My parents want to retire...here is their situation.

[Ahopco]

My parents are in their early and mid-sixties and are wanting to retire. My dad was a small business owner for forty years, and my mom worked as a school nurse. They had six kids, so we were always very middle class. We always drove used cars, never ate out, never bought fancy things, Christmases were always frugal,  but they always paid for music lessons and private school. We never went on vacations, except local camping trips. They were always living paycheck to paycheck.

I am new to personal finance myself, having just begun to implement MMM advice into my own life, so I am by no means an expert. It has been helpful to talk with my parents about their finances to try to understand what they did and how to avoid mistakes they made.

I would love to get Mustachian advice on their situation.

Here is a rough sketch of their finances: they happened to luck out and buy real estate near Seattle way back before Seattle boomed, so they currently own outright two Seattle-area properties with homes on them valued at $900,000 and $400,000. They live not far from Seattle in a house valued at around $450,000 with $160k remaining on their mortgage. (The house had been paid off but they took out a second mortgage to pay for some medical issues and also to pay off one of their other properties.)

In addition, they have $70,000 in an IRA, $60,000 in my mom's school district retirement savings, $10,000 in a REIT account. They have about $25,000 in cash.

They recently bought their first ever new-ish car (a Honda) and have a $15,000 car loan (their first ever car loan!).

Their monthly expenses are about $4000, and they receive about $2000/month from rental income.

They want to downsize their life and stop working. Their mortgage ($1700) and car payment ($400) and health insurance ($800) are their biggest monthly bills. They have basic cell plans, no cable, no credit card debt.

SO. With all that information. What would mustachians say would be the best way for them to retire? Should they keep all their money tied up in real estate, or sell and invest elsewhere? Should they use some of their cash to pay down the car loan, for example?

I look forward to hearing ideas!

[NeonPegasus]

They own rental properties worth $1.3 mm and are netting $2k/mo? Assuming expenses account for half of their income, they're grossing $4k/mo. The 1% rule says that a good real estate property will yield at least 1% of the value in rent. For your parents' property, that should be $13k/mo.

I recommend they sell their rental properties. $1.3mm should yield around $4.3k if you withdraw 4%. That would cover their expenses and allow them to retire.

They would probably do well to use the proceeds from the sale to pay off their mortgage, depending on the interest rate. Same thing with the car loan.


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[Imma]

Are both of the properties in Seattle rented out? A $2000/month rental income on $1.300.000 worth of properties seems rather low. Even if you substract property maintenance costs etc. If they can't increase the rental income, I'd consider selling up. Invested conservatively, they'd be able to draw an income of about $4300/month from the proceeds of the sale. They also wouldn't have the hassle of maintaining the property, dealing with renters etc.

Does your dad still own the business? Would he make any money from selling the business if he decided to retire? They don't have a lot invested for the retirement yet. Even if they decided to sell the rental properties, they'd still barely meet their expenses. It's good that they want to downsize, because especially their mortage payment is high for their income. If they'd sell their current home, would they be able to buy a decent place in your area from the $300.000 left after paying off the mortgage?

I would also strongly suggest getting rid of the car payment. Even if they just got the car and it's their first ever car loan. What's the interest percentage?

[CygnusX1]

My response is the exact same as Neon's. Time to get out of real estate and draw the 4%. Pay off the final mortgage and the car. Start drawing SS and enjoy retirement worry free.

[Mother Fussbudget]

SO. With all that information. What would mustachians say would be the best way for them to retire? Should they keep all their money tied up in real estate, or sell and invest elsewhere? Should they use some of their cash to pay down the car loan, for example?

First, I would let parents come to their own conclusions.  You can talk to them about what their desires are for retirement, but realize the decisions are theirs to make, and IMHO, if they want feedback on their situation, they should do the asking themselves vis-a-vie submitting a case-study. 
In your shoes, I would not put myself in the middle of the conversation - let them do the asking. 

Some things they have probably considered:  Do they want to stay in the PNW in retirement, or do they seek sunnier climes?  Why are they holding onto the 2nd house - is this 'the plan' for passive income generation in retirement?  Have they read anything on MMM (ex: "Start Here"), other Financial Independence websites, or "Your Money or Your Life"?

Selling the rental property seems like a no-brainer way to reach FI *TODAY*.  But again... the thought process should ideally come from them.  Ultimately, it's their decision.

All the best, MFB

[Laura33]

First, I agree that the rental numbers seem really low given the value of the properties.  If part of the goal is to simplify life, then here is a pretty easy way to do it:

1.  Sell both properties.  Minus commissions/costs/paint/etc., assume net @$1.2M.  What is their capital gains rate?  I'd assume they'd lose a chunk of this, so, what, $1M left?
2.  Use proceeds to pay off remaining mortgage and car loan.  Assume net remaining @$800K.
3.  Invest $800K in a balanced Vanguard portfolio, retire on 4% rule, withdraw @$32 K/yr.  Note, however, that removal of those two debts (@$2100 total) leaves their monthly expenses at around only $2K, so there is plenty of leeway here.  They could then keep their other investments as basically a cash EF for one-time expenses and to ride out any market troughs.

Note that they can also keep the mortgage and the car and just invest the entire remainder of whatever they net.  But assuming they'd net $1M, that would only provide @ $40K/yr, and with their two other debts, they would still need $48K, so they're not quite there yet under this approach.

[Another Reader]

Your dad should have been paying into Social Security.  He should be eligible for the annuity.  He can go to the Social Security website and get the earnings information and be able to estimate the payment using various ages at retirement.

Your mom may not have paid into Social Security.  However, does she have a pension as well as retirement savings?  If she worked long enough, there should be some type of pension.  The savings could be in a 403 (b), although it's hard to tell without more information.

Selling the rentals may be a good idea, but more information is needed about the income and expenses, their condition, and their true market value.  They will owe a large amount of capital gains tax if they sell.  Washington does not have a state income tax, so they probably owe 20 percent of the capital gain plus the additional Obamacare/Medicare excise tax on some or all of the gain.

More information and thought is needed before any action is taken.  A visit to the CPA with the property information and their income information is probably in order.

[doggyfizzle]

They will owe a large amount of capital gains tax if they sell.  Washington does not have a state income tax, so they probably owe 20 percent of the capital gain plus the additional Obamacare/Medicare excise tax on some or all of the gain.

More information and thought is needed before any action is taken.  A visit to the CPA with the property information and their income information is probably in order.

I'd look into a 1031 exchange on those properties.  It might require a bit of legwork on you or your parents' behalf, but you should be able to roll the cash less realtor fees into "like-priced" new rental properties and defer the capital gains owed to the Federal government.  I'd figure you walk with ~$1.2 million, which can easily be used to find 2 properties that will yield much more than the current $2k/month your parents are receiving in rental income.  Also, if you parents (eventually) pass and bequeath the properties to any heirs, the cost basis steps up and you avoid capital gains altogether (until later sold by the heirs).

[soccerluvof4]

The common denominator is for sure to dump the two properties as they don't make sense. As others have suggested different things from their , really do your homework to help them do this saving as much of their money as they can.

[frugaldrummer]

You should encourage them to wait at least until full retirement age to collect their social security. (That is, don't collect it early at the reduced rate).

They should be fine, agree with others above about selling their rental properties. If they enjoy being landlords, you could do the exchange. But frankly, if they're making so little from their rentals, I'd guess they're not very savvy landlords( or too soft-hearted).

If they're nervous about getting out of real estate, they could always sell both properties, buy one rental property with better numbers, and put the other half in stocks and bonds.

Sounds like they're in great shape. Kudos to them.