Personal Finance

How to Prosper in Retirement Through Purposeful Investing

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For decades, I’ve called what I do in terms of investing “purposeful planning.” It involves four pillars, which have evolved over the years and proven themselves to be very effective. In fact, more often than not, over time, they’ve allowed for the investor to utilize strategies providing seriously beneficial, synergistically enhanced results.

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Let’s review all four pillars—in no particular order of importance.

The 4 Pillars of Purposeful Investment Planning

  1. Discounted notes secured by real estate in a "Roth wrapper" [i.e., IRA, solo 401(k)]. Provides maximum tax-free retirement income.
  2. Residential income property acquired in the investor’s name.
  3. An insurance policy—EIUL—structured for maximum tax-free retirement income.
  4. Discounted notes, secured by real estate, in the investor’s name.

Here’s more information about each.

Discounted Notes in a Self-Directed IRA and/or Self-Directed 401(k)

Let's first define these investment types. If you've ever borrowed money to buy a home, you signed a note saying you promised to pay it back in periodic installments for a specified period of time. There was also either a trust deed or mortgage, which was officially recorded at the County Recorder's Office. It said that in case you defaulted on your periodic payments or violated the loan agreement in any other way listed, the home you bought with that loan was security—that is, it was the loan's collateral. Don't pay? You eventually lose the property.

When a note holder (the lender), wants to sell the note, it's almost always at a "discount." That is, it's less than the balance of the note itself on the date of the sale. For example, the note balance might be $30,000, but the market value of that note might be 10 to 30 percent less, depending on the many factors governing value. If the investor pays $25,000 for the note, they’re still owed the balance at the time of sale (in this example, $30,000).

Close up view of bookkeeper or financial inspector hands making report, calculating or checking balance. Home finances, investment, economy, saving money or insurance concept

In this case, the investor isn’t you; it’s your IRA/401(k). The payments go there, and the payoff goes there—period. The note payments grow tax-free, and when/if the note pays off early, as the vast majority do, the profit—usually a capital gain—is also untaxed. But, you may ask, “What’s the actual real life return on discounted notes secured by real estate?”

I'll speak only from my personal experience. As some here may know, my first discounted note acquisition was in May 1976. A client had given me the choice of being paid a cash commission of $6,000 for the sale I'd negotiated OR—a $9,750 note, secured by a local fourplex, payable at 10 percent, interest-only monthly payments, the balance due and payable in five years. I chose the note. My pre-tax yield was 23 percent annually when the dust cleared.

This past May marked the 43rd anniversary of the acquisition of that note, which was the beginning of my note portfolio. Since that day back in 1976, I've averaged a 10 percent annual return from discounted notes. I've NEVER earned less than 10 percent on any note I've ever purchased—nor has any client ever made less than that return. This includes performing notes. It includes non-performing notes (which are notes not receiving promised payments or already served a Notice of Default). It includes first, second, third and even fourth position notes. It includes notes that required foreclosure. Not one of them in the past 43 years has ever—from first day in, 'til last day out—earned less than a 10 percent annual return. My all-time highest return exceeds 300 percent annually.

Now, imagine your Roth entity starts out with say, around $30,000 or so. Every year for 30 years, beginning at age 30,  you combine with your spouse’s Roth IRA to contribute $6,000 EACH into your respective Roths. Let’s figure out how that works out to be by the time your 60th birthday arrives.

Turns out the total dollars accumulated by age 60 is well over $2 million. By the time they have just $150,000 in their combined Roth IRAs, their monthly payments, combined with their annual contributions, have acquired new notes every year. By the time they hit the $500,000 mark, their contributions plus incoming payments are acquiring a new note every four months or so. By the time that amount hits $750,000, they’re acquiring a new note every quarter—and so on ’til they hit the million dollar mark.

Those figures don’t take into account the notes that randomly pay off early, which as noted before, is the rule—not the exception. In fact, in 43 years, I’ve never had a note last even 20 years, much less 30. Every note that pays off represents another untaxed profit. You immediately replace it with another note, usually slightly larger with payments a bit higher.

So, what’s the annual tax-free income when the combined balance of this couple’s two Roth entities hits $2 million? Experience tells us it’ll be around $200,000 yearly. And… wait for it… it’s tax-freakin’-free!

Related: 6 Do’s and Don’ts of Self-Directed Retirement Investing

Free and Clear Residential Income Property

First off, let’s free ourselves of the mindset—once and for all—that residential income property’s cash flow in retirement is the best thing since free pizza. In my experience and opinion, it’s gonna be your biggest retirement income disappointment. I can say with confidence that for virtually everyone who begins investing by age 45 or younger, their cash flow in retirement from rental properties will be the lowest actual yield of all four pillars. I didn’t make that up; it’s just my experience over the last several decades and in multiple states.

The real life value of multiple free ‘n clear rental properties is that, in retirement, they become the defacto Bank of You and Your Spouse. Let's say you had just four or five duplexes bought over the 30 years before you turned 60. When you retire, they might have a market value somewhere in the range of $350,000 to $500,000 apiece. That's $1.4 to $2 million of gross equity. Need half a million for a cool home located in your favorite vacation spot? Borrow it by refinancing a couple of your duplexes. The tenants are makin' the payments for ya. And since it's the worst yielding investment (pillar) you have, you simple don't care about the piddling loss of cash flow, relatively speaking. This doesn't even take into account the distinct possibility of using that vacation home as a nightly rental. Hmm…

Let's backtrack a bit to see what the retirement cash flow might be on a couple million dollars of equity in your four free ‘n clear duplexes. Based on my experience in Texas, that would easily be somewhere around $6, 000 to $7,000 monthly. Let's call it $6,000/mo. Much of it will be sans tax shelter (depreciation) when you turn 60 or pretty shortly thereafter, right? So, that cash flow is gonna shrink via your income tax return. Compare that cash flow to the TAX-FREE cash flow coming from the two Roth IRAs, flush with discounted notes, all of which are safely secured by real estate. Around $72,000 to $84,000 a year before taxes for real estate cash flow vs. $200,000 a year tax-free from the notes in Roth wrappers.

Can you see what I mean about real estate investing now, relatively speaking? Yes, it’s still a pretty wise way to go. No argument there. But when compared to the other three pillars? Not so much. Very few months go by without me telling a new investor client not to buy real estate for the purpose of producing cash flow in retirement. They’re either without enough capital or have no realistic chance to hit retirement with the property/properties free and clear. That leaves notes in a Roth wrapper and/or in their own name. Also, if they have the premiums and the time, they can get an EIUL insurance policy instead.

Remember, in purposeful planning, there are no formulas. In fact, over the last many decades, I’ve learned something useful about formulas. Most of ’em seem to work—right up ’til the day they don’t.

An EIUL Insurance Policy

Just gonna sum things up here, as most folks don’t think of insurance as an investment (which is understandable). Suffice to say, I’ve urged both my kids to get one and to get each of their kids one, too. Here’s the summary.

You kickstart it by putting around $5,000 to $10,000 up front. Then, you decide the premium amount affordable for you. In this case, we’re talkin’ about a 30-year-old couple. Some, like my kids, will take the 20- to 30-year premium route. Some will opt for a “quick” 15-year policy. Either way, the income in retirement is, again, tax-free. It can be for just 15 years, or the income can last over 30 years. It’s your choice.

For the example 30-year-old couple we've been using here, let's say they opt for an initial $500/mo. premium and kickstart it with $8,000. That's what my team's EIUL expert recommended for my own daughter and son-in-law. They'll volunteer to add the previous year's inflation to the current year's premium. In the end, at age 60, they'll be the happy recipients of around $108,000/year 'til they're 90—again, tax-free. Oh, and before you ask, the No. 1 question my expert is asked is about the failure rate of EIULs he writes for folks. The answer's always the same: “The next one that fails will be the first.”

Pensive African man sitting in the office at the table making notes in a notebook

Discounted Notes Secured by Real Estate in the Investor’s Name

Same kind of notes with the same performance as before. The big difference, of course, is that the interest is generally taxed as if the owner has a second job. However, the profit built in by the purchase price discount is almost always taxed as a capital gain, which is nearly always lower than the ordinary income tax rate.

Note: The note must've been held by the investor for over a year to get that low capital gains tax rate.

Depending upon what your ordinary (job’s) income is, your tax rate can vary wildly. This is also the case when comparing your state’s income tax schedule with other states’. For example, if you live in Florida and your sister lives in California, her ordinary state income tax rate is likely to be 9.3 percent at the least. It could be 1 to 4 percent higher! Every buck over $1 million in California is taxed at a cool 13.3 percent. Let that sink in.

Let’s make the assumption that the combined state/federal income tax rate will subtract roughly 30 percent from your total yearly note payments received. It could, of course, be much higher for some of you big earners out there. It’ll lower your ultimate return by the amount of taxes. But it’s a growing asset! IF you started at say, 37, and retired at around 67, you’d have grown your personal discounted note portfolio tremendously.

It all depends on the random payoffs of those notes. Let’s go through one to see.

Related: Why Your 401k Is A Retirement Income Loser!

Example Payoff of a Discounted Note Secured by Real Estate

Let’s say you buy a note, $50,000 balance, for $45,000. It’s a 30-year, fully amortized loan with a 10 percent note rate. The payments are $438.79/mo. What’s the return if it pays off in five years?

First, the payoff is $48,287.

The return is 12.75 percent. You pay the taxes on the interest as if it’s a second job. Capital gains rates are applied to the “profit” when it pays off, provided you held it for over a year. What you likely do at that point is rinse ‘n repeat. You do this ’til retirement.

Note: It’s possible for some investors to have their note interest “sheltered” by excess depreciation—IF—their adjusted gross income (AGI) is greater than $150,000. But that’s a different post altogether.

The moral is to understand that nothing here is rocket science—not even close. It’s all, relatively speaking, safe. No wild risks.

Also, there are nearly endless ways to invoke the principle of real synergy into the equation. Bottom line? At least some of these pillars, if not all four, are available to you. Maybe we’ll talk soon about actually bringing synergy to the party.

What do you think of the four pillars? What’s your investment strategy? Any questions about mine?

Leave a comment below!

Licensed since 1969, broker/owner since 1977. Extensively trained and experienced in tax deferred exchanges, and long term retirement planning.
    Wenda Kennedy JD from Nikiski, Alaska
    Replied about 1 year ago
    Yelp, all of this works well. I've done everything except for the insurance part -- so I can say with conviction that it works. And in the end, when you are sitting pretty, someone who partied while you worked will tell you how lucky you are. You can tell them thanks and smile back. You are lucky that you have the drive, the education in investing, and the smarts to run circles around them. You're not out sitting on the curb with them, burping and chirping!
    Jeff Brown from San Diego, CA
    Replied about 1 year ago
    Great Job, Wenda!
    Dave Rav from Summerville, SC
    Replied about 1 year ago
    Good article. Advanced strategies for sure. Where can I learn more about EIUL? I'm not familiar
    Jeff Brown from San Diego, CA
    Replied about 1 year ago
    Hey Dave — Tread very carefully. I'd call my in-house expert, Dave Shafer. Call ‭(727) 804-9271, and tell him I sent ya. If you'd like to expand that chat afterwards, gimme a call. Happy to help. Good luck!
    Marvin Lusky New to Real Estate from Aventura, FL
    Replied about 1 year ago
    Dave, Great article! We feel that we’ve come late to the party at 55, but we’re finally ready to start planting our trees. Where can we get more information on purchasing notes for our Roth IRA’s?
    Marvin Lusky New to Real Estate from Aventura, FL
    Replied about 1 year ago
    Sorry, I meant Jeff
    Joseph Chan from Jersey City, New Jersey
    Replied about 1 year ago
    Can you go into the math for the EIUL that will pay $108,000 a year after 30 years of investing? I'd like to know what returns you are assuming over the 30 years you are investing? In general I'm not a fan of whole life unless you need it for estate planning and you are over the $24mm estate tax. Otherwise, I'd opt for a cheap 30 year term for coverage and then invest my cash at a higher IRR. Most insurance polices pay an ave or 4% yield and even if that is tax free, I think I can do better investing in notes at +10% and paying tax.
    Jeff Brown from San Diego, CA
    Replied about 1 year ago
    Hey Joseph — It's NOT a whole life plan, primarily. It's structured primarily as a tax free income stream. In fact, you go out of your way to reduce the death benefit, so make sure you have a death benefit policy that fits your circumstances. Also, one of the KEY ingredients of the EIUL is that you won't have any losing years. This is one of the best parts. The insurance company takes the loss in down years, but takes everything over your "ceiling" in good years. The floor/ceiling in the policy my expert is currently writing is 0% and 17%.
    Vance Baker Real Estate Investor from Dayton, Ohio
    Replied about 1 year ago
    Where do you find all the notes to buy? I once ran a flyer campaign “we buy notes”, and never got a single response or note to purchase from it. That was over 15 years ago.
    Jeff Brown from San Diego, CA
    Replied about 1 year ago
    Hey Vance — I hear that all the time, so you ain't the Lone Ranger. You likely need a guy like me, and I'm not rare either, just so ya know. :) You must understand that the note community hasn't grown much in the last 50 years. I suspect this will change in the next 5-10 years, as investors turn more 'n more to adding notes to their overall investment portfolio. Boomers are rapidly now finding out about 'em, which has helped to reduce the discount now available. But, alas, that will also change over time.
    Jacqueline Gardiner Engineer from Punta Gorda, Florida
    Replied about 1 year ago
    Hi Jeff, Are you a broker for discounted notes? How do you assess the risk? Should one consider buying through a fund or pool of notes initially to spread the risk? What happens in an economic downturn? Have you had to foreclose on some of the properties?
    Jeff Brown from San Diego, CA
    Replied about 1 year ago
    Hi Jacqueline — I am, and if you need any help with questions, I'm available to you.
    Jeff Brown from San Diego, CA
    Replied about 1 year ago
    Jacqueline — I have foreclosed many times. THE key is in the purchase of the note, not when things sometimes go south on ya. Loan to value, LTV is possibly the most important factor.
    Robert Gibbs
    Replied about 1 year ago
    Hi Jeff. Loved your article and ideas here. I am going to go back and read some more of your older articles. I have been struggling with the dilemma of having to pay taxes on a traditional 401K when I retire in 4 years. You say "free and clear" rental property is a pillar of retirement. I was thinking that "newly purchased" rental property might be a better pillar. If one is willing to work 750 hours/year in some capacity on these rental properties in order to qualify as a real estate professional, wouldn't it be possible to withdraw the 401K tax free by offsetting it against depreciation losses?
    Jeff Brown from San Diego, CA
    Replied about 1 year ago
    Hey Robert — If anyone qualifies for the status 'real estate professional' or more exactly, 'Professional Investor', it'd be me. I've never opted for that due to the restrictions on my actions. However, that said, though it depends upon the actual balance of your 401k at this point, and how old you are now, there are ways to attack this you may not've thought about. Please set up an appt to chat, and I'll try to give you some options. Great question!!