a year, after taxes, MINUS almost $7,000 a year for the house payment. Her real net, after taxes woulda barely been $21,000 a year. By instituting this Plan and executing with with unrelenting Purpose, she increased her after tax retirement income, net/net, by roughly $15,000 annually.
To her, that’s an improvement of over 70%!!
Is she living the life of a Queen? Hardly. But she’s livin’ one heckuva better retirement than the one for which she was unhappily careening. ‘Course, I think she might be able to do even better. What if . . . she’d pulled out another $100,000 by refinancing both her rentals? It’s not even a taxable event. If she did this at retirement, she’d likely need to use a portfolio lender, payin’ slightly higher interest, and maybe a shorter amortization period. In any event, the LTV (loan to value) wouldn’t be much over 40-60%, which would allow the cottages to easily handle the payment with money left over. That $100,000 would then allow her to acquire an additional $13,000 a year in retirement income. However, cuz she bought it in her name, the interest received would be taxable at ordinary income tax rates. Let’s say she nets out around $10,000 or so. On the surface that seem to be an almost sideway move, right? But remember a couple things. Her rental income is now completely naked, no depreciation left. All of it is taxable. The note income is too. The reason she might give this move very serious consideration is that when the note(s) pay off, even after paying capital gains taxes on the profit, she’ll be able to rinse ‘n repeat, acquiring higher value notes yielding bigger monthly payments. In other words, she’ll have traded her relatively static income property income, for an income that over time will provide opportunities to increase her income. This means she’ll have two separate income sources with that ability build in from Day 1 — her Roth IRA, and her personal note portfolio.
That’s how regular folks can make a very positive, real world impact on their currently depressing retirement income outlook. None of this is rocket science. But to benefit from it, you gotta realize it exists, and is on your menu. The key is to have a realistic plan, and to execute it with relentless purpose.