Retirement Blueprint – Part III
In Part I of this series I recapped my goals of retirement by the age of 35. Then in Part II the specifics of the resources I will have by the age of 35 were detailed. In this post I will tweak the assets with various interest rates in order to calculate the possible retirement income I can generate at the age of 35.
Before I do that, it is important to separate the asset categories into two sections:
- Those I can use without incurring penalties and can be deferred to attain a 15% tax rate – real estate properties, savings, and stocks
- Those if I use before age 59 1/2 will incur penalties and will also be taxed at the income tax rate (in this scenario we will assume that the rate is 30%) – retirement accounts
The assets need to be separated because the tax effects (and thus the resulting after-tax income) is different depending on the section the asset falls under.
For Section 1 assets I plan on putting them into tax-efficient vehicles such as stocks, bonds, mutual funds, or real estate for more than one year so that it can get taxed at a lower tax bracket – the long-term capital gains tax rate of 15%.
For Section 2 assets I do not plan on withdrawling the money before the age of 59 1/2 because I don’t want to get slammed with a 10% penalty. Instead, I will let it grow tax-deferred (or in the case of the Roth IRA tax-free) until I am of age to withdrawl it penalty-free. In Part I of this series I had emphasized that even though I want to generate a monthly income after-tax stream of 5,353, I do not plan on spending that much every single month and should actually save at least 20% of the income every month. Thus, the Section 2 assets, which account for 14.8% of the total assets, will be a majority portion of the money I save every month. I will let that portion grow unfettered until I am 59 1/2.
Here is an assessment of the income stream the assets can generate depending on the interest rate that is used:
In the above chart I applied both Section 1 Assets and Section 2 Assets to various interest rates ranging from 5% to 10% to calculate the interest generated from the assets. Then I deducted the respective taxes (long term capital gain tax rate of 15% for Section 1 Assets and retirement income tax rate of 30% for Section 2 Assets) from the interest generated to get the after-tax income (columns 2 and 3). The total of the after-tax income is shown in column 4.
Of course this is not completely accurate because I plan on letting the retirement accounts grow tax-deferred and tax-free for about thirty years, so in actuality the income generated would much higher than this projection. But overall the above projection works for our current purposes. I just wanted to see how the numbers would look assuming I am withdrawing money from the retirement accounts.
As seen above, assuming a conservative interest growth rate of 5% per annum the total after-tax income generated would be 60,167.26, which is not too far from the goal of attaining a yearly income stream of 64,236 after taxes. The difference is 4,069 a year. I believe I will be able to make up the difference since I had estimated conservatively in Post II. And if I can generate an interest growth rate of higher than 5% then there is no problem of hitting the goal I set out for myself.
All in all, this gives me confidence that I will be able to hit my goal and retire by 35.
Related posts:
I don’t mean to oversimplify things and I do understand that all the pieces of a financial plan have value, but when I look through what you wrote, it does seem like it all hinges on two things. The amount of your non-real estate assets at 35 is only about $100K (excluding your tax-sheltered assets), so that is not really a big part of the plan. It looks like a liquidity buffer to me. Thus, the main thing seems to be whether you can produce adequate income with the 3 houses.
So the question is whether 1.1 million in real estate assets can produce a 6% income stream after expenses. While I’m not a real estate expert, I think it’s safe to say that is very unlikely unless the houses are paid off. However, as I understand it, you do in fact plan to have them paid off by 35. So I think the probability of your success ultimately rests on: (a) how confident you are that you can pay off the mortgages by 35, and (b) how confident you are that you can yield 6% on your properties after expenses.
6% is not unreasonable, but properties run the gamut, including much higher and much lower. You should already have a pretty good idea right now of whether you can generate that sort of income with the properties. Excluding the principal and interest payments, does the current rent (excluding provisions for property taxes and maintenance) yield 6% or more? If that is the case, and you think that you can keep any occupancy gaps short, then I think your plan will work.
Hi S.B., thanks for visiting my site. In regards to the plan:
(a) I am pretty confident that all three houses will be paid off by 35. If we follow the plan and continue to prepay house #3, let house #2 be covered by rents, and later prepay house #1 with house #2 profits after house #2 is paid off then according to all my calculations, all the houses will be mortgage free by 35. The leftover fixed costs would then be property taxes, property insurance (and HOA for house #3).
The only variable in that plan is that the fixed interest rates for two of the houses are pretty low (4.5% and 4.8%) so there is likelihood that I might change my plan and not prepay depending on what happens to interest rates in the future. If inflation hits and interest rates skyrocket like they have done in the past (~10%) then I would be better off saving that money for other uses than prepay the fixed mortgage interest rates. So that part is up in the air depending on the economy of California as a whole.
(b) Lol, you got to a future post of mine. I was planning on covering the current yields on the real estate properties in another post. But there is one thing that I probably should have explained in my blueprint, I’m not sure whether or not I will keep the real estate properties after I am 35. There is a possibility that I will liquidate the properties and use the proceeds to help me generate the yearly income. I believe it is very possible to generate 5-6% after-tax income if you are invested in more tax-advantaged investments.
Based on my calculations for real estate yields, it can be tough to have a 6% yield… especially on single family homes, those are not as profitable as more compact housing. As a result, it is also possible that I will do a 1031 exchange and convert the single family homes to more lucrative N-plexes, condos, apartments, etc…, which would boost the profits quite a bit. Actually, I’ve been discussing that possibility with family as something we might do in the future.
Overall, there is quite a bit of various things we can do in the future; the calculations I did for 5-10% interest rates were mostly to give a benchmark of what to shoot for in order to attain my goal of retirement. Nothing is set in stone yet since life can turn on a dime and it is especially hard to predict what the future will be like in 7 years.
Regarding uncertainty, variation, predictability, etc: completely understood! The “magic number” is always a guess and will change over time. Besides, the biggest factor is actually your risk tolerance.
At any rate, the use of properties for income is something I’ve considered for a long time, but in the end, I think my wife and I just don’t want to be landlords no matter what, so we need to take another route. As I’m sure you know, the average base case for equities is generally considered to be better than that of real estate, but the variability of returns is a killer. While 8% over a long period of time may be reasonable for equities, you can get clobbered by a couple of bad years (e.g. 2007-2008; haha…) occurring right at the onset of your retirement and that will pretty much assure your plan is ruined. Hence, the origin of “safe withdrawal rates” for equities around 4%. With real estate, I presume the cash flow is much more predictable, but as you can’t get something for nothing, the yield is often lower. No free lunch. :-)
BTW, great blog so far…