Case Study: How Two 30-Somethings Can Create $200k+/Year Tax-Free in Retirement

by | BiggerPockets.com

I talk to a lot of 30-somethings, and most of ’em have a few things in common. They’re making nice money at work. They’re married, and their spouse also gets paid pretty well. They bought their first home. They both give generously to their respective work-related 401k plans. They live below their means. They’re savers. They’ve seen in real-time how their parents’ retirement or looming retirement isn’t anywhere near what was anticipated.

Let’s take a composite couple from my own files in this age group and financial status, see where they are today and where they might be at around 60 years old. Again, I’m purposefully ensuring this composite couple represents who I work with much of the time—speaking of that specific age group for this post—not some amazing couple making half a million a year, with a million each already in their 401k accounts. For the record, the age range of 90% of my clientele is roughly 25-57 years old. Likely the biggest group’s members are in their 40s.

Today’s Reality: A Financial Snapshot

Doyle and Marian (how are those for old school names?) are 37 and 35 years old. He works as an engineer in the private sector whose contracts are largely with the military, earning around $120,000 annually plus small bonuses. She’s a buyer’s agent for a local stud real estate agent’s team. The team leader allows her to work very flexible hours and days due to having a couple kids, 5 and 9.

She also has a Masters Degree in Computer Science, an industry she had to leave due to the hours involved. After getting her feet wet in real estate, she averages about 1.5 sales monthly, with an average sales price of about $350,000 or so. The last three years, she’s averaged just over $75,000 in pretax income. Working in an office with over 350 agents, she also started a small company that troubleshoots and fixes computers for agents, not to mention keeping her team leader’s computers healthy and well maintained for free. So far this year, she’s made almost $20,000 doing that. Let’s assume that results in a computer income of around $30,000 yearly.

  • Total annual pretax income: $120,000 + $5,000 bonus + $75,000 + $30,000 = $230,000.
  • After-tax income: $160,000 more or less.
  • Total cash required yearly to live, including everything we can imagine: $80,000.
  • Money available for retirement investing: $50,000+ per year.
  • Money they’ve managed to save in the last few years due to their wise budgeting: $130,000

Doyle’s been maxing out on his firm’s 401k plan, at around $18,000 a year. His current balance is $150k or so. He’s put an end to that recently due to his well founded anticipation of an overdue downturn and the fact he can do far better with less risk elsewhere. Less invested cash than the after tax version of that will be redirected to an EIUL, which will be structured to begin paying out when Marian hits 60 and will continue paying ’til she’s 90.

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Related: 7 Achievable Steps to Reach 7-Figure Retirement Savings

Let’s Talk About Marian’s Solo 401k

She’s going to take about $20,000/year and contribute it to the Roth side of her Solo 401k. (You must be an independent contractor or a small business owner to have a Solo. There are exceptions, but they don’t apply here.) She’ll do this for 25 years—or until she’s around 60 years old. From day one, the Solo will invest in discounted notes secured by homes around the country. They’ll be first position and have a minimum of 25% equity behind the actual loan balance at the time of purchase, usually more. We’ll compound those contributions at 10% annually.

Wait just a freakin’ minute here—10%? Are you kiddin’ me?!!

If you’ve read me before on discounted notes, feel free to skip the next couple paragraphs. This spring marked the 41st anniversary of my first discounted note purchase. That’s a long dang time, right? In that time, I’ve never—as in, never, ever—had a note, not one, that from the first day in ’til the last day out didn’t produce a yield of a minimum of 10% annually. That’s history, people, not a silly spreadsheet projection. There literally hasn’t been one exception since that first note investment back in May of 1976. Oh, and yes, I did have to foreclose on several over that time.

In fact, there were many times I ended up with more money in foreclosure from the sale of the property than if they’d merely paid what was owed. No, really. Also, a brief note on the foreclosure scenario: If anyone tells you that foreclosure can be avoided by simply doing your due diligence expertly, either they’re massively ignorant or they think you are. Studies have shown conclusively that when a couple with FICO scores both over 800 lose their jobs, their FICO scores still can’t make their next house payment. Who knew?

Takeaway: Over the long haul you will foreclose, no debate, period.

How Does $20,000/Year for 25 Years End Up?

As it turns out, pretty freakin’ good. Her Solo 401k balance at retirement will be about $1,967,000. Experience tells me it’ll likely be a bit more, but at that amount, using a 10% cash-on-cash annual return, she’ll enjoy an annual income, tax-free, just short of $200,000. Now for those who’re screaming that there’s no way to know if 10% cash on cash will be reality 25 years from now, I agree. Merely pointing to over four decades of experience when yields never dropped below that figure isn’t in any way evidence it will continue for another several decades. The past, much to the chagrin of many, simply doesn’t necessarily predict the future. That lesson is best learned early and followed closely. Even if she should only get a cash-on-cash 6% yield at that point, her tax-free income from that source alone would still be over $100,000.

Marian’s EIUL: A Life Insurance Policy Structured for Tax-Free Income

I asked my EIUL expert, Dave Shafer, to let me know two separate figures for tax-free income. The first would be using the government’s required yield guideline. The other would be using the midpoint between the government guideline and what’s actually happened empirically the last 25 years. Here’s how the policy would be set up in general.

Related: Ashley’s Story: How to Retire by 30 While Traveling the World

It would use $6,000 up front as a “jump starter.” That doesn’t seem like much, but over a long time, it actually makes a pretty big difference. The monthly premium would be $750. Voluntarily, Doyle and Marian would raise the premium each year, using inflation as a guide. You’re going to get clipped by inflation either on your premiums or your retirement income. Choose your premiums if you can.

The ultimate tax-free income from their EIUL would be in the range of $72,000 to $86,000 yearly. The reason for the spread is simple. The government recently required the use of no more than roughly 7.1% annual yield in calculating policy income. However, the index Dave uses the last few years has produced, historically, not projected, around 9.24% annual yield. This was for the most recent 25 years, not a small time sample.

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Where Are They So Far?

Without a dollar invested into any income property yet and no personally owned discounted notes or note investment group shares, they’ve set themselves up for around $270,000/year or so, both sources completely tax-free. Next week, we’ll examine what they decide to do in the real estate investment arena. They’ll be making solid use of the tax code to maximize their return in a compressed timeline. At the end of that timeline, they’ll also be able to begin their privately owned discounted note portfolio. We’ll begin applying real synergy to their purposeful plan.

Questions or comments about this case study?

Leave them 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.

45 Comments

  1. Dominick Dahmen

    Hey Jeff, I am a financial strategist as well as yourself and I love the idea of building a Roth and Life insurance policy at the same time and use it for real estate for some semi guaranteed (real estate income) tax-free earnings. However I have one problem. Why are you using an EIUL? Why not a properly structured whole life policy? Also. Who do you use that allows you to invest in notes for the Roth? My sales manager said that they wouldn’t allow that at the firm.
    Thanks!

    • Jeff Brown

      Hey Dominick — I’ve done comparative analysis multiple times showing the long term results of ‘properly’ structured whole life policies and EIULs. The EIUL slaughters it every time. However, I suspect insurance may be your area of strong expertise. I strongly recommend you and Dave Shafer chat about it. I’d love to be in on that chat, and would provide the platform for it myself. It would be, and would stay private, of course.

      Self-directed IRAs are anything but equal. You can invest in notes inside your SD Roth with the proper structure. Please email me a request, and I’ll immediately send you the name of one of my Roth experts. He’ll show you how easy it is to make note investments from a Roth.

      • Adam Anstatt

        But doesn’t the cost of insurance for the EIUL increase with age? And can’t this eat away at the cash value until the policy lapses with no value? Alternatively, whole life is a safe and guaranteed thing. I don’t see the upside to introducing risk back to the insured.

        • Dominick Dahmen

          Adam,

          Yes that does increase with age. In my opinion, that’s why IULs are so dangerous. You have awesome upfront cash compared to whole life, but it dies especially around the 70’s.

        • The cost of insurance always increases with age. Whole life merely over charges you in the early years, while the EIUL charges you the actual costs on a year to year basis. This also demonstrates a misunderstanding of why permanent life insurance builds up cash value inside of policies. The cost of insurance is not based on the death benefit, but the death benefit minus the cash value. So, if you have a $1MM dollar policy and you have $600,000 of cash value, then you are purchasing insurance on the $400,000. As you build up cash value [as you age] the corridor between the death benefit and the cash value decreases. In an EIUL, you are building up much more cash value, therefore paying for less actual insurance. At the end, when you are taking our tax free income, your death benefit in the EIUL is going down keeping the corridor as small as possible. All this is demonstrated in my illustrations; it is much easier to understand with the numbers in front of you. As an aside, the Whole Life agents have seen their product sales decreasing, while EIUL sales are taking off and therefore have been trying to muddy the waters [or just plain confuse folks] to scare people into buying Whole Life. Wall Street has also been worried and is now adding in their propaganda. But the actual performance numbers of 20 years of EIULs don’t lie.

        • Dominick Dahmen

          David,

          You are correct that whole life front loads the costs, however they do this so that premiums can remain the same while cash value will be credited faster over time especially when dealing with a mutual company (which I only work with) that pays non guaranteed dividends. Now correct me if i’m wrong, but the reason you can fit more money into the EIUL or IUL is because you are basically buying term insurance for the DB so the MEC limit is way higher. The problem with that is that the DB will not increase with dividend payments because EIULs don’t earn them. In whole life policies there comes a point in time where you actually have more cash value than what you put in, same with EIULs. However, I just ran a annual renewable term (ART) illustration (yes I am an agent) and found that for a 45 year old, the total payments are more than what he would receive as a DB by the time he is 76. It works the opposite way with whole life. Because they front load that costs, it’s less expensive in the long run because you have time on your side. With the term aspect attached to UL policies, you have to pay for the actual cost on a year to year basis. I suspect most if not all of your clients are younger. What happens when they are in their 70’s and there is a bear market. Sure they don’t lose money because they might earn 0% and nothing less, but are they going to pay 6-10% of the DB per year when that happens?? Also remember UL exploded on the seen in the 80’s with high interest rates, however over time the cost of insurance devoured the policy. The kicker here also is if they pulled out more money than they put in and the policy lapsed, they had to pay tax on the difference. Last point. David, you seem very knowledgeable, but I feel your last comment was a tad un professional as it had a blanket accusation about “whole life agents.” First off, i can sell IULs, my clients and I just choose not to because it doesn’t fit their needs. However, it is my belief that most “whole life agents” are selling whole life because it is the best. That of course is opinion. But no one is “scaring” people into buying whole life. I know you feel EIULs are the next best thing. But what if they’re just the “next” thing and that’s it? They certainly have a place for short term INVESTING, but not long term financial planning UNLESS and only unless there are guarantees and/or there is a plan you move the money somewhere else safe for retirement. So as you can see i respectfully disagree with you and Jeff on the EIUL side. But overall I absolutely agree with you guys on the real estate and tax free money side.
          Sorry for the long post. Hope that helps!

  2. Dominick Dahmen

    Hey Jeff, I am a financial strategist such as yourself and I love the idea of building a Roth and life policy at the same time while using real estate. However, why are you using a EIUL? Why not a properly structured whole life policy? Also. Who do you use for note investing in a Roth? One of the higher ups at my firm said they don’t do real estate in the 401ks or Roths.

    Thanks!

    • One reason might be average internal rates of return in whole life products average around 3%, while in EIULs they average around 8% over the last 20 years. Another reason is that EIULs loans are structured to either be “no cost” or to allow for positive and negative arbitrage, which using historic numbers gives you a 2-3% advantage. The basis of whole life is to guarantee death benefit, while the universal life products are designed for cash value build-up [and have their guarantees on that side]. So if you are looking for tax-free retirement income the EIUL would be the more appropriate product, while if you are looking for guaranteed death benefit [perhaps in a trust to pay inheritance taxes] then whole life is the appropriate vehicle.

    • Jeff Brown

      Great question, Alex. The more successful you are in building up the Roth’s wealth, the more important it becomes that it IS a Roth. The reason is that to match a tax free dollar coming out of that Roth in retirement will be equal to roughly $1.25-1.45 in pretax income from a pretax plan.

      I often hear the argument saying, “I can build up my 401k pretax plan at work to $2 million in the next 31 years. Once I retire I then roll it into a completely self-directed IRA. I then make your 10% cash on cash in notes. I win, see?” My answer goes like this, “No, you merely sentenced your self to pay more in taxes in the first 5-7 years of retirement than you saved in the 30+ years of contributions. Imagine getting $200,000 a year in taxable income, and that’s in addition to any other income you might have at that point. You’ll likely incur an income tax liability, state/fed of at least $50,000. That means you’ll have paid more taxes in your first 5 years of retirement than you saved via contributions most of your adult life. Why would you do that to yourself on purpose?” That pretty much ends the discussion.

      But wait, there’s more grief ahead. 🙁 When you have a pretax IRA or 401k when you reach 70.5 years old, you’ll find out up front and personal what RMD’s are all about. That’s Required Minimum Distributions. See, and you know, the gov’t knows exactly what day all us are gonna die. They tell you at 70.5 when that is, exactly. Let’s say it’s 10 years out, and you have a huge balance in your pretax IRA or 401k. That balance gets divided by 10. That amount then must be distributed to you each year, minimum, for those 10 years. And yeah, it’s taxable, and yeah you’ll also be forced upward a bracket or even 2. Then your $2 million is a whole BUNCH less, and you’re still gonna invest it for income, cuz you know, you need to eat ‘n stuff.

      The Roth is the way to go, period. Now, if you have a traditional IRA you can add to it a separate Roth IRA. Slowly but surely as you can stand the tax pain, roll your pretax dollars to the Roth. Am I making sense, Alex?

  3. ryan tatro

    Jeff, I always enjoy reading your articles and detailed responses to posts. Thanks you. I have a question regarding eligibility to contribute to a Roth. My wife and I are currently over the taxable limit in order to contribute to a Roth within our work retirement plans. Is there another vehicle we can use to take advantage of what you discuss?

    Also, when we were younger we did put some funds into Roth accounts. Could we transfer these funds penalty free to an EIUL? I am very green to EIULs.

    Thanks in advance your sharing your experience!

    Ryan

    • Jeff Brown

      Really good question, Ryan, and one I’ve never been asked. To my knowledge, and I defer to my IRA experts, you won’t be able to do what you suggested. (tax free move from IRA to EIUL) If, however my experts contradict me, don’t believe a word I just said. 🙂

      If you or your wife have a side business, or is an independent contractor with 1099 income, you’re eligible for a Solo 401k. You can make any amount of money and still contribute. Furthermore, the max contribution allowed annually is just short of 10X what you’re limited to with your IRA.

    • Michael Pazirandeh

      Hi Ryan, I am no expert in this area but from my understanding you can still contribute to a Roth IRA even though you’re over the income limit. Most people don’t know about this, but you need to do what is referred to as a back door roth IRA.(http://www.rothira.com/what-is-a-backdoor-roth-ira). In essence, you are putting post tax money into a traditional IRA and then converting it into a roth IRA. This method only works, however, if you do not have any pre tax money in your traditional IRA. My understanding is that if you put post tax money into a traditional IRA that already has pre tax money, and then do a back door transfer, the IRS cannot distinguish between the pre and post tax money. The end result is you will end up being taxed on the pre tax money in the traditional IRA. I’ve personally never done this myself, but have researched a bit about it. Hope that helps!

  4. Hi Jeff,

    How would your assumptions change for a working couple living in a high cost of living area such as the Bay Area, CA? Having about $50,000 to invest might be unrealistic in this area. How would your strategy change?

    Thanks
    Varun

    • Jeff Brown

      Hey Varun — There are no formulas, at least not in my world. Everybody’s different, even when they seem very similar. There are things you can do, especially when it comes to notes. Contact me and I’ll give you the detailed lay of the land.

  5. I thought IULs have only been in existence since 1997? How can one predict what they will do in the future considering they have not cycled through even one generation yet?
    Let me know your thoughts

    Thanks

  6. Jen Simbolw

    My husband and I are interested in investing in notes. We would like to invest in a fund since we don’t have any experience and don’t feel properly educated. We were told you had to be an accredited investor to invest that way, which we are not yet. Any advice?

    Thank you.

    • Jeff Brown

      Hey Jen — You’re right about that, as most of the note funds of which I’m aware require their investors to be accredited. This is why I started a note investment group allowing a limited number of investors who aren’t accredited. Contact me and I’ll give you the scoop. There is a way. 🙂

  7. Patrick Campbell

    Jeff, I too enjoy reading your articles and answers to posts. I have a question about contributions to Roth IRAs. As I read the rules, there are income limits on making Roth IRA contributions. For a married couple filing jointly, they are $196K for 2017. http://www.rothira.com/roth-ira-rules. In your example, the young couple have an AGI somewhere above $200K. So how can Marian contribute to a Roth IRA? A “back door” Roth wouldn’t be advantageous, either, as you have to pay taxes on the conventional IRA funds converted to a Roth IRA. So I understand Marian setting up a solo 401K, but wouldn’t that be funded with pretax income and taxed upon withdrawal like a conventional IRA?

    • Jeff Brown

      Patrick, good question. But if you look closely, she’s contributing to a Solo 401k, a different animal altogether. You’re correct about the income limits for IRA contributions. There are ways around those limits though, one of which was brought up in this thread.

    • Jeff Brown

      Hey Dre — The main difference between a permanent, more commonly called whole life insurance policy and an EIUL is simple. The former is primarily structured to distribute a death benefit. The later is structured to produce tax free income in retirement. Though many use whole life policies to produce income, the EIUL easily out performs whole life IF the goal is tax free retirement income. Make sense?

        • Dividends in whole life are just a return of expenses that were over charged by mutual insurance companies. They are the device in which mutual insurance companies build cash value inside of the policy. Therefore they should be compared to the interest credit given inside of the EIULs. Whole Life policies have a range of internal rates of return [which includes dividends] of 2-4%. While EIULs range over the same time period from 6-8.5%. Dividends are determined by the company, at the end of the year based on the movement of the general funds that back the product. Interest credits inside the EIUL are determined by the movement of stock indexes with a 0% floor and a cap rate [17% for my favorite option at Minn. Life]. Much harder to manipulate stock index movements than internal decisions by mutual insurers.

        • Dominick Dahmen

          You are partially correct. Dividends are not what was “overcharged” per se, and they do get pretty sizeable overtime. A client I have had an older policy, and he only paid premiums on a 500,000 policy for 13 years, and hasn’t paid premiums for another 13 yet his policy has grown to 625,000 in DB. I don’t remember the CV. Dividends can easily become 10x or more of the annual premium in the mid to later years of a policy. Now rate of return is alittle tricky to calculate in policies without an illustration. But policies usually offer 3.5-4% GUARANTEED interest plus dividends (which are not guaranteed but I only work with companies who have paid dividends 100+ years straight. That includes all years of the depression). At the end of the day, EIULs are an INVESTMENT. Whole life policies offer steady compounding guaranteed (and non guaranteed) growth for “safe money.” That’s why it is so powerful when you combine real estate and whole life. If you are interested in hearing about this idea, we could talk about it privately if you’d like. Also what happens if you have an older client and the market has multiple years with 0% return, they are taking from the policy for income, AND they have astronomical cost of insurance?

          Side note: Does Minnesota Life do point to point for the interest?

          Thank you

      • Dre Scott

        Great, thanks for the response. I’ve had insurance people try to sell me on permanent life insurance in the past. I’m not wholly against it; just wanted to learn more about other insurance avenues and see what actually fits my situation best.

    • Jeff Brown

      You’re not alone in that belief, Cynthia. In fact, many 401k plans sport the option of after tax contributions, in other words, Roth. I have many clients whose employers also offer a Roth option. But the best is the Solo 401k, the entity we used for Marian. It sports both pre-tax and Roth contributions. Also, it’s easy as pie to move pre-tax Solo money into the Roth side. Of course the taxes would hafta be paid, but it’s Roth at retirement, which means the income is tax free by IRS definition.

      Here are the major differences — benefits if you will — between your work related 401k, a self-directed IRA, and a Solo 401k.

      1. Given adequate income from either 1099 earnings or your small business income, the Solo allows its owner to put in about (it changes all the time) $53,000/yr. Contrast that to the $18,000 or so max now in force with your employer’s plan. Sure, add the employer match, it’s likely it will still remain below even half of what the operator of a Solo will have invested.

      2. The Solo allows its owner to invest in anything approved by the IRS. Not so with employer based plans most of which are attached at the hip with Wall St. products only. Discounted notes slaughter Wall St. over any given decade in my lifetime. Period.

      3. The Solo allows just short of 10X the annual contribution as do IRAs.

      4. The owner of a small business can hire their spouse as a W-2 employee, making them eligible for a sub-account in the Solo. That means both can max out at $53,000 EACH/yr, which moves to $59,000/yr each from age 50 forward.

      5. Once you hit 70.5 years old, EVERY retirement plan except the self-directed Roth IRA requires you to begin disgorging the entire balance over a prescribed number of years, based upon your anticipated lifespan.

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