If You Retire Well, It’s Not Likely Your Income Tax Rate Will Fall – II
Just before we took off for Denver, I wrote about how retirement income isn’t what most financial advisors on Wall Street predict. You know, they tell us our tax bracket will be lower in retirement. I countered with a couple very simple observations. Your house is probably paid off — scratch interest deduction. Your kids are having kids — that write-off is history. Most folks hit retirement with their incomes virtually naked. No clothes, or rather shelter.
So, Ron ‘n Karen are now the proud owners of four Texas duplexes. However, they’ve decided they’re just about done with living in their fourplex. It’s been very good to them, but it required so much time and work for the initial rehab, they’re over it. Though they haven’t yet made the final decision, it appears that’s the road they’ve chosen. The equity will get them another six duplexes, but they’ve also been thinkin’ very much about buyin’ instead of renting for awhile. Eliminate one of those extra properties.
They’d likely be required to execute a partial tax deferred exchange due to the significant capital gain involved. The portion in which they live would be treated as their primary residence, tax wise. Let’s now review their projected retirement income, at least from their real estate investment portfolio.
As noted in the initial post, they’ll be able to combine total real estate cash flow with ‘disposable’ after tax ordinary income, in order to pay off all loans in 8-12 years. Even if they screw up, it’ll happen in 15. They’ll be in their mid-late 40s.
The real estate income at retirement
Assuming no appreciation in value or increase in Net Operating Income, their annual cash flow would be approximately $165-170,000. That’s just under $14,000 monthly at the bottom of the range.
They have choices. After consulting closely with my ‘in-house’ expert, David Shafer, the following results are available to Ron and Karen. But first, the nuts ‘n bolts of the process.
They’ll budget $1,000 a month for the premium. It’ll go on for 25 years. ‘Course, I’ve already actively applied my approach, Strategic Synergism, to goose the ultimate results. Here’s what I’m proposing.
Note: Dave says they can opt to apply an ‘inflation’ adjustment of around 3% a year to their premium, or just keep it a flat $1,000 a month for the 25 years. Adding the inflation hedge results in a tax free income of $85,000 a year. The ‘flat rate’ premium would yield $66,000 a year tax free. Both would commence 25 years from conception. They’d be about about 63 years old.
This is when I tend to stir the pot
What if — that’s the way it starts, right? What if we take the first couple properties that become free and clear, and sell ’em? What if, due to using the cost segregation approach to depreciation, any capital gain and/or depreciation recapture is completely offset? (This would happen via massive unused depreciation, kept on the shelf for precisely this strategy.
This would net our intrepid Ron and Karen around $500,000 in tax free cash. This would occur somewhere around the 50th to 55th month of the Purposeful Plan.
What to do? 🙂
First, yielding to human nature, let’s just assume at the get-go that they’ll opt to grab $100,000 of that tantalizing cash. Wouldn’t you? You know you would. Get the custom RV — or the boat — or the mountain cabin for weekend getaways. That leaves $400,000. My Plan calls for them to make one more call to David Shafer about another EIUL.
Turns out that if they put the remaining $400,000 into a newly created EIUL, with five payments of $80,000 made over four years and a day, it’d be a good thing. (Don’t ask, it’s a regulation.) If structured to merely sit and grow ’til the same point in time the original EIUL comes to fruition, around age 63, here’s the combined results.
The original EIUL, using just the flat rate approach, will yield a retirement income of about $66,000 a year — which will, of course, be tax free. This is the approach eschewing the inflation hedge that would produce more income, but end up costing a lot more per month, as the premium increased to account for perceived inflation.
The second EIUL, funded with the $400,000 tax free, not tax deferred, capital gain, will yield around $78,000 a year. Both incomes will be triggered at roughly the same time — when they’re about 63. Also, don’t ever forget the real value of all that income being completely tax free. Not tax deferred. Not tax sheltered. But tax freakin’ free!
Let’s now review Ron’s and Karen’s bottom line retirement income
Their real estate income in retirement, beginning in 8-12 years or so, will end up being about $130,000 a year, or $10,800 a month. Their real estate investment portfolio’s net worth at retirement, assuming no appreciation ever, would be roughly $1.8 Million.
The two properties they ‘transformed’ into an additional EIUL? Well, they gave up half a million bucks in net equity, and a tad over $3,000 a month in retirement income to make it happen. In return for that repositioning of capital, they end up with around $78,000 a year/$6,500 a month in tax free income. Here’s the difference: Real estate income of around $3,000/mo., mostly taxable, beginning some time in their 40s. OR — over twice that amount, NOT TAXABLE, beginning in their early 60s. Understand, if their ultimate tax bracket at that point is only 30% (state/fed), that $6,500 is the rough equivalent of almost $9,300 monthly. More clearly put, that makes the before tax income triple what the real estate cash flow woulda been. In fact, let’s pile on, shall we? Their total tax free income of $144,000 a year is, in reality for most folks, over $205,000 a year, BEFORE taxes.
Not a really tough decision, it turns out. But we’ll wait and see how things develop in the next five years or so. You never know what will happen, right? Right.
Their Purposeful Plan results in retirement in their 40s, beginning with about $130,000 a year. About 15-17 years later, another $144,000 in 100% tax free income begins. From about 63 years old, they’ll be living on $274,000 yearly, over half of which will be tax free. This doesn’t include Karen’s pension, which should provide superb walkin’ around cash. (Sorry, Karen) It also doesn’t take into account the possibility Social Security will be functioning at that point. Karen’s pension will nudge their retirement income over the $300,000 mark.
Want more articles like this?
Create an account today to get BiggerPocket's best blog articles delivered to your inboxSign up for free
And they lived happily ever after.