Case Study 10 Years from Retirement — Video

Are you wondering about your own case study 10 years from retirement? Even if you’re 20 years away, is your plan workin’ out the way you projected? Here’s an alternative for you to check out.

 

Transcript:   Hi this is Jeff Brown the “BawldGuy”. Today, we’re going to talk about somebody who is may be ten years from retirement and they’re wondering what to do. They’ve looked at their 401k. It’s got about $300,000 and maybe a little bit more into it from a previous employer, and they realized that that’s just not going to get the job done. They long ago realized that the path down which they were going, as my English teacher would say, was leading to a dead end, what to do. Well, let’s first look at what his status quo would yield. If he’s got ten years to go and it took him twenty, twenty-five years to get $300,000, let’s be really grandiose and say that in the next ten years he would turn that $300,000 into $400,000. Now, the 4% that Wall Street tells you you’ll get in retirement keeping your risk down which is wise and prudent, that 4% is a whole $16,000 a year in retirement. Now I don’t know about you, but when you start thinking of retirement with $16,000 a year and that is going to be taxed, it’s not thrilling and doesn’t make you look kindly on all those years of sacrifice and discipline doesn’t. So here’s what I’m suggesting. It’s a rollover from a previous employer. So as the law allows them to get that 401k, which is exactly what I’m going to tell him to do. I’m going to further assume that the taxes, state and federal, and penalty is going to cut that $400,000 away. He doesn’t have it yet, three hundred thousand today in half to 150 grand. Now, we have choice. What are we going to do with that $150,000? There are a couple of ways to go. One is he can take all that $150,000 and have moved it into a tax-free type of Roth setup on a solo. He would then go out and buy discounted notes. They’d end up beginning at about $230,000 face value. They’d give him somewhere around $2,000 a month and then come to the 401k that would be Roth. He would be able to take it all in about five or six years if he wanted to when he got fifty-nine and a half. He’s about fifty-five now. He could do all that and that’s something he should consider. The problem is that when he did that, he would then begin taking that income in retirement which wouldn’t be bad. It’s a couple thousand dollars and if we assume we’d make a couple thousand in social security. Another six, seven years later, that would be okay but that doesn’t sound good enough to me. Does it for you? No, no. I didn’t think so. So let’s look at the big picture. He’s got ten years to go. Let’s put half of it in a Texas duplex. It’s going to cash flow him around $280 a month which is low, but we’re going to use the Murphy rule of 50% overall expenses in vacancy factor. So he’s going to take that 280 bucks and he’s going to set it aside for a loan payoff in addition to his normal payment which the ranch is paying for, anyway. He’s going to then take that extra seventy-five grand and he’s not going to buy a second duplex. No. He’s going to buy a note and that note is going to be hundred and something, the low hundreds. It’s going to yield about a thousand dollars a month. He’s going to pay taxes on it. He’s going to end up with may be seven hundred or so. He’s going to take that seven hundred added to the $280 from cash flow, which is completely sheltered, by the way. Then he’s going to take 250 bucks a month which he easily can and very comfortably so from his family budget. He’s going to add all that together. He’s going to put it every month to the payment on his loan on a duplex. I’ve done the numbers. That’s going to pay that duplex off in about nine years and two or three months. That means he’ll have a free and clear duplex that’s going to be given him may be 18, $20,000 a year. It doesn’t really sound that much to me, but meanwhile back at the ranch his notes have been paying off. They’ve paid off a couple times in ten years. I say a couple of times because they’ve been paying off on an average of two to five years. I took the longest of five and did it twice. That means that in ten years, he will have been collecting a thousand dollars a month and then down the road a little bit more than that, which I didn’t count, by the way, and how long it took the pay off his duplex. I was very conservative with that. In the end, it’s ten years down the road. He’s got a free and clear duplex which has been stoking up $18,000 for the first year before he retired, so he’s got that in the bank. He had $50,000 in cash when we started ten years ago, but I told him to keep that as a cash reserve. Very old school that way. Murphy is alive. He knows where all of us live. Let’s don’t be unwise. So now, it’s ten years. He wants to retire. He has a free and clear duplex. It’s 18 or 20 grand a year to him. Maybe 40, 50% of it is tax sheltered. He now has 2 or 3000 a year, maybe 4000. We’ll call it 3000 a year from his notes. Now, his notes are time to pay off in the tenth year. He buys more. He probably does now have about 50,000 a year before taxes in note payments. Let’s say he nets out about 36. We don’t know what it’s going to be net, but that’s probably right. That’s 3000 a month after tax. He’s doing around 18 or 20. We’ll call it 18 from the duplex. That gives us 18 and 36 or 54,000 a year. He’s going to get social security. Thank you Lord, and that means that the bottom line is he’s may be built himself around 5, 6, $7000 a month, much of it after tax money for retirement. Now, is that a whole bunch you’ve seen me talk about people that are getting hundreds of thousands a year? Look at it. He started with a plan that was failing him. He only had ten years to go. So unless he wanted to keep working until he was seventy-five, we took what the market gave us. We were realistic. Could he end up with a hundred thousand? Sure but don’t count on that. That’s a flash in the pan. It can happen, but it’s just probably not in the cards. Bottom line is do what you can do. That’s the lesson to take from this today. Do what you can do. Improve what’s going to be the status quo. In this case, he probably tripled to quintupled what would have ended up with. Try it yourself. Be realistic. That’s the lesson. This is Jeff Brown. Thanks for joining me. I’ll catch you next time out.

5 thoughts on “Case Study 10 Years from Retirement — Video

  1. Glen Sonnenberg

    Jeff,

    I’ve watched a number of your videos and one thing has always concerned me about your advice has to do with the “gut your 401k” part. I know it’s just a rule of thumb but you always talk about this process cutting your balance in half. It seems like you’re advising that people take the whole balance as a distribution in one year which would result in taxes and penalties which could eat 50% of the balance. Why don’t you suggest pulling it out in chunks over a few years so that the tax burden is reduced? In the scenario discussed in this video (55 and 10 years away from retirement), the person is only 4.5 years away from being able to avoid the 10% penalty. They could take a small portion of the balance to get started each year for 5 years and then do a large chunk at 59.5 and avoid the penalty. I’ve never heard you suggest that converting a 401k over a period of time would be a good suggestion to avoid taxes. It seems like a waste of money that could be used in your investing ideas. Overall I like your ideas but this seems like an area where your ideas could be optimized a little. Thoughts?

    Glen

    Reply
    1. BawldGuy Post author

      Hey Glen — Your points are incredibly well taken. I give much of that advice to clients WHEN it makes sense. However, if time isn’t your friend, waiting a couple years to stretch out your tax issues is so often counterproductive. Here’s what I mean.

      If an investor reduces their $500K 401k/IRA by half due to taxes and sometimes penalties, what happens with their ultimate results? Remember, the market in real estate and/or notes can change pretty quickly, as we’ve learned several times in the last couple generations. So time must never be presumed a friend. This is especially true for those with a relatively short time window. For example, if our investor wanted pull out their cash from an IRA to buy income property, but hated to pay the taxes/penalties he’d use the multiple year approach. What if, then, he chose to spread it out over a three year period beginning back in 2002? What would his outcome have been?

      1. The cost paid for each successive year’s purchase would’ve risen big time, therefore reducing his buying power.

      2. His third purchase, in 2004, would’ve ended up ‘under water’ in no more than two years. In many markets, way under water.

      3. There’s also the very real chance that his third purchase would’ve been impossible to execute due to the outa whack rent/price ratios in 2004. In other words, he wouldn’t have had enough for a down payment that would’ve ensured the property would cash flow even a little bit.

      On the other hand, if he’d taken his ‘paltry’ $250K in 2002 and purchased say, $1 million in property (A prudent 25% down.), he would’ve benefitted from over four years of the cartoonish appreciation BEFORE the mother of all bubbles hit. At that point his initial capital would’ve literally more than doubled, AFTER a 35% value correction. I used SoCal numbers there. If I’d of used Arizona numbers during that time period the numbers would’ve been off the chart better.

      Let’s now look at notes instead of real estate. $250K today gets him roughly $40.5K in annual income. It also starts the ‘clock’ tickin’ on how soon his various notes pay off. If he spreads out his withdrawals over 2013, 14, and 15, he has very likely retarded his ultimate retirement income significantly. Why? Cuz over time his notes pay off randomly. Every year counts. So by parsing out the money over a few years he’s purposefully limiting his end game income, which makes no sense at all. Also, how much is the money earning him inside his retirement plan? 0-10%?The notes are making far more than 10%. Furthermore, as the years pass, even into retirement, it means that lesser income grows at a lesser rate. The gap widens over what is vs what could’ve been. In real dollars that’s often a difference of $1-5,000 monthly.

      ‘Gutting’ one’s 401k/IRA isn’t an always OR never right/wrong approach. The real takeaway here is that there are far too many instances when the result of an honestly objective analysis is astoundingly counterintuitive to what appears Captain Obvious at first glance.

      Let’s get even simpler. For the 10 year period of 1/1/2001 to 12/31/2010 what was the yield the typical American made in his mutual fund loaded 401k? According to Dalbar Corp. it was around 3.5% or so. Notes are now yielding roughly 16% cash on cash. That’s more than quadruple the 3.5% yield. Just one year at that spread and $250K earns an extra $31,750. Just one year. Compound that over three years. The opportunity cost alone will likely equal or surpass the taxes/penalties you saved by spreading things out for three years.

      That time lag then compounds the problem over time. More often than not, Glen, rippin’ the scab off in one swift move is the most profitable strategy. Am I makin’ sense to ya?

      Reply
  2. Greg

    I’ve seen Jeff mention, on occasion, if you’re close to the end of the year, pulling half out now, and half out in January, so the tax bill is spread across a couple years, but nothing more than that. And I would agree. When I got going, I wanted ever nickel moving as fast as possible.

    Reply
    1. BawldGuy Post author

      It’s all about what works, right? Results are too often shoved to the back of the room in favor of process. ‘Course, that’s my OldSchool DNA comin’ out.

      Reply
  3. Scot

    This is some scary advise!!

    1. If you have $300K in a 401K it is almost certainly in a mutual fund. On average, most mutual funds approximately get a market rate of return, which over time has been 10-12%. At just 10%, a $300K portfolio will grow to $778,122 in just ten years. His “grandiose” example that it night grow to $400K in ten years would be accomplished with an anemic return of just 2.92%.

    2. There are two and only two reasons why anyone should take funds out of a retirement account. The first one is to get an operation that will save your life or some similar circumstance and the second one is that you have reached retirement age! Never withdraw from a 401K!!!!!!

    3. If you have $300K in a 401K and you want to invest in real estate, roll your 401K into a traditional IRA. Then roll your new traditional IRA into a self-directed IRA. In a self-directed IRA you can purchase real estate. It’s a little more complicated to do it this way, but you won’t pay the 10% penalty and any rental income or capital gains from the rental property will grow tax free.

    Reply

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