Frankly My Dear, Retirement isn’t as Bad as it Now Appears (at Least not With the Help of REI!)

28

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?

Related: Capital Growth,Cash Flow, Taxes And Timing: Planning for Your Retirement the Smart Way

Retirement Talk…

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%!!

Related: How Separate Note Portfolios Can Both Speed Up AND Enhance Your Retirement Income

The Results…

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.

Subscribe to our mailing list

* indicates required Email Address * First Name Last Name

About Author

Licensed since 1969, broker/owner since 1977. Extensively trained and experienced in tax deferred exchanges, and long term retirement planning.

28 Comments

  1. Can you point me in the direction of an article that goes into detail about acquiring the discounted notes you refer to in all your posts? I’ve read several, but would love the overall primer on these. Also, you present them as pretty much no risk, hands-off investments. Is there more to it?

    thanks.

    • Jeff Brown

      Hey Adrian — I would point you to David Van Horn’s firm, PPR. They have many funds specializing in discounted notes, secured by real estate. Mine, The BawldGuy Note Fund, is the only one specializing in 1st position notes. You’ll get your questions answered there.

    • Jeff Brown

      No Trevor, there are many options available, services, that for a fee, will handle your foreclosure, if need be. I bought my first note almost almost 40 years ago, and have never foreclosed myself. I’ve always used those who’ve specialized in that service. My ‘leg work’ is limited to walking over to the phone. :)

      • Are these services inside the websites that provide these notes that you talk about? Where do you go to buy your notes? Do you buy performing or non-performing?

  2. The article makes it seem that an old lady can easily get a 13% return on a note + some appreciation at the end. It also makes it seem like it’s fairly risk free. If I could get a 13% return on a low risk investment (requiring no work on my end) I’d take it in a heartbeat.

    • Jeff Brown

      To be accurate, Paul, you inferred ‘fairly risk free’, which as I infer from your comment, is insanely ridiculous on its face. I’ll be more than happy to answer any questions you might have.

      • Ah yes, the risk aspect of a private note.

        Jeff, did you have a conversation with this near-retiree telling her “If the note that you purchased with your ROTH IRA funds should happen to default, you will lose a sizeable chunk of those funds. That means that income will disappear and you will have to go back to work (in your late 60s or later) or move in with your kids. Ma’am this part of this plan is HIGH RISK (exclamation point)!”

        Jeff, you pointed out the best that could happen but as you replied to Paul, it is far from riskless. I hope this woman knows that too.

        • Jeff Brown

          You bet I did, Kevin. Also, the entity from which she’s buying her note(s) offers a warranty on her purchase. You’ll surely agree it’s probably a good idea to pen a post talkin’ about the ins and outs of note purchases. The thing is, each post can’t be thousands of words long. I leave that job to Brandon Turner. :)

          I’m asked almost daily about the mitigation of risk in these type of notes. Much of it comes from using a pro to assist you, that is if you’re not comfortable with your knowledge level. Much of it comes from whom or what entity the note is being purchased. I acquired my first note back in 1976. I’ve never owned a 1st position note, though that will change in a big way this year. I’ll be allotting several hundred grand for that purpose. ‘Til now I’ve always owned ‘junior’ position notes, 2nd position or lower. But then I’ve always been an ‘insider’ in my own local market, having bought/sold/brokered real estate there since Nixon was in office.

          I never advice clients to do anything I haven’t done, don’t do now, or wouldn’t do in their circumstances. In fact, the Solo 401k I so often talk about is the main entity housing notes.

          We’re definitely on the same page on this one, Kevin.

        • Jeff Brown

          One more thing, Kevin. These notes originated with institutional lenders, like say, Wells Fargo. They’re definitely not private notes. Sorry, I shoulda caught that earlier.

        • I wonder why a large loan originator, like Wells Fargo, would sell an asset that pays them 8% or higher? The note probably sold at a discount (any signal there?) to push the yield up to 13%. This note probably made a microscopic portion of their total loan portfolio.

          I also wonder why the broker/seller offers a guarantee (again any signal there)? Is that guarantee ‘costless’ to the note broker?

          I guess I will just have to wonder.

      • What kind of returns have you seen on your persoal notes portifiolo over the past 10 years (indlucing all expenses associated with foreclosing, etc)? Have you been able to sustain an average of a 13%+ gain per year?

        • Jeff Brown

          Yep. In fact, Paul, here’s the reality. Even lenders who lend directly to local flippers with conservative LTVs, are getting that and more. 13% isn’t rare. I have clients who’ve been getting that and more, via direct lending. Buying at a discount, in first position, will generally get you roughly 12-15%, cash on cash. If it pays of sooner than agreed, that number rises. Make sense?

        • Getting a 13% return on your notes over the past 10 years (especially with the big drop in real estate values in the mid to late 2000s) is very good. You must be doing something right!

        • Jeff Brown

          Don’t gimme too much credit for that, Paul. It wasn’t all that difficult. Remember, I’m second generation in the same large market, and therefore somewhat of an ‘insider’. That is, I can’t be fooled about the value of the security property, etc. Even a low interest note bought at a discount can yield 10%, if you paid more than the market price. People in the ‘note world’ know this. It’s not that the risk isn’t there, cuz it surely is. It’s that the experience/knowledge level/expertise of a real pro can go a pretty long way in mitigating the risk.

  3. Let’s see….$1,680/month * 12 = “a couple HappyMeals over $20,000 annually — before taxes.”

    And what does it really look like after taxes? Well…$1,680/month * 12 = $20,160. Less tax of ZERO = still $20,160. Social security benefits aren’t taxed for a single person until their income exceeds $25,000.

    I won’t quibble with your overall point, but if you’re going to use taxation in multiple places to reinforce the argument, please get the facts straight.

    Here’s a URL with some additional info on the taxability of social security benefits:
    http://www.ssa.gov/planners/taxes.htm

    • Thanks Lukas. I wondered if the lowest tax rate had escalated to 40% while I was not watching.

      $4,000 taxes on $20,000 in SS earnings = 20% but only half of SS benefits are taxed unless the total income exceeds a certain amount – thus $4,000 taxes on $10,000 or SS earnings = 40%.

        • No. Not when that overestimation of taxes caused the recommendation that she take large risks reaching for yield which could imperil her nest egg.

          No where in the original message did you mention the $24,000 in income … a rather significant detail.

    • Jeff Brown

      Thanks for your kind and gracious comment, Lukas.

      However, I fear you’ve been misinformed. In the post, our widow collects about $20,000/yr in Social Security. She also has income totaling roughly $24,000. She’s on the cusp, tax wise. The IRC says if half of her SS income + all other income is more than $34,000, then fully 85% of her SS income would be subject to personal income tax. Therefore, if our widow in the post falls over that line, she’ll find herself paying taxes on the vast majority of her SS income.

      Hopefully she’ll fall under, at least early on. As time passes though, she’ll end up with note income which will push her over that line. This is the problem for most folks with their 401k and IRA plans. It doesn’t take much income to push them into a taxable position re: their SS income.

      Thanks again for gettin’ my back, Lukas. It’s always appreciated.

    • Kevin,
      You asked why WF would discount a loan and the reason is because the investor or bank behind the loan needs liquidity. BTW, WF services loans for over 3500 investors besides servicing their own loans. The bank also has to set aside reserves for every defaulted loan and this inhibits their ability to go to the federal reserve for $$ to lend out & after all they’re in the lending business. As for why companies like mine warranty our re-performing notes is because we statistically know how many re-default and how many we buy back. We are also confident in our workout team. (who would also have a charge back if we buy an asset back since our asset managers are paid salary + commission) Our warranty is probably the best marketing strategy we’ve ever used and does enable us to get a little bit of a premium for our notes as well. Hope this explanation helps.

      Dave

  4. Hi Jeff,

    Another great article and another great idea. For me the only difference was why wait until retirement to invest in notes or something else similar. I started doing this about 10 yrs. ago and to all the skeptics on BP my results have been excellent. It is possible to have a default, just like you could have a vacancy on a rental, you still have collateral with an underlying, often times, owner occupied, asset though where late fees, missed payments, and any corporate advances (e.g. legal actions, taxes or forced place insurance) can be added to the payoff. Besides the average FC in the U.S. is @ $2-3K. If one is risk averse to your idea you could still do a private 1st mortgage for a rehabber like I did when starting out. Anyway, thanks for shining the light on this great wealth building strategy.

    DVH

Leave A Reply

css.php