So you’re approaching retirement and you’ve done a good job saving up a pretty large nest egg in your 401. And you’ve also paid off your house. You have no debt on your house. The challenge is you want to retire, you want to leave your job. But how are you going to generate enough income and how are you going to support support yourself in retirement given the situation?
Welcome to the Ask Coach edition of the podcast. If we haven’t met yet, my name is Chad Carson. You can also call me Coach. And my mission here is to help you get out of the financial grind so you can do more of what matters in the Asked Coach podcast series is where I do my best to answer your burning questions about real estate, investing and personal finance. Today’s question comes from David Robinson, one of our viewers on YouTube, and he said, love your videos.
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Would you consider discussing strategies for folks approaching retirement who want to diversify their 401 case, someone whose home is paid off and they are interested in leveraging that asset, their home, plus their nest egg? Thank you. So, David, thank you for this question. I really like the question in particular because this is something I spent a lot of time on in my book, Retire Early with Real Estate. So I want to use this opportunity and actually give you a caveat first, that you should never listen to a podcast and use the advice from a podcaster like me to go in and apply that to your particular situation without a lot of fault and without a lot of consultation with a professional.
So when you get into the retirement planning world, there’s a lot of nuance, there’s a lot of details. There are a lot of assumptions that I don’t know about David’s situation, but I thought this was a good opportunity to talk about principles. And that’s a lot of what I did in the book. I gave a lot of case studies of how do you actually use real estate to retire early? What does that mean to live off of your investments?
And I like this particular question because this is the real situation a lot of people find themselves in as you’re getting closer to retirement age, whatever that age might be. Let’s just say that’s 60 years old, when you can start taking money out of your 401K without penalty, you might have a pretty big nest egg in your 401K. And maybe you’ve been fortunate enough to pay your house off and own your house, but you don’t have a lot of other investments. And here you have this nest egg probably in the stock market. How do you live off of that?
How do you do that? And so I want to talk about two main principles that I dug into a lot in the book. The first is this concept of a financial independence number. Second concept is going to be something called an income floor. So let’s talk about the first one, your financial independence number.
And this is the conversation I would have, David, if you and I were just sitting here talking hopefully over a craft beer, because that’s the best way to talk about retirement plans is sitting around casually with a craft beer somewhere outdoors in a really beautiful setting. But the financial independence number, let’s just go over that, the basics of that. This is an approach to figure out what do you need to be financially independent, what number? And the way I start with that is thinking about your personal expenses. So how much do you need to live off of?
And this gets into different levels of your basic necessities. There’s this idea called lean financial independence, or leanfi. What kind of income or wealth do you need just to pay your basic bear necessities? And you can kind of move up the ladder. You can have regular financial independence where you’re pretty comfortable.
You’re paying most of your expenses that you can have, like a fat fire. They call it fat financial independence, where you’re living the luxury version of your lifestyle. And let’s put real numbers of that. Let’s say that a lean fire for a lot of people might be $5,000 per month, $60,000 per year. And I know some people might be able to do less than that.
Mr. Money Mustache, a friend of mine out in Colorado could do less than that, of course. But let’s say 60,000 is a lean fire number. Let’s say that $90,000 is a nice, comfortable place for people to be. Maybe that’s the kind of fat fire number or close to it where you can do what you want.
You can have some luxury type vacations. You can do some things like that. But the point is for yourself, you just need to think about that number and have a cushion in there, because what you’re going to do is you’re going to work it backwards and say, if that’s my number, that’s what I need to live off of. I’m replacing my salary. I’m not having to work a job anymore.
I’m working part time. That’s what I need to cover to live my lifestyle. So that’s the first step of a financial independence number. The second step, though, is to ask yourself, how much wealth would I need to have to support that financial independence number? And the traditional way that it’s done in the financial independence movement.
And this is not related to real estate. There’s a study, and I’m drawing a blank on the name, the Trinity Study, I believe, or something like that. That said you can live off about 4% of your wealth in a typical retirement period. I think it was 30, 35 years. If you draw 4% of your net worth, 4% of your investments, then you’re probably not going to run out by the end.
And they ran a bunch of different variables and different models. But the point is roughly 4%. If you had a million dollars in your 401K, that’s $40,000 per year, that’s 4% would be kind of your safe withdrawal number. There’s a lot of assumptions behind that. But the biggest point there is that even with a million dollars in your 401K here we are talking about $60 to $90,000.
And to have a million dollars doesn’t pay you enough to safely withdraw that money from your 401K. So what do you do? Well, one answer is just, oh, you need to save more money. You need to have two point $25 million, I believe is the number to safely withdraw $9,000 per year. And if you want to do the quick math on that, by the way, it might be easier to say $90,000 times 25 instead of trying to figure out the 4%, 90,000 times 25 is two point 25 million, or if it’s $60,000 per year, let me put myself on the spot there.
That’s about $1.5 million. So what if you find yourself, though, you’re approaching 60 years old and you don’t have 1.5, you don’t have two point 25 million and you still want to retire? How do you think about this? So a big part of what I talked about in a couple of chapters in the book was an idea I got from someone else. This is not an original idea was to build an income floor.
So the difference, a nuanced difference between this and the 4% rule is that the priority when you’re approaching retirement, when you’re going to live off of your investments, whether that’s early retirement or kind of a 60 65 retirement or traditional retirement. It’s the first and foremost prioritize building an income floor that pays for your expenses no matter what a safe, steady source of income, very salary, like something that you have on a monthly basis to know what’s coming in. And the traditional approaches to this. This might mean you buy something called like an annuity where you pay an insurance company. It’s like the reverse of getting a mortgage where you pay money, you pay $100,000 to an insurance company and they give you a monthly payment.
There’s a lot of different types of annuities, but there are some reasonably low cost annuities, and I believe there are fixed annuities where you could pay one lump sum and they pay you amount of income. And I don’t know what the current rates are, but it’s a reasonable way to generate some income, and it guarantees it for the rest of your life. So that’s one way a lot of people did it in the past. Other people might get bonds by basically loaning money to the government or the companies. You get small interest rates.
Those are really low interest rates now. So that’s the challenge. With that, you could try to live off dividends on your stocks, which are about 2% or a little bit less than that on the S and P 500 right now. So the point of all that is a lot of the options we have out there for a traditional way to build an income floor are not really good. They’re not really high returns to be able to pay for your retirement.
So how do you do that with an alternative? This is a real estate podcast. I talk a lot about that. I have found that building an income floor with free and clear real estate properties is one of the best ways not only to number one, build that income floor so that you have a base of income that keeps coming in and keeps coming in, but also the challenge of when you build an income floor, you want to make sure that money is still paying you enough 30 years from now. If you’re 60 years old and you live to 90 or if you’re 40 years old and live well into your later years, inflation can erode away at that money.
A dollar today is not the same as a dollar 30 years from now. A dollar will buy a lot less 30 years from now. So free and clear real estate is a really great way to build that income floor because it pays you that money at a pretty reasonable rate. I’ll talk about some numbers here. And if you’re buying in good locations, the rent today will probably go up 2030 years from now.
So that that income stream keeps getting bigger and bigger and bigger. You could sell the property at some point if you needed to, if you have a kind of a collection of properties. So I like the idea. Let’s go back to the original question here. If you have a 401K, I’m going to assume let’s say, David, I don’t know what your numbers are, but let’s just assume you had a million dollar 401K.
You have your house paid for. And we’re using those numbers I talked about earlier. Maybe in the extreme example. I’m not saying you should do this, but let’s say that you and your if you have a spouse, we’re going to get some Social Security income or you’re willing to work a little bit until you do get the Social Security income, just have a little bit of money. Let’s just say that’s $40,000 per year between the two of you, you’re going to get a $40,000 per year Social Security income or just a little small part time job.
So how do you fill the balance of that $60 to $90,000? Well, let’s look at our real estate. So if you invested a million dollars into free and clear real estate and let’s say you were able to get a 6% rental yield on that, which I think is a pretty reasonable proposition in a pretty good cash flow market, well located real estate, 6% would mean you’d have $60,000 per year. So 60,000 coming in net net from your real estate, 40,000 from your Social Security income. It’s about $100,000 per year in income.
So that solves your problem, right? You’ve got that. But that might be a little extreme. This is where your own personal preferences come in. You’re 100% of your all your retirement account and real estate.
Is that something you’re comfortable with? So maybe you try to find some balance. Maybe you go 50 50. Maybe you put 50% of your money into free and clear real estate. And maybe you try to buy a little bit more aggressively on the income property spectrum.
Maybe you get like a 7% return instead of a 6% return. And that might give you about $35,000 per year. You can run the math on that 500,000 times 7%. It’s about $35,000. Plus you have your $40,000 from Social Security income.
That’s about 75,000. And then let’s say you invest the other 500,001K into the stock market and you get like a 2% dividend on that. That might be like $10,000 per year dividend income. So there you go, 40,000, 35,000. That’s 75,000, plus another ten.
That’s 85,000. So that’s another way to kind of get close. And this is where you have to adjust your strategy based on what you’re comfortable with. If you have a financial adviser, which a lot of you might have, what do they feel comfortable with suggesting to you? But the point is you build that income floor first, and then you try to also grow to meet the challenges of inflation and other things down the road.
How do you execute that, David, personally, if you have a 401K and you could invest that money in a self directed account, one of my sponsors here on the show and on the Coach Carson platforms, American IRA. I’ll put a link to them in the show notes in the podcast description, in the video description, they let you self direct your retirement account so that you could actually put the money into their account to their custodian for your retirement money. And you could buy pieces of real estate with that. You can also make loans to other people. That’s a variation on that.
You could make a bunch of loans at 8% interest to other investors. Now you could have $500,000 making 8%. It goes into your retirement account, and then you can make distributions from your retirement account to you. So that’s a kind of quick version of talking about my approach to this. This is just what I do.
I’m not a financial advisor. I’m not helping people put these plans together. But that’s what the book was about, giving you a blueprint for how to do that and a few different paths to do that. I hope you see there’s some variations there. You’re going to have to figure out what you’re comfortable with, what you’re willing to do.
But the principle here, the takeaway. Figure out your financial independence number and then decide how are you going to build an income floor that makes you safe and secure and what type of asset are you going to use? I like real estate in particular for retirement. I like free and clear real estate. There’s a lot of benefits, a lot of simplicity to that.
How many do you need? What are those numbers? That’s the doubles and the details there, but I hope that’s been helpful for you to kind of go through that exercise. I hope you enjoyed this edition of the Asked Coach podcast. If you’d like to have your question featured in a future episode, just send an email to [email protected]
We do get more questions when we have the ability to publish, but to increase your chances, please number one, keep your question as clear and as short as possible. And number two keep it relevant to the topics that we cover on this show real estate investing, personal finance, early retirement and personal development. If you like the show, I’d like to invite you to subscribe to my free email [email protected], Rei. Tullkit. In addition to weekly updates, articles and behind the scenes tips from me, my email newsletter subscribers get my real estate investing toolkit, which includes a property closing checklist that I actually use when I buy properties, a real estate deal worksheet, a tenant screening criteria checklist and other spreadsheets and goodies that will help you on your journey to financial independence using real estate.
You can get it all for [email protected] Rei toolkit. I also want to take this time to thank the people behind the scenes who make this podcast possible each and every week. This includes my podcast editor extraordinaire, Michael win, my amazing virtual assistant Megan Thompson, my wife Carrie who helps me behind the scenes and is my partner here at coach Carson. And of course, thank you to all of you, the listeners of the show who make everything possible. This show exists for you.
It exists because of you and I really appreciate you being here for another episode. Everything I’ve shared with you in this episode has been for general education purposes. I have not considered your specific situation or risk before buying your own investments. Be sure to consult a financial real estate or a legal professional until next time, I’m Chad Carson. You can also call me coach and this is a show all about helping you get out of the financial grind So you can do more of what matters.
See you next time.
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