Grandpa Economics — Bad Dreams — Brown Shoes And Tuxedos

I’ve ceased even pretending to be surprised at how questions on one topic or another seem to come at me in bunches, often completely out of left field. In the last week or so, a few readers have asked me what remedy I might suggest to improve their current or impending retirement scenario. The main factor in common is how relatively well they’ve done for themselves, at least in successfully arriving at retirement with some fairly nice income.

Ever had that dream where you wandered into a crowded room and suddenly realized you’re running around in your underwear? Imagine you’re either retired, or about to be retired. Counting all sources, your income will be at or a little more than $100,000 annually. You’re very proud of the fruits of your decades of hard labor, sacrifice, and planning. Until, that is, you realize you’re now living that terrible dream in real life — at least one day every year — April 15th.

Those pesky taxes.

To quote one of my favorite long ago comedians, “Ever feel like a pair of brown shoes in a room full of tuxedos?” That’s what wakin’ up on April 15th every year with six figures of income — and not enough shelter to hide a Happy Meal. It’s an empty feeling.

Here’s a few common mistakes you might wanna avoid.

BawldGuy Tip #1 — The lure of annuities for most people is huge. The vast majority of them are taxable as they begin spewing their income.

Strike one.

BawldGuy Tip #2 — 401(k)s and IRAs are not only taxable, but will also force you sometimes to take more income than you want or need. Yeah, they can and will do that to you — and it’s all totally taxable. I won’t even address the potential losses in income possible through Wall Street misbehavior.

Strike two.

BalwdGuy Tip #3 — Your plan to enter retirement with that cool duplex you bought when Reagan was in office all free and clear? It’s now outa depreciation, or close enough for horseshoes. 80-100% of it’s cash flow is now taxable. Not only that, but you have a relatively high maintenance property which will tend to retard your cash flow, sheltered or not.

Strike three — yer out!!!

What pains so many finding themselves in this position is the realization their Plan, which they faithfully executed for 20-40 years, was in fact designed without much if any thought about the difference between before and after tax income whatsoever.

For those reading this who still have enough time to make the appropriate modifications to their strategy, here’s what you might consider avoiding, and what you might consider pursuing instead.

Avoid annuities which by definition are totally taxable income. There are so many sources of tax sheltered income, or, better yet, tax free income — why would anyone choose to pay more taxes than necessary?

Keep in mind your 401s/IRAs are the classic two edged sword. Problem is both edges don’t really come into play ’till you retire or die. Ghoulish, isn’t it? First, all income taken out is taxed. Then, if you don’t take ‘enough’ to suit them, they force you to take more — forcing a higher tax bill. Then, when you die, they basically apply what 3rd graders call ‘short division’. They virtually divide your estate in half — not exactly consistent with the intent to provide for your heirs. Oh, and don’t dare live longer than the ‘tables’ say you should. You’ll run outa money following the ‘qualified plan’s’ rules. And no, I’m not making that up.

Those who’ve included income property as part of their strategy should aggressively and Purposefully Plan to make use of the IRC as it relates to depreciation. Though the restrictions have increased in the last 20 years, there are ways the taxpayer/investor can turn them into a positive force — especially around retirement time.

It’s almost always possible to create a scenario in which you’ve arrived at retirement with more depreciation (tax shelter) than you know what to do with. This allows you to morph your portfolio at an appropriate pace out of possibly aging properties and into relatively lower maintenance buildings — with much higher cash flows — and enough tax shelter to allow the cash flow to grow for many, many years. And you should be able to accomplish all that without surpassing the available shelter for quite some time.

But what if it’s time to retire, you’ve never owned income property, and your six figure retirement income is hanging out in the wind in nothin’ but its BVD’s? Here’s a possible solution.

What you can’t change.

Unsheltered income is probably gonna remain so. You can create ‘after the fact’ exceptions, but usually only marginally.

What you can do is use available cash, and/or other relatively liquid assets to acquire a series of smallish income properties for the purpose of creating additional income. If you’ve retired with six figures in income, it’s more likely than not, you have $250,000 to make this happen. At a doable 8% cash on cash return, you’ll have generated an additional $20,000 of completely tax sheltered annual income. If history is any gauge (It has been, but who knows?), that figure will, over time, tend to increase. Even if that new income rises by 80% over the long haul, it will remain untaxed due to the depreciation.

That’s an additional $1,670 in before and after tax income — at 8% to boot. If you’d been taking in $100,000 without any write-offs to speak of, adding $20,000 of after tax income is no small accomplishment. Inflation? Rents and real estate values tend to rise when inflation makes its presence felt. You can take advantage of a tidy capital gain, or enjoy the increased after tax cash flow. Again — your choice.

One last word on annuities.

Since most folks tend to spend years building up annuities, I offer a question for your consideration.

Would you prefer, if you could choose, to have that income be taxable or tax free? Go ahead — take yer time — no rush. (Jeopardy music playing in background.) You have that choice. Yet millions of people insist on arranging retirement income guaranteed to be taxed into oblivion.

I know I pound this to death, but I do so for the best reason: Tax free income isn’t just superior to taxable income. It’s like saying an ice cream cone with two scoops of your favorite flavor is better than a double dose of castor oil. Does anyone dispute that analogy?

Crickets.

Excellent. Take an EIUL over the run of the mill annuity every time. There’s no way that matters in which an EIUL isn’t orders of magnitude superior to the typical annuity. Folks who sell annuities know this for the most part. The ones who don’t aren’t worth talking to.

This is just a quick overview of what you might do if you find yourself hurtling headlong into this scenario. The first thing you can do is call me. You can do things to improve your situation, or even create some new avenues of income and tax shelter for yourself. My number is 619 889-7100 OR just send me an email, and I’ll take it from there. Have a good one.

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3. Grandpa Economics & Your Future — You Have NO Future Via Grandpa Economics
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5. A Classic Case Of Grandpa Economics Virus — Doomed Retirement