#1 Symptom of Grandpa Economics Flu — Retiring Via Fantasy Boulevard

Posted @ 9:13 am - Filed under Cool Info, 1031 Exchanges, San Diego Property Owners, Cash Flow, Retirement Income, 401(k)'s & IRA's, Depreciation

Had a guy in the office late last week. Very smart, yet unassuming. Liked him right away. He lives and works in San Diego, and depending on the year, makes $70-125,000. He’s in his mid-50’s, very healthy, married to his high school sweetheart, and wondering about his retirement. Fair enough.

So, I ask, give me the Reader’s Digest version of your current financial status.

Turns out he owns a small bunch of local stuff. His net equity is easily $1.5 Million. All the properties are older than Moses’ youngest son. When he retires in about five years, his rents will total roughly $9,000 monthly. His annual depreciation will run out when he’s 76 or so.

Their 401(k)’s total around $800,000.

He immediately told me he feels taken by the fact all the income generated from their qualified plans will be taxed in retirement just like he never quit his job. He also knows they’ll be almost totally naked tax-wise when this happens. He’s one of ten who understand the true impact of this before retirement.

If they stay on the existing road, Fantasy Boulevard, here’s what their retirement will be for the rest of their lives. Oops — not that long, as the government will force them to take more cash out of their qualified plans than they want. This will be financially unhealthy by their mid-70’s.

Their annual pretax income in five years (when they retire) will look something like this:

$60,000 from their local (very old) income properties.

$56,000 from interest (yield) on their qualified plans.

No Social Security until six years after they retire, possibly longer.

They will have no tax shelter from their free and clear home, with the exception of real estate taxes. This will be, charitably, about $10,000. Their own numbers show the depreciation is $25,000 — but runs out 15 years after they retire.

Income: $116,000 Tax write-off: $35,000 Rough taxable income: $81,000

Give them the benefit of the doubt on taxes, and say they’ll net somewhere around $90,000 a year.

Sounds pretty cool, doesn’t it? You bet.

Not so fast retirement breath.

What if we can create a detour for them…

What if…..

…they take their $1.5 Million and move it into growth regions for the next five years?

…the newly acquired properties are, well, new — or at least not — old.

…total value of his new stuff was around $7 Million or so.

..their initial annual income from this exchange was easily $135,000+ — and 100% tax sheltered.

…their net equity grew over a million bucks in the next five years. (4.5% annual appreciation does it.)

…their tax write-off was a little over $200,000 a year.

… the worst that could happen is increasing their tax shelter by a factor of 8 — lowered their operating costs significantly — and retained the ability to sell property tax free occasionally.

Look, I’ve not gone all complex on you here.

I’ve left out their ability to create, in five short years (coincidentally exactly the same time ’till they retire) $4-7,000 a month tax free income — for life. Or how we’ve already spoken about a couple pretty cool short term moves that would more likely than not give them bigger short term equity gains.

That’s another post though.

What’s clearly illustrated here, is the #1 symptom of Grandpa Econcomics Flu. It shows up in the investor’s vision. They look at their current status and see a stress free retirement with more than adequate income.

Wait a second — I said besides seeing a fantasy retirement.

The real #1 symptom?

A euphoric feeling, as folks begin to anticipate their retirement, (usually within 10 years of retiring) comes over them. They add up the income numbers, their eyes get big, and the endorphins kick in like Niagra Falls.

Life is good. Right — a sure sign of The Flu.

An after tax income of $90,000 annually looks good. Analyze what is generating that income and you see it’s riddled with the flu virus — guaranteed to come back and bite you in the future. A bunch of old properties held for too long, with high equity positions are just what Grandpa ordered.

A tax deferred (1031) exchange, as shown above, moves their after tax income to over $135,000 before we add in the yield from their $800,000 in savings. With the newly acquired tax shelter, that $56,000 is now only $31,000 before they even start doing their tax return. Their total taxable income is now just that $31,000 — cool.

In the end, they’ve gone from $90,000 after tax, to about $175,000 after tax annual retirement income. My math teacher taught me that was almost double.

That’s worst case.

It doesn’t mix in any use of appreciation.

It doesn’t even predict appreciation.

In reality, these guys will probably retire with well over $15,000 a month before and after tax — without accounting for what I’ll be telling them to do with their $800,000 in savings.

The only known cure for Grandpa Economics Flu — is a large dose — of reality.

Are you feeling euphoric about your retirement?

Is it real — or is it The Flu?

This entry was posted on Thursday, October 4th, 2007 at 9:13 am and is filed under Cool Info, 1031 Exchanges, San Diego Property Owners, Cash Flow, Retirement Income, 401(k)'s & IRA's, Depreciation. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.