Let’s create a very credible scenario today. Surely by now BiggerPockets is closing in on its gazillionth member, and most of ’em are regular folk like you n’ me. They go to work, and most get married and have a family. Furthermore, in far too many families, the economy for quite a while now has demanded both parents work to make ends meet and maybe get a teensy, weensy bit ahead. Here are the “facts” about our fictional couple. See if they don’t sound like you or many you may know.
Gary is 40, and his wife, Nicole, is 39. Married in their early 20s, they now have a couple kids, 12 and 9. Gary makes $48,500 a year before taxes. Nicole makes $16 an hour for 25 hours weekly as a bookkeeper, which comes out to approximately $20,000 a year pre-tax. They live in Texas, where they were both born and raised.
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What They’ve Done So Far
For the last 15 years or so, they’ve each been putting $250 a month into their self-directed Roth IRAs. It’s what they’ve been able to afford. At first it was due to what they made at work, but then with the kids, well, I’m sure you get the picture. This has resulted in them having a combined balance of about $115,000 between the two accounts. Not a stellar return — about 3.5% a year average — but it’s nothin’ to sneeze at.
They also bought a modest home using FHA financing back when the prices were, um, “reasonable.” 🙂 They’ve remained there, as the home has three bedrooms and a couple bathrooms. However, they wish they could move to a home with more square footage. They have no other investments and pretty much live on a strict budget. They go out occasionally as a couple and as a family. The normal stuff. Over the last 15 years, aside from their separate Roth IRA contributions, they’ve been able to put away a bit over $25,000 — what they call their “rainy day” fund.
Though Gary gets small raises ever now and then, his income will be lucky just to keep up with inflation. The question begging to be answered is — Just what are they gonna do for a retirement income?
What Are Their Options?
They have many. Here are a couple.
- Refinance their home loan to lower payments significantly. They’ll cut their monthly payment down by $300. This is a Captain Obvious no-brainer and should be done regardless of anything else they may choose to do.
- Put both of their self-directed Roth IRAs into discounted first position notes/land contracts, secured by real estate.
They can easily accomplish the latter through an investor group model. They have neither the knowledge, expertise, nor experience to invest in notes by themselves. In fact, investors moving into discounted notes without experience or professional advice are far more likely than not to end up with an advanced degree from Hard Knocks University. I’ve seen it far too often. Note investing shouldn’t mirror amateur night at the local comedy club.
Note: Last month was the 40th anniversary of my first discounted note purchase. In that time, I’ve yet to have a note produce an overall yield — from day one in ’til last day out — of less than 10%. Every now and then, pretty rarely, I’ve had a non-performing note/land contract return less, even lose money. But the returns on non-performing are so much higher than performing that the occasional loser is less than a blip on the screen, relatively speaking. How high can the yields be on non-performing liens? Cartoonishly so. But the super high yields are just as much outliers as the losers are IF it’s done professionally. However, those of you wishing to get your foot in the door of non-performing notes/land contracts secured by real estate should always keep in mind that those much higher yields come with equally higher risk. Most folks don’t like talking about it, but there it is. The higher the risk, the higher the yield, and the bigger chance of failure. Don’t kid yourself. This is why using a pro to mitigate that risk, non-performing OR performing, is a necessity if you’re serious. This point cannot be over emphasized.
If Gary and Nicole keep putting in the modest sum of $250/month a piece into their Roth IRAs for the next 25 years and put that money into discounted notes — performing — let’s see what happens. In order to make the point more compelling, we’re gonna assume they average a paltry 8% overall annual yield, something I’ve not seen in my professional career as it relates to discounted note yields.
Present value = $115,000
Annual investment (payment) = $6,000
Time (n) = 25 years
Interest/yield (i) = 8%
They’d end up when Gary turns 65 with about $1.25 million in their two Roths combined. If we extend the lousy 8% example annual return ’til they both die, that’s a tax-free income BEGINNING at around $100,000 a year — wait for it — tax free. Why do I say “beginning”? Simple, cuz their portfolio of performing notes/land contracts will continue to do what they do, which is to pay off early in a totally random manner. (Most pay off in a 3-9 year range.) Inside the Roth, there’ll be no taxes on the profits. The money will be reinvested in larger liens with slightly larger monthly payments. This means, in essence, that they’ll forever be getting random “pay” raises their entire retirement. How freakin’ cool is that?!
Can they do other things? You bet. But considering they have a couple kids and haven’t yet figured out how to print $100 dollar bills, this will have to do. They can do other things. But given the cost of living for a family with this income, regardless of the fact they live in a relatively low cost-of-living state like Texas, this plan is eminently doable.
Let’s compare this approach to the typical family with their 401k plans. I’ll make this short. 🙂
If this same family across the street from our couple ended up with a work-related 401k balance at age 65 of $1 million bucks (make-believe at its best), then made the same 8% return (another delusion), they’d be living on $80,000 yearly — BEFORE taxes. In other words, they’d be grossing far less income than Gary and Nicole will be netting. The neighbors’ net income would be around $67,000.
The kicker? The neighbors can’t even come close to achieving that in their work related 401k. It’s a fantasy to say the least.
Getting ourselves to a very nice retirement, one allowing a full lifestyle with travel and whatever else makes your day, doesn’t hafta be super complex or sophisticated. It does require a cogent plan and for that plan to be executed on purpose. Gary and Nicole will retire with more tax-free income than they likely ever made pre-tax in their lives, combined. All they did was what they could do and what they could afford. Imagine if somehow they’d been able to shoehorn in a rental or two? 🙂 When the smoke clears, the truth is that none of this, assuming there’s a pro in the mix, is rocket science.
Investors: What does your retirement strategy look like?
Let me know with a comment!