Case Study: How One Couple is Using Real Estate to Retire With $410,000/Year by Age 62

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Let me introduce you to a married couple who began their retirement planning a couple years ago. They’d been doing what most couples do for retirement, which is contribute to their 401K at work, figuring that’d do the trick. The bottom line reasoning for their reliance on the two 401k plans was the usual. “We get $X in matches, so since it’s ‘free’ money, why wouldn’t that be a good thing?” they wondered. So, how’d your 401Ks do in the crash of 2008?” I probed. 🙂 Silence.

Before we continue with their plan, allow me some time on their initial path. Let’s talk about the ultimate effectiveness of your 401K. Oh, and for the record, this couple is real, not hypothetical.

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Why Your 401K Will End Up Disappointing You — Big Time

They’ve been around for over 35 years, easily long enough to establish efficacy. Boomers are the first generation granted the opportunity to have had them for almost their entire working lives. They’re now hitting 65 with an average of $100,000 or less in their work-related retirement accounts. Hardly impressive. In fact, it’s downright depressing.

Many of you are now yelling that the match is free money, and how can you pass up that deal?! Those retiring Boomers — though many simply can’t retire — are wondering where they went wrong, though most of ’em had the matches many think are magical.

The Role Investor Behavior Plays

When we have a Nasdaq crash like we did at the turn of the century, or the Dow in ’08, people often respond less than objectively. They find themselves selling too late in the downturn and sometimes buying too late in the upturn to make up for it. Never mind that in the example of the Nasdaq crash, it took about 13 years to get back to the level it was before the crash. Thirteen years. That’s a whole lotta gettin’ nowhere fast on the financial treadmill. Meanwhile, the investor keeps having those pesky birthdays. Yeah, I know, not funny.

For Heaven’s sake, the investors who insist upon executing the hugely inferior buy ‘n hold, never sell strategy with real estate come out so far ahead of those counting on 401K plans. it’s unfair to compare the two. That’s how badly 401K plans have “performed” since their inception. Finally, let’s take the outlier, which everyone thinks they are, of course, and see how they fare.

funding-real-estate

Let’s Assume You Arrive at Retirement With a $2 Million 401k Balance

You won’t, but let’s pretend. Let’s also assume you’ll always get a 7% yield on that balance while retired. Again, you won’t, but keep pretending. Virtually every Wall Street type with whom I’ve discussed this will stick with the party line: “You’ll either be drawing out 4% of the principal yearly or yielding no more than a 4% yield on the balance.” Four percent ain’t much to be sure, but we’re pretty risk aversive once retired, right? Think about the retired folks you know today trying to make the best of their relatively disappointing 401K balance. The 10 year Treasury Bond is now (as I write this) hovering around the 1.75% mark. Is generating a yield more than double that on Wall Street still gonna pass the risk aversive test?

Seven percent on $2 million is $140,000 a year before taxes. Let’s say you live in a state without income taxes. Current tax brackets say your federal income tax hit will be (rounding up less than $700) $30,000/year. If you contributed to your 401K for 30 years and saved an average of $5,000/year in income taxes, that means you save about $150,000 in taxes over the 30-year period. However, in retirement you’ll have paid the same tax bill in just five years! In other words, you set yourself up to pay the same amount of taxes in five short years of retirement that it took you to save in 30 years. But that’s not the worst of it. You did that to yourself on purpose. Why would anyone do that if they knew the ending? (Don’t answer, it’s rhetorical. :))

The numbers get horribly worse in states with income taxes and downright depressing in high tax states like Illinois, New York, and California, to name just three. For you Californians out there, the annual tax woulda been around $40,000/year.

Back to Our Investment Couple’s Plan

They began by investing in a new duplex. They put 25% down. It cash flows fine. They’ll close a second duplex in the next month or so. They’ll be executing what I’ve come to call the “cost segregation strategy” on the first duplex, retroactively. This will generate at sale net proceeds in the approximate amount of $250,000, virtually tax free. It could be up to $50,000 more depending upon the loan balance at close of escrow. The sale will happen, barring Murphy’s entrance, in around three years, give or take.

Related: How to Retire in 3 Years Through Real Estate Investing

At that point, IF the market and the overall economy are cooperative, more likely than not, they’ll replace that duplex with two more. They’ll spend the rest on discounted notes secured by real estate, either directly or indirectly in a note investment group. The overall goal is to have all investment property loans paid in full by 62 or sooner. That’s not a random age, as another pillar of their plan comes to fruition at that point.

Their EIUL

To review, an EIUL is nothing but an insurance policy, but with a different structure to create a different outcome than a typical life insurance policy. With life insurance, the person dies, and the designated person(s) get paid a lump sum of cash. With the EIUL, though there are some similarities, for example there’s cash value buildup, but the core difference is that the payoff is while you’re still alive. You get tax-free income in retirement for however many years for which your expert structured the contract. Here’s what this couple did.

Their premium is $12,000 yearly, and they kickstarted the policy with $8,000 up front. The premiums are indexed to inflation so they don’t get spanked on the income side at retirement. This will go for 23 years. At that point, they’ll be in their early 60s and will begin receiving $117,000 a year — tax free — ’til they’re 90. Now, in California to net $117,000, you’d need to make somewhere in the vicinity of $180,000 at today’s fed/state tax rates.

Back to Their Real Estate Portfolio and Strategy

They’ll be executing the cost segregation strategy on their first duplex, acquired a couple years ago. In a nutshell, here’s what that involves. Cost segregation (CS) is merely a different flavor of depreciation. Depreciation is a “paper” loss on investment real estate that isn’t an actual loss out of your pocket. The concept is that your building is deteriorating so depreciation allows for that physical process. It has nothing whatsoever to do with the actual deterioration of your property. Again, it’s all on paper. All CS does is take all the components used to construct the building and give them a much shorter lifespan than the normal “straight-line” approach does. In smaller, residential income properties, i.e. 2-4 units, it tends to double the annual dollar amount available depreciation.

This strategy’s success is based upon the investor(s) making over $150,000 a year on the job. At that point the tax code literally bars them from applying any depreciation leftover from sheltering the property’s cash flow. It must go to the sidelines to gather dust. However, during the first five years of ownership, the loan is paid down to (preferably) zero. A sale at market value is then closed about the same time. This allows the investor/taxpayer to then utilize all five years of unused depreciation against that year’s household income. Bottom line?

Their tax savings on the personal income tax side tends to mostly or completely offset the cap gains/depreciation recapture tax liabilities. My experience is an average offset of around 75-100%. This results in avoiding a 1031 tax deferred exchange and all the baggage it brings to the party. It also allows the investor to replace the sold property with two new properties if that’s their plan. They’d still have money left over to make some significant discounted note investments directly or indirectly. I’ve also had a few clients take a large sum, low-mid six figures and open a second EIUL policy, using only that money for premiums paid five times, over a period of just four years and a day.

real-estate-partnership

What About a Discounted Note Portfolio?

They have roughly $200,000 combined in their self-directed IRA accounts. One is Roth, the other isn’t. Before they retire the pre-tax IRA will have been fully moved into Roth status. Their timeline is roughly 20 years. Here’s their scenario.

They’ll both keep putting $5,500 a piece in. In this calculation, I’m not even gonna include the last 12 years of them putting in $1,000 a piece per year more after turning 50. We’ll use an annual portfolio return of 10%. People often raise their eyebrows at that, which is understandable. Ask anyone who’s invested in discounted notes for a while, and they’ll tell you that’s real. I’ll go another step with that. This month marks the 40th anniversary of my first ever discounted note purchase. The next performing discounted note or land contract I buy that doesn’t produce a yield of at least 10% from the day I acquired it to the day it paid off will be the first. Period. Over ‘n out. 🙂

Anywho, they’ll end up with the following balance in 20 years. I invite you to do the calculation yourself. Start with $190,000 in present value. I use an HP 12C, so it’d be input as a negative. Put in 20 for the number of years, “N” on most calculators. Input 10% for “i,” that is, interest or yield. Then put in a negative $11,000 in “PMT.” The last step is to solve for “FV,” which is Future Value. In this case that comes to approximately $1.9 million. Even if we say they’ll only make, say, 7% overall yield in retirement, which would be a first in my lifetime, their tax-free Roth income from discounted notes would be roughly $133,000 yearly. Experience tells me it’ll exceed that by a long shot. At 10% you can do the math. 🙂

Let’s Now Conservatively Estimate Their Anticipated Retirement Income

Their tax-free income derives from two separate, stand alone sources: Notes in a Roth “wrapper” and their EIUL policy. The EIUL = $117,000 a year. The note income via their Roth IRAs = $133-190,000 yearly. Remember, these two sources are tax-free by definition of the tax code.

Related: The 6 Basic Principles (& 3 Common Myths) of Investing For Retirement

Taxable Note Income Both Directly and Indirectly Held

Between investable capital saved periodically over the years, plus after-tax proceeds from executing the cost segregation strategy 1-3 times, they’ll also have established an impressive personally held note portfolio, including both directly held notes and indirectly via note investment groups. They’ll have well over $1 million invested in their personal note portfolio. At a conservative 10% rate, that would indicate a taxable income of about $100,000 yearly.

Whether in a tax-free (Roth) envelope or taxable, the income at the beginning of their retirement will be the lowest they’ll experience while retired and alive. Notes pay off early usually, at a random rate. The note investor then reinvests in slightly larger notes with equally larger payments. Random Raises In Retirement — the name of my new band. 🙂

Real Estate Cash Flow in Retirement

I’ll assume that over the next couple decades, they’ll end up with no less than three small income properties, all of which will be free ‘n clear by the time they’re 62. The cash flow at that time will be in the range of $20-30,000/yr each. We’ll use a total of $60,000/year, though experience tells me it’s much more likely to be higher. It’s also possible they’d end up with more properties, but let’s stick with the conservative take for now.

What goes unsaid by most at this point is what the real value of debt-free investment real estate is once you’re retired. As you can clearly discern by the comparative incomes from the EIUL and notes, cash flow from real estate comes in a distant third. Their real value can be found in your ability to draw out tax free cash when needed. Call it “The Bank of (Fill in Your Name Here).” In this case, their real estate portfolio’s more modest amount would be around $1 million or so. If they wished to pay half a million bucks for a cabin near their favorite mountain lake, all they need do is call their lender, get a loan, and pay for the cabin with tax-free money.

Related: I Quit My Day Job, Retired Early & Started a New Venture Using Real Estate: Here’s How

They haven’t lowered their ultimate net worth, just rearranged where it is. Sure, they’ve reduced their real estate cash flow, but considering the other sources coming their way, do you really think they care much? 🙂 The same scenario would work if they needed cash in a hurry for a negative reason like medical problems, or…? The reason I’d advise them to borrow against their real estate is that we surely don’t want ’em to mess with either their note or EIUL income. It just makes sense.

retirement-goals

So, What’s Their Income When They Retire in Around 20 years, at 62?

  • Real estate cash flow:  $60,000 at the very least. It’s highly likely it’ll be significantly higher.
  • Note income in a Roth wrapper: $133,000 — It’s all tax-free by Internal Revenue Code definition.
  • Note income subject to income taxation: $100,000 — Sure, it’s taxable, but you’ll still bank it, right?
  • EIUL income: $117,000 — As is the note income from inside their Roth IRA, this income is also tax-free by definition.

Total retirement income beginning at age 62: $410,000 a year. Roughly 61% of which is tax-free!

That’s a boatload of money, to be sure. Thing is, once we get away from Wall Street and begin expanding our options menu, many more outcomes are possible. I’ve said this for years: “Given enough time and capital, the typical American should be able to retire on more annual income then they made in the best year on the job.” It’s not that hard to get done. In fact, it’s boring. It requires a real plan and purposeful execution. Add some serious flexibility, and most are surprised at what’s actually possible.

Any questions about this strategy? How are YOU planning for a comfortable retirement?

Leave your comments below!

About Author

Jeff Brown

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

38 Comments

    • David Shafer

      Jim, great question. EIULs get an interest credit tied to the movement of stock indexes with a floor of 0% and a cap of between 12-17% [depending on which company and which indexes they are tracking]. So if the index goes negative you would just get no interest that year. That is one of the best strategies employed by EIULs because you avoid sequence of return risk which can ruin planned retirement income levels as you point out. Periodically the market goes down 20-40% and the likelihood of that happening right before or after retirement is pretty high. Avoidance of negative return years allows one to sleep well!

  1. Hello Jeff,
    Your CS strategy is complex and will require a second reading. I think the concept is good, but I need more than the basic knowledge to comprehend the methodology.
    Thanks.

    • David Shafer

      Brad, perhaps you would like to be more specific about why you think “EIUL discredits the entire read.” EIULs have been around for 18 years now and have worked exactly as they were designed to do. Like any financial product, there are limits to what it can accomplish. And of course, like everything out there, there are some sales people who either don’t understand what they are selling or simply aren’t truthful about it. EIULs have proven to be a useful financial tool as long as it is structured correctly initially and used as it is designed to be. Certainly, it is a better retirement income tool than the ubiquitous mutual funds inside a 401K wrapper that is being sold to the public by a combination of Wall Street, corporations and the US government. Most of my clients have strategies with multiple pots that include investment real estate. Some still put money into 401Ks, but are astute enough to recognize the weaknesses in that strategy and are creating less risky retirement income strategies to go along with the government created 401Ks. EIULs are currently the fastest growing product of retirement oriented products as well as life insurance products. Admittedly, it is still a small drop in the bucket compared to mutual funds. But since this website is devoted to real estate investing, according to the public, a very risky endeavor, non-mainstream thinking should be appreciated.

      Good Luck in your endeavors.

  2. Ryan Arth

    The one thing that I never hear people mention is to contribute to their 401K(or SIMPLE,etc) enough to get the match and then cash the total out quarterly, annually or on some other schedule.

    You pay ordinary income tax on your contributions, plus 10% penalty. You were going to pay the tax anyways if you hadn’t contributed, so the only loss is the penalty. You pay tax and penalty on the employer match, which would have never been your money. You can pay your 10% penalty on your contributions out of the employer match net. You would still net out ahead.

    • Jacob Pereira

      Thank you! Every once in a while someone on BP tries to argue that you shouldn’t take an employer match but rather just invest the 50% that you make into real estate, and this is objectively bad advice. I mean, there is literally no argument here. Like you said, you can always take the penalty if you want to put all your eggs in one basket; I wouldn’t recommend it personally, but I can see why you might want to do that if you have a great deal coming your way and are strapped for cash. An even better strategy, imho, is to take a loan against your 401k. You can loan 50% of the value of your 401k, up to $50k, to help with the down payment on a property, usually at an interest rate around 4.5% THAT YOU PAY TO YOURSELF.
      I don’t mean to belittle your article, but this advice can be seriously detrimental to the long-term growth of your reader’s net worth.

    • David Shafer

      I’m not sure what you mean by “lost.” The death benefit is always higher than the cash value, so you are actually using the insurance as leverage on your money. If this happens early in the policy years, then the actual return on your money is extremely high. Later on it only adds on slightly to your cash value. Because it is a life insurance policy it creates financial security no matter how long you live. Most people in their financial planning make “bets” on longevity. Using this strategy no bets are needed as you are covered whether you live for 2 years or 40 years [assuming you have folks you want to take financial care of].

    • David Shafer

      Sorry forgot to add this:
      3 Risks people don’t generally think about
      1. Longevity risk- The risk you will die earlier than planned or later than planned
      2. Sequence of Return Risk: Risk assumed by participants in market based products that there will be significant negative returns close to the time you need to use the money invested
      3. Tax Risk: The risk that taxes will go up or previous strategies that created tax breaks are disallowed or that, heaven forbid, you succeed and have significant retirement income that puts one in a high tax bracket with little in way of tax credits or deductions.

    • David Shafer

      I am an independent agent and could sell any EIUL I choose. Every year I rate the top EIULs in the market which includes a look at the financial stability of the companies. My top two companies:

      1. Minnesota Life
      2. North American

      Both highly rated with Comdex of 92 and both with high performing EIULs.
      Over the last year I have sold Minnesota Life’s Omega Builder exclusively because of its ability to decrease insurance costs and it’s blended index option which has a superior 25 year look back on performance. Historically, the Minn Life product has outperformed all others. You can’t go wrong with either companies EIUL.

  3. Justin R.

    I’m following everything except the “However, during the first five years of ownership, the loan is paid down to (preferably) zero” part.

    How are you proposing the loan gets paid down entirely in only 5 years?

    • Jeff Brown

      Yep, sure am. The extra payment usually doesn’t come 100% from the ordinary income of the investor, Justin, though it certainly can. It’s usually a combination of real estate cash flow from the entire portfolio, if there is one, and note income. Then, if all that isn’t enough the investor uses their own money. This strategy works best when the investor’s adjusted gross income is $150k or higher.

      If you’d like to get into the weeds on this, reach out to me and I’d be more than happy to answer any other questions.

    • Jeff Brown

      Hey Adam — How high? Exactly how many years before you wanna pull the plug? Do you have any investments in real estate/notes now? How much capital do you have with which to begin? What’s your annual income? Those are just the first few questions. 🙂

      Reach out to me, as I have several ongoing clients in your situation, who’re pretty dang young with extraordinary savings rates.

    • Jeff Brown

      It can, James, but not nearly to the dollar amount of retirement income. This couple’s timeline allowed the synergy generated by multiple strategies 20 years generate exceptional results. If you wish to retire in, say 10-12 years, you’d certainly do far better than what your future likely bodes now, but likely not as good as this couple.

      On the other hand, I don’t know your financial particulars either. I’d be happy to spend some quality time with you to find out what’s actually doable. You can contact me through my site.

  4. Ivan Hsu

    You kind of cherry pick stats on the stock market to fit your narrative. The stock market is back to levels higher than before the financial crisis. Yes, the NASDAQ took a hit in the dotcom bubble but unless you put all your money in at the top, your cost basis should be much lower. You also assume sub-optimal investor behavior and completely leave out portfolio diversification (even as simple as bonds vs equities) that robo advisors can determine for you these days.

    • Jeff Brown

      I’m gonna let Dave Shafer give a more detailed answer to this excellent point you’ve made. What I’d contribute in response is the 10,000 Boomers turning 65 every day since 2010, and continuing through 2030 who’ve not come close to the results you suggest. Forbes research those folks and found the average 401k balance was at or below $100,000. We both know they all had matches, and that most of ’em had 20-35 years of contributing, along with the matches to do better than your point might imply, or at least what I inferred from it.

      What say you, Dave?

  5. Drew McLaren

    I think it should be pointed out that while, yes, baby boomers had 25-35 years of “opportunity” to contribute, the reality is that most failed to do so. And those that did contribute did not come anywhere near maxing out. This is the reason they are dealing with pathetic amounts in their 401k. Those of us that did max out over the past 20 years see our 401ks looking pretty darned good right now quite honestly.
    That said, I found the post quite informative and thought provoking.

    • Jeff Brown

      You make an excellent point, Drew. Please allow me to be Devil’s Advocate. Let’s assume you retire where you live now, (a half hour or so north of me, by the way 🙂 ) and you do so with $2 million in your 401k. You’re very unlikely to do that, but kudos if you do. ‘They’ consistently tell us you can either take out 4% of the principal per year, or plan on no more than a 4% yield on the principal balance. First off, if you’re as risk averse as most retirees are at that point, tell me where you’re gonna get 4%? As I write this the 10 year Treasury is an unimpressive 1.82%, so getting more than double that could prove problematic, assuming very low risk tolerance.

      We’ll assume your home is debt free at retirement. We’ll further assume you’ll get a 4% yield on your $2 million, and never have to deal with a falling yield. (NOT gonna happen in real life.) That means you’ve turned your 25-35 years of maxing out into a whopping $80,000 a year, wait for it, before taxes. You live in CA, not known for it’s low taxes. Your state income tax bill will likely be around $4,500, maybe a bit more. Your fed tax should be around $13,000. Combined, you’d be left with a less than impressive $62,500/yr on which to live.

      In my circles we call that a giant fail. ‘Course, remember that scenario assumed the yield would never go down, something we both realize is a fantasy at best. Am I making sense?

  6. Drew McLaren

    Thanks Jeff. Yes I’m with you on the inadequacy of settling for a 4 percent return on the nest egg but keep in mind that most scenarios where a 4% draw is recommended assume that you are keeping your money in stocks and bonds and not that you are finding some magical and completely safe money market account that pays this amount. We all know that markets can go up or down so in the bad years you’ll be drawing your 4 percent and seeing your savings dwindle but in good years you’ll be drawing your 4 percent and your balance will still grow. Most predictor models show you’d have better than even odds of having MORE money in your account than you started with 20 years later if withdrawing at a 4% rate.
    For my wife and I, I believe our success in achieving our savings goal has been more about the commitment we made to diligently saving than it has been about the investment vehicle itself. But moving forward I agree that it is going to be all about deploying what we’ve accumulated in the most advantageous way. I am very much intrigued by the note space and look to continue to expand my knowledge base there.
    Thanks again.

  7. Tony Castronovo

    Great article, Jeff. Like many investors I read a ton, listen to podcasts, network, and try to absorb as much as I can. I read a book called “Bank On Yourself” last year that sounds like a part of your strategy here (EIULs). I’m still rather new to REI (two properties under my belt) but trying to formulate a strategy for semi-retirement (don’t think I want to ever “retire”).

    I am not sure I completely follow your comments around “the tax code literally bars them from applying any depreciation leftover from sheltering the property’s cash flow. During the first five years of ownership, the loan is paid down to (preferably) zero. A sale at market value is then closed about the same time. This allows the investor/taxpayer to then utilize all five years of unused depreciation against that year’s household income.” Is this only related to the CS approach?

    • Jeff Brown

      Hey Tony — No, it’s not only for the CS approach. If the investor has an AGI over $150k all depreciation in excess of the cash flow will be set aside. This is true whether or not it’s straight line or CS depreciation.

  8. Frank Sanchez

    This is an interesting post.

    “Investments shall not be mixed with life insurance. Buy term and invest the rest”

    There are very specific cases where it can be applied, but this is not one of them. The more complexity an “investment” has, the more likely it is to be a bad option for the regular Joe.

    When you mixed investments and life insurance, you protect the salesman family – they get a juicy commission- not your family.
    Here:

    https://www.bogleheads.org/forum/viewtopic.php?t=67679

    http://www.forbes.com/2010/08/10/truth-about-equity-indexed-annuities-personal-finance-bogleheads-view-lindauer.html

    “Existing equity-indexed annuities are too complex for the industry’s sales force and its target investors to understand the investment.

    –This complexity is designed into what is actually a quite simple investment product to allow the true cost of the product to be completely hidden.

    –The high hidden costs in equity-indexed annuities are sufficient to pay extraordinary commissions to a sales force that is not disciplined by sales practice abuse deterrents found in the market for regulated securities.

    – Unsophisticated investors will continue to be victimized by issuers of equity-indexed annuities until truthful disclosure and the absence of sales practice abuses is assured.”

    The rest of the info is hard to follow; for instance,

    2M @ 4% is 80K withdraw per year. I ignore where the 140K stated comes from. The recommended withdrawal rate is 4% with a 6% return to make your money last 30 years or so.

    Total taxes paid on 80K should be about 18K, call it 20 for kicks. Retirees can shelter that through mayn different options like HSA.

    Regardless, let’s assume no shelter:

    150 / 18= 8.3. Where does the 5 year statement come from?

    The most disturbing part is that this disregards the time value of money. 150K accumulated over 30 years is by no means the same than 150K paid thirty years later. It disregards the investment return that the pretax money earns over that period. Anyone in the industry can point to this and plainly throw away the whole claim.

    People, be very cautious of those recommending mixing life insurance and investments. This is not a good idea.

  9. Don Spafford

    This is a very interesting article. it is unfortunate that this kind of financial education isn’t taught in schools. I am about to turn 40 myself and am starting to think more about retirement and my 401k savings will never be to the level it needs to be which is why I decided to make the move into Real Estate which I wish I would have done in my 20’s. How would one know if a financial advisor/retirement planner is knowledgeable enough in this type of plan to provide beneficial advice?

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