One of the things I like most about writing on BiggerPockets Blog is the comments and questions from readers. Some of those comments inspired this article, as they compelled a reasoned answer worthy of more exposure than the comment section for one article. The article in question can be found here. Whenever I encourage folks to either gut their 401k/IRA or roll it over to a Solo 401k, some recoil in horror at not takin’ long term advantage of the ‘free money’ routinely contributed to the accounts by their employers. On the surface it seems reasonable to accept that free money as a turbo charged way to a golden retirement. Some are more tempered in their objections. They proffered the reasoning that limiting the taxpayer’s contribution up to the amount of the employer match would act as merely a small part of the person’s retirement plan. Supplemental retirement income if you will.
Let’s take that approach to it’s maximum benefit
- We’ll assume they contribute $15,000 yearly with a 100% employer match, for 30 years
- Since they’re effortlessly, and without risk, doubling their money annually, they don’t ever lose money
- This results in an account totaling $900,000. The average 58 year old man has less than $100,000.
- A post retirement yield of 4% will be used to create the supplemental income stream
We’ve assumed 30 years in a row without a penny lost. Warren would be proud. 🙂 And yeah, before ya bring it up, I know there’s likely no employer in the country giving a dollar for dollar match near or at the maximum allowed employee contribution. But there’s a point to be made here. Since such a microscopic percentage of folks hit retirement — even with a healthy employer match — of anywhere near $300,000, much less nearly a million bucks, this extreme example should be illustrative.
At the 4% rate Wall Street financial experts recommend for post retirement yield projections, this would produce a supplemental income of $36,000 a year before state & federal income taxes. We’ll be kind and project an after tax figure of roughly $30,000. A figure to be proud of, given it’s status of merely supplemental. We would, of course, assume this taxpayer invested well in whatever was their prime retirement income vehicle(s), and did exceptionally well. We’ll assume it was real estate. 🙂
In fact, let’s assume that after 30 years they ended up with an impressive real estate retirement income of $100,000/yr.
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An Alternative Approach
- We’ll take the same yearly $15,000 contribution, but make it a $10,000 after tax amount
- $5,000 will go towards the annual premium for an EIUL — 30 years of premiums indexed to inflation
- $5,000 will go towards the annual contribution to their new Solo 401k Roth — again, for 30 years
- They’ll invest in discounted notes in the Solo — we’ll assume they pay off an average of every 5 years
- Note payments will be invested as appropriate, based up the ability to acquire new notes
As in the first approach, they’ll invest and do very well in real estate. They’ll end up with an enviable retirement income from their real estate investment efforts — $100,000. However, let’s concentrate instead on the ‘supplemental’ income they’ll create with the $10,000 a year they’ve been allotted.
First the EIUL
I brought in the expert in the EIUL arena, David Shafer, a fellow BiggerPockets contributor. I told him we were dealing with a 35 year old man, who’d be taking the after tax leftovers of his former annual $15,000 401k contribution, and puttin’ half of it — $5,000 — into an EIUL, indexed for inflation. At first, Dave said he’d run the analysis based upon our guy livin’ ’til 90. Anticipating somebody askin’ about the possibility of him living to 100, I insisted that age be used. It lowered the ultimate income at retirement, but also lowered the possibility of those who’d object to him ‘only’ living to 90. 🙂 Summarizing, Dave had him payin’ premiums for 30 years then triggering the income, probably around 66.
The income our intrepid investor would be receiving ’til 100 years old would be $96,250 annually — every single penny of it TAX FREE.
If he comes to an untimely end before 100, his heirs would receive any cash value in the policy — again, TAX FREE. See, by IRC definition, unlike your handy dandy job related 401k, cash value in the EIUL is not even considered to be part of the estate. Heirs like that.
The remaining $5,000 a year goes into his new Solo 401k, on the Roth side
He contributes the $5,000/yr for five years, yielding interest of just 4%. At the front end of the sixth year he adds that year’s $5,000, which brings his total to that point to approximately $32,000. He acquires his first discounted note/trust deed. It’s face value is around $49,000, with payments adding up to roughly $5,160 a year.
Years 6-10 his payments accumulate to around $25,800. His note pays off, net proceeds amounting to about $47,300. He takes this payoff, adds the accumulated payments to it, and with the princely sum of $65,000 (he started a slush fund of about $8,000) he acquires a new discounted note for $100,000. The payments from years 11-15 amount to about $52,600. The note payoff proceeds are, give or take, $96,500. He then sets aside another $12,000 for the slush fund, now totaling over $20,000, and acquires notes with a face value of approximately $211,000. Payments total $22,200/yr, which comes to $44,400 in the first two years (years 16 & 17), which he prudently uses to acquire another note, this time for $68,000. Those payments total $7,160/yr. Total annual payments are now $7,160 + $22,200 = $29,360. In two more years that adds up to a tad more than $59,000. He buys another note with a face value of $90,000, with annual payments totaling around $9,470. $7,160 + $22,200 + $9,470 = $38,830 a year in note payments received by his tax free retirement account — which he administers.
He rinses and repeats ’til his 30 years are up. His income at retirement is well over $100,000 from this approach — all of which is tax free by definition. But we’ll say it’s ‘only’ $100,000. ‘Course, that’ll keep increasing as notes pay off and he acquires larger ones to replace them.
Raises In Retirement — the name of my new band. 🙂
The alternative I propose to using your 401k as a source of supplemental income turns out to be a major part of your overall Purposeful Plan for retirement.
The EIUL income ends up being $96,250/yr — tax free ’til you’re 100.
The Solo 401k (Roth) provides at least $100,000/yr — again, tax free. It also increases at random intervals ’til you’re gone. We love income increases in retirement.
That’s almost $200,000 a year in tax free retirement income. Hardly supplemental. 🙂
Add to this 20-35 years of prudent real estate investing, and your retirement will indeed prove to be magnificently abundant. In fact, since they both produced $100,000 a year from real estate investing, the difference comes in the other paths they pursued. One of ’em retires with $136,000 a year, most of it taxable, and all of which will be taxable when the depreciation runs out.
The other guy will be living on just under $300,000 a year, the vast majority of which — over 2/3 — is tax free by definition.
‘Course we must all make our own choices. Which method appeals to you? Go ahead, take your time. No rush.
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