A Retirement Case Study: When Time Isn’t Your Friend

by | BiggerPockets.com

More and more these days I find myself chattin’ with Boomers about retirement plans gone rogue. Honest analysis has shown the reality of what might be a bitterly disappointing retirement — or worse, a postponed retirement. It’s not that they don’t have capital and/or equity. No, it’s that the inertia of their current plans indicate the main goals simply won’t materialize.  It often seems worse when the capital/equity available is relatively substantial. In this case, we have Wayne, a 59 year old with:

  • About $95,000 in the bank.
  • $420,000 that will be available from inherited, but poorly producing real estate.
  • $175,000 in a traditional 401k that will become available later this spring.
  • And a $110,000 Roth IRA, also available this spring.

Don’t say it, I know what you might be thinkin’. “Really? He’s afraid of generating a retirement income with that much?”

Excellent point — let’s take a look at the situation in a bit more depth.

  • His pension will be better than nothin’, at roughly $1,100 a month — before taxes.
  • The cash in the bank should be viewed, as much as possible, as a cash reserve.
  • The real estate equity is a nice chunk — no argument there. But is currently a terrible income source, even free ‘n clear.
  • His Roth IRA, at $110,000, will generate what? Mostly it’ll generate a whole lotta not much. Remember, in retirement you’re doin’ your best to avoid risk, not court it. More on this later.
  • His traditional 401k, roughly $175,000, is completely taxable, and not of much use in making a serious difference, as it stands.

His job income is around $75,000 yearly. It’s not super secure due to the economy, which certainly doesn’t make him the Lone Ranger. In any case, if he should either lose it or choose to retire, he can get employment in his industry at lower pay, but still doable — if his retirement income outlook can be improved.

His pension and bank cash speak for themselves. They exist (The pension when he leaves his current employer.), and are what they are. The cash can be used judiciously, but only when the benefit is deemed to be more than worth the reduction in reserves. So let’s talk about movin’ his real estate equity to greener pastures.

After executing a tax deferred exchange (Sec. 1031 of the IRC) he’ll have moved from old underperforming property to a couple duplexes. He’ll acquire one of ’em for cash. The other, when the smoke clears, will have a new loan of roughly $110,000 — payable at 4.75%, over 30 years. With the cash flow from both properties, he’ll be able to pay off that loan in just over four years. Even if it takes five for some reason, he’ll still be a bit short of his 65th birthday. If Murphy camps out at his door, he still has the Roth IRA available to tap if he chooses to erase the loan with that cash.

Let’s pause here to look at why most folks with a half a million or more at retirement won’t be living as expected.

Half a million bucks sounds like so much to us, but when retirement hits the fan, reality tends to show its ugly face. Here’s what I mean. If most or all of that is inside a 401k — which is the norm — you’ll begin to behave as most folks do when on the cusp of their new life. You’ll be far more risk averse. That’s a good thing for sure, but as risk is reduced, so is yield. There are some rare exceptions, but they only serve to prove the rule.

What this means is that that half a mil in your 401k will produce a maximum of $20,000 a year — before tax. The next thought most folks have is that their Uncle Fred’s Social Security income is more than that. So in the real world, half a million bucks in your trusty 401k translates into a whole buncha not much for most Boomers nearing retirement. This is definitely not what they had in mind 30 years ago. This depressing epiphany is becoming the rule among those who’ve quietly sped by 55. This case study is meant to illustrate what might be possible for them, even without having any real estate investments, though it obviously helps to have some.

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OK — Back to Wayne.

Wayne’s newly acquired income property, once free ‘n cleared of debt, will yield $30-36,000 a year, assuming his NOI never rises after acquisition. Once the smoke cleared on his exchange, he then waited to turn 59.5, so he could have unfettered access to his Roth IRA, and somewhat fettered access to his 401k. (Somewhat fettered is code for state & federal taxes. 🙂 ) He’d convert his 401k funds to what’s known as a Solo 401k. It offers both Roth and traditional approaches. Once he rolled his old 401 into the Solo’s traditional side, he’d then take a big breath and roll it once more into the Solo’s Roth side. This will cause immediate and significant tax pain. In fact, Wayne will probably be lucky to end up with $100,000 from his original $175,000 when all is said and done. Sounds Draconian, and you won’t get an argument from me on that, but in the long haul, you’ll love the results. Here’s why.

After he’s done with the rollover, his total in the Roth IRA and the Roth Solo is around $210,000. Let’s round that down to $200,000. Remember, he’s gonna get this done almost immediately after he turns 59.5 — Time ain’t his buddy. What should Wayne do with his Roth money? Here’s a suggestion.

How ’bout discounted performing notes secured by post bubble real estate?

Keepin’ back $25,000 cuz he can, he’ll acquire around $270,000 in notes. Notes aren’t for everybody. I’ve been doin’ notes since Ford was in office, acquiring my first one in 1976. It was secured by a 4th TD with nearly 50% equity behind it. Before continuing here, allow me to repeat what I tell folks when first considering note investing.

If the thought of having to foreclose on a note you’re thinkin’ of buying doesn’t immediately get you doin’ the HappyFeet Dance — DON’T BUY THE NOTE.

Since risk aversion will be a foundational factor in Wayne’s choice of retirement income generators, that should be the first topic addressed when notes are the topic. The risk for notes can be broadly categorized as the following:

  • Loan to value — What percentage of real equity is behind the note in question?
  • Location quality of the real estate used as security.
  • The predicted ability of the note’s payor to make payments as agreed.
  • Having premium title insurance coverage
  • Foreclosure scenarios — What happens if property/security loses another 25% in value?

There are more we could list, but those are the real biggies. Let’s take ’em one at a time.

Loan to Value

Wayne will be acquiring notes at roughly 65% of face value. The note seller’s LTV will be a maximum of 80%. Let’s do some simple math. If the property in question has a verified market value of $125,000, that means the note has a face value of $100,000. 125,000 X .80 = 100,000. If he pays $65,000 — .65 X 100,000 = 65,000 — What’s Wayne’s LTV? Simple: 65,000/125,000 = 52% LTV. What it means when the smoke clears, is that there is about 48% equity behind his note — significantly less risk than just 20%. As long as we’re satisfied with our valuation of the property/security, the risk, at least in terms of loan to value, has been markedly reduced. We like that.

Location Quality

Back in the day, when teaching note analysis, I made it abundantly clear that my personal/professional standards for long term investment property location were demonstrably more demanding than for properties acting as security for notes. Why is that? Common sense mostly. Here’s why.

It’s congruent and consistent with my thinking about long and short term real estate investing. Long term investment should adhere to the highest location quality standards. Short term — flipping, wholesaling, selling a foreclosed property — are just that, short term. In the case of gettin’ rid of a foreclosed property, you’ll own it for a relatively short time, sometimes measured in weeks. The location quality should be good enough that selling it won’t cause logistical problems for the agent on the ground. Of course, clearly bad areas should be avoided from Day 1. Duh. But the so-called blue collar neighborhoods, first time buyer areas, and the like, are just fine in my experience. However we choose to describe any particular neighborhood, we know a bad one when we come across one. I’ve learned to rely heavily on my team’s local knowledge.  Again, common sense should prevail.

Payor’s ability to pay as agreed

The payor — some call it ‘payer’ — is often the homeowner occupying the property. Sometimes it’s any easy decision one way or the other. These days though, experience can make the difference. For example, what if the payor’s credit score is relatively poor due to a fairly recent short sale or even foreclosure? Dig more deeply. Was their credit good to excellent before he lost his job? Since gettin’ another job have they been payin’ their bills as before? Is their income sufficient to comfortably afford the note payments, including taxes and insurance? Is there already a history for this particular note — or is it brand new? I like to know if it’s a family or not. Sometimes that makes a difference to me, sometimes not. One thing for sure, many times it boils down to a judgment call. Remember the HappyFeet Dance axiom. 🙂

Title Insurance

I don’t compromise on this, as in never, ever. I either get the premium coverage or I pass. No compromising on this one, people. You want the title insurance company to be on the hook when there’s anything missed or a mistake in their research, etc. As I mentioned in a previous post, when the IRS has recorded a lien against real estate, NOTHING comes before it, including your previously recorded security instrument. Don’t be cheap when it comes to this coverage. Fact is, the note seller often pays for this anyway, in order to ensure the buyer’s gettin’ what they’re payin’ for. Again — do not compromise on title insurance — ever. No exceptions to this rule, at least none I’ve ever seen.

Foreclosure Scenarios

This is where ya wanna be deadly accurate. Let’s say it’s five years down the road, and your payor gets laid off. You foreclose. Let’s make the numbers pretty bad. You lose six month’s worth of payments — we’ll call that roughly $5,500 in Wayne’s case. The agent on the ground says the home hasn’t risen in value, but hasn’t gone down either. Still worth $125,000. Not wanting to waste time, Wayne takes my advice and lists it for $115,000. But wait, the agent tells us it needs $5,000 of ‘prettying up’ money. That means even before he puts it on the market he’s lost over $10,000. He approves the fixxin’ up and the property hits the market lookin’ great, at $115,000. It sells quickly, being $10,000 under the competition. Wayne agrees to pay a 6% commission. Also, what with normal closing costs AND the 2% he offered the buyer for a closing cost credit, his selling costs hit 10%.

He nets $103,500 at close of escrow. Take away the $10,500 he lost from unpaid payments and fix-up costs, and that figure is reduced to around $93,000. In the five years he did receive payments, they added up to around $52,500. This means in five years Wayne turned his original $65,000 into $52,500 + $93,000, or $145,500. As bad as that sounds, it’s not what it could be, not by a long shot.

What if . . . 

. . . the value dropped another 25%, from $125,000 to around $94,000 or so? The net proceeds from the sale at that value, using the same 10% sales costs would be approximately $84,600. Take away a year’s worth of payments this time — $10,500. Also the $5,000 fix-up costs. That leaves a real net of around $69,000. But wait, there were foreclosure costs too, right? Let’s add a nice round $4,000, probably high, but let’s do it. You’ve now recovered a net of $65,000 after a horror show of a foreclosure. Still, you made the $52,500 in payments, plus the net, net of about $65,000 when the sale was completed. In other words, you made a double digit return on your money after taking a few of Murphy’s best shots.

Wayne’s first year retirement income

If he retires at 65, the income from his real estate acquisitions would be the aforementioned $30-36,000 yearly. The note income might be as follows. At 59 he bought roughly $270,000 in various notes for around $175,000. The annual income from them is a bit under $28,500. In the five years or so since he bought ’em, his tax free plans have banked about $142,000 in payments. With these payments he purchased another $90,000 or so in notes. They in turn produced annual income of, give or take, $9,500. So far, he has available note income of $38,000 — all of which is tax free by definition.

If the original $270,000 note(s) purchases had paid off in six years — when retirement day arrived — he’d keep back around $20,000 to boost reserves, and buy another $385,000 in notes. The income would then rise to around $40,500 a year, plus the more recently acquired note income of $9,500 — for a beginning retirement note income of $50,000 a year — tax free.

Will those notes pay off in six years? Who knows? It’s completely random. Recent history shows a 2-5 year payoff time, but counting on that is foolish at best. It’s fair to say, however, that whenever any particular loan pays off, Wayne will buy a slightly larger note, which will result in a raise in his retirement income — again, tax free.

Real estate income of $30-36,000 — about 40% of which will be tax sheltered 20 years into retirement — plus a minimum of $38,000 a year in tax free income from his note portfolio. That’s $68,000-76,000 a year to start, with most of it either tax sheltered or tax free. Add into that his $1,100/mo pension, and his Social Security check, and he’ll be doin’ far better than if he’d maintained the status quo. Think roughly six figures.

If somebody had a million bucks in their 401k at retirement, they’d have to generate a minimum yield of 8% annually before taxes to even come close to what Wayne will do with a whole lot less.

Photo: lrargerich

About Author

Jeff Brown

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


  1. Hi Jeff, I really enjoyed this article. Thanks for taking the time to write it out in such detail. I have a couple of questions.

    – Where do you find / browse for notes for sale?
    – Can you explain more about why note income is tax free “by definition”?


    • Jeff Brown

      Hey Fran — Frank’s comment has a correct assumption on the note income’s tax free status — it’s directly due to being inside a Roth envelop.

      Finding the notes is a different discussion. It boils down in large part to who you know. There are dozens of note sites, some are no doubt pretty solid and reliable. The vast majority I’ve been to leave much to be desired, but that’s merely one guy’s opinion. I can also say that about Realtor sites.

  2. @Jeff Brown This is an excellent and thorough discussion of a really important topic. As a boomer myself, I think I can safely say that very few of us, no matter how clever we think we are, take retirement planning seriously enough. It usually goes something like…

    1. I can live great off the big bucks I’ll have in my 401k. (What do you mean I have to pay maybe 30% or more in federal and state taxes?)
    2. I’ve always got Social Security to fall back on. (What’s that “Going Out of Business” sign in the SSA window all about?)
    3. The government will take care of me. (They can’t pay their own bills; I should expect them to pay mine?)
    4. I plan to win the lottery. (This one has about as good a chance as the other three, so why not?)

    It’s understandable that most of us put off thinking about funding our retirement. Just about all of us have been in the situation where we focus all of our energy and attention on making it through the present. The future is, well … later, and it seems like much later.

    I’ve never invested in notes, and your article is going to provoke me to learn more about it. In the meantime, let me throw in one more possibility for consideration by the under-50 crowd: A triple-net or double-net property that you buy in when you’re in your 40’s (or younger, if you can) and hold for the very long term. Jeff, you hit the nail right on the head when you said, “Long term investment should adhere to the highest location quality standards,” so buy in the best area possible. You want a NNN property (or properties) in just such a location so that you can attract a high-quality tenant, one that is credit-worthy and will commit to a long-term lease. This, I believe, is the key. When you think NNN property, think also AAA location and tenant.

    I would suggest using whatever cash flow the property generates first to pay any income tax liability it spawns, and then put the rest in reserve in case you need to bridge a period of vacancy, or need to make improvements, perhaps if re-leasing. If the reserve gets large and too tempting, use some of it to pay down the mortgage. (In other words, treat this property like a retirement account and resist the urge to take money out. You want to live off this later, not now.)

    You’ll probably have to finance it for no more than 15 years (maybe 20), so the property should be paid off at about the time you want to retire, leaving you with a nice ongoing cash flow. The NNN structure generally insulates you from volatility in costs like property taxes and maintenance; but perhaps best of all it involves low-impact management at a time when you rather be playing with your grandkids or traveling to exotic climes.

    This is not a strategy that should replace any of your other investment plans (to coin a phrase, “supplement, not supplant”), but if you do it early enough, I think it can set you up with a fairly reliable stream of income just when you need it most.

    • Jeff Brown

      Hey Frank — Your points are well taken. Though I’ve eschewed the NNN approach, when the capital required to acquire them is available, and the purchase is congruent with the circumstances, they’re a solid, viable option for sure.

      Your ‘supplement, not supplant’ is spot on, and demonstrates massive experience on your part.

  3. Hi Jeff! Thanks for the informative article. I gather the note income is tax-free due to it being in a Roth? Frankly, I’d be terrified to be 59 yrs old and have only his level of assets – but much depends on one’s cost of living. I just hit the big “55” and can no longer claim to be in my early 50’s (although my brother suggested that I tell people that I am almost 54!). My exit plan is to sell some properties here and there and hold financing – I guess not much more risk than buying notes.

    That said, I would like to explore some note purchases. Do you recomend that a “newbie” note owner put $$$ with a company that does this as a business OR go it alone (doing the due diligence you suggest)? I can see both sides of this. My parents did well carrying the financing on their apartment houses via installment sale. I, however, am very interested in the discount.

    I also thought that the legal fee’s of foreclosing should be mentioned.

    • Jeff Brown

      Hey Cheryl — About the costs of foreclosing: I said, “But wait, there were foreclosure costs too, right? Let’s add a nice round $4,000, probably high, but let’s do it.” It was no doubt easy to miss, and I probably could’ve worded that sentence in a way to make it easier to discern the topic was indeed, foreclosure fees.

      Newbie note investors should probably attach themselves to an expert, generally speaking. A mistake in due diligence can be terrible, just as in real estate investing. As usual, it’s mostly about the individual investor’s comfort zone.

  4. karen rittenhouse

    You’re a great teacher. Thank you for this.

    I’ve only dabbled a bit with notes and they’ve always done very well. Your article is makin’ me scratch my head and wonderin’ – “Why aren’t I doin’ more note buyin’?”


  5. I think the flaw in your advice is touched on in several of the questions you are getting from people posting. When someone is in their mid-to-late 50s, it’s not the best time for a beginner to start putting most of their retirement funds into notes they dig up. I love the idea of finding great notes but am scared of the thought sinking $200k into something I’ve just started dabbling in.

    I think there’s a business opportunity out there for someone with expertise to sell notes/select notes just as a financial planner would pick stocks and bonds, etc. That type of service doesn’t seem to exist, or am I incorrect?

    • Jeff Brown

      Hey Shari — You’ll not find anywhere I’ve ever advised those who aren’t highly knowledgeable to invest in real estate, much less notes. I agree with your point, as it is exceptionally well taken.

      There are pros who are experts in notes and will help you. I’ve been doin’ notes since my first one, when Ford was president. Heck, I used to teach it to other pros. There are many others besides be who can help you. But you’re completely accurate when you say rookies shouldn’t be doing this by themselves. It should be axiomatic.

      When you read anything I write, or videos in which I’m talking, the assumption is always that an expert should be guiding the investor, without exception. The DIY approach can sometimes carry with it unintended consequences.

  6. Have been judiciously reading your columns — great stuff that makes you think. If you have the opportunity, I’d love your thoughts on traditional retirement plans vs. self-directed IRAs investing in real estate. Some of the big players in the self-directed market have been caught up in lawsuits and other problems recently, one reason I’ve been delaying making a decision to move into one:


    If you’ve written about this before, I may have missed it. Perhaps post a link if so. (I see several others have written about this, but more by way of information and not opinion).

    • I would also be really interested in hearing some thoughts / feedback on using self-directed IRA to acquire investment properties. The cases mentioned in the WSJ article sound to me like some folks were carried away by scam artists, pulled their IRA money into self-direct, got screwed, then turned around to sue the administrators.

      • Jeff Brown

        Hey Thomas — I won’t speak to the WSJ article, as I agree with Shari. I will tell ya that I make at least one attempt to dissuade folks from using their self-directed plans to buy real estate. The reasons are many, but bottom line is, they can ‘gut’ their plans if traditional, pay the taxes, and most of the time have enough for down and closing on the same properties they were gonna buy inside the plan. At 70.5 years old they won’t be forced to begin cannibalizing their wealth in order to satisfy the government’s hunger form more taxes, paid sooner.

        By owning the property(s) outside the plan, when future opportunities arise, the taxpayer can grow their net worth/cash flow far more quickly. The down payments are 50-60% lower. The interest rates are significantly less, as is the length of amortization. Over time, the ultimate net worth and cash flow will be impressive.

  7. I have ROTH and SEP accounts with Equity Trust and I’ve never had a problem with the company. I hold a piece of real estate and I have used some of my rental income to buy stocks in those accounts as well. I have made all my own decisions–nobody from the company has ever tried to contact me about investments. I read the article and in my opinion there was very little investigation involved, it was more a report about a couple of people who say they have been scammed. Most of the comments were uneducated; not even understanding what a self-directed IRA is. I gave up on the WSJ several years ago because of weak reporting.

    Several years ago I had a problem with a different company but it was not because I was scammed. They had inaccurate accounting of some of my funds and investments, so I transferred my accounts to Equity Trust and I have never had a problem with them.

  8. Excellent article Jeff! Notes, in my opinion, are the ideal way to back into RE. When you figure out how to leverage the purchase of notes 100% give me a call – I’ll go all in. Otherwise, I’ll just have to continue on in the boring game of land lording 🙂

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