Author Topic: Rat Race Retirement Strategy  (Read 5816 times)

yddeyma

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Rat Race Retirement Strategy
« on: September 23, 2014, 07:44:30 PM »
I need some help weighing options and wanted to get the opinions of folks who also want to be out of the rat race.  I know your instinct will be to urge me to lower expenses (and I promise I am, I've cut over $1k from our budget in the last six months or so!), but I'd like this post to be about how to generate more, or the right type of, income for me to quit.  My DH loves his job and is not interested in quitting.  So this post talks about replacing my income only, but we have joint assets to consider.  I'd like to quit in the next 2 years, and I am having trouble making the numbers work.

My Current Net Income = $4,000/month from Rat Race Job; I'd like to replace this fully with other income before I quit.

Here's what I figure my options are:
1. Invest in more rental properties, but I'm not sure of the best way to fund them
2. Freelance, I've found a job that pays great but I doubt I can find another like it
3. Cash out 401k to pay off personal mortgage, only gets me part of the way to goal
4. Combination of above?

I recently started a business with a colleague from work to invest in rental properties.  We've had it about 4 months and are doing well; we paid cash for two properties and both are rented.  In my market, I can invest $55-60k and generate NET monthly income of about $800-850/month.  We aren't taking profits from the business right now, but instead are building a cash reserve with the intent to buy more properties.  We are unsure whether to leverage the properties we currently own to buy more or let the reserve grow until we can buy a third (will take about 3 years).  I've run the numbers, and if we start mortgaging properties to fund buys I can NET about $550/month per property and remember I have to split profits with my partner.  Numbers wise, it does make sense to leverage and buy more, we come out ahead in the long run. 

I have about $215k in my 401k.  My spouse has about the same.  I cannot withdraw from my 401k at all (the rules don't allow it), but I can take up to a $50k loan @2.25% over 5 years which all gets paid back to my 401k.  If I quit the loan comes due immediately.  I have recently reduced our 401k contributions to just get the company match and now am saving/investing in regular taxable accounts to give us some more options when it comes to saving/spending.  But it will take years to build up the same amount of money in a regular taxable account.  I do not want to take anything from DH's 401k, as I'd like it to continue to grow.

On a suggestion from this board, I got an elance account and started freelancing.  I got a job within a week; I was so thrilled and amazed at how easy it was and I love what I'm doing.  Unfortunately, I've discovered that the job was truly a dream job.  Despite over a month of searching, I cannot seem to find similar opportunities.  Fortunately, this job is on-going, but only until March.  My NET earnings are about $2000/month doing this.  Knowing the possibilities I am confident I will always have some type of side job, but I am extremely doubtful I will ever find another job of this type that also pays this well. 

I've got a 15 year mortgage @3% with about $180k and 13 years remaining.  Payment is $1700/month.  This is my only debt, but if I paid it off then I only need to replace $2300 a month in income.

I guess my "pie in the sky" thought was the following:
1. Continue freelancing earning $2k/month, in 2 years buy another income property for NET earnings of $800/month
2. Start taking my share of the profits from my existing rental property business for NET earnings of $800/month
3. Let 401k grow for another two years, cash it out and pay off the house for "earnings" of $1700/month
4. Freelance to earn the remaining $700/month

But here's where I get worried:
1. Doubt I can sustain the $2k/month in freelance income (not a big issue, since I'll still be working full time during this period, but it means I won't make my goal)
2. If I take profits from the business, it can't grow anymore (this really doesn't bother me at all)
3. Hate to have to pay the 10% penalty and I'd have to absolutely QUIT (this scares me if I don't get a warm fuzzy from my other income sources), plus I'd be heavily reliant on investment return which may skew my schedule if I have to wait for the market to tank and recover again (though I do love a good market crash, it would wreak havoc on my timeline)
4. Doubt I can earn a steady income freelancing (BIG concern here)

I need to find a way to replace my stable Rat Race Income of $4k/month.  The freelancing gig has made me want so much more.  I realized that if my house were paid off and I had a steady freelancing job, then I could quit today.  I feel like I'm so close but just cannot quite get there.  I have good income and cashflow, and given enough time I know I could quit the workforce.  But I want it to be within 2 years and I'm not sure the best approach to take. 

Ideas?

LouisPritchard

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Re: Rat Race Retirement Strategy
« Reply #1 on: September 23, 2014, 08:09:19 PM »

I have about $215k in my 401k.  My spouse has about the same.  I cannot withdraw from my 401k at all (the rules don't allow it), but I can take up to a $50k loan @2.25% over 5 years which all gets paid back to my 401k.  If I quit the loan comes due immediately.  I have recently reduced our 401k contributions to just get the company match and now am saving/investing in regular taxable accounts to give us some more options when it comes to saving/spending.  But it will take years to build up the same amount of money in a regular taxable account.  I do not want to take anything from DH's 401k, as I'd like it to continue to grow.


Your mortgage is at 3% so you'd only save 0.75%? Seems pointless to risk the 401K. Also I highly doubt the 2.25% that you pay back goes to the 401K, that almost always goes to the lending company, they just use your 401K as collateral against you defaulting on the loan. Also if you lose you job/quit/get fired/laid-off/default etc... It'll be considered a early distribution and you'll have to pay the 10% penalty on top of taxes on the amount borrowed. I would leave the 401 alone and find the 50K somewhere else. 

arebelspy

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Re: Rat Race Retirement Strategy
« Reply #2 on: September 23, 2014, 09:41:54 PM »
I think you may be approaching the whole thing backwards.

Picking a timeframe and trying to force numbers to work into that (arbitrary?) timeframe doesn't tend to jive with reality.

I'd like to quit in the next 2 years, and I am having trouble making the numbers work.

Why not just say "I'd like to quit tomorrow and am having trouble making the numbers work"?

Does that sound absurd to you?  If so, why?  Is it because the timeframe is so short that you're sure you're not there?  Then how is that different than the two year time frame where you also can't make the numbers work?

Rather than picking a timeframe, start working on making as much extra income as possible, both passive and active (the real estate business being a good example of one way to do this - though I see some questionable numbers there - netting 850 on 60k, are you renting them for 1500ish? - so you may want some expert eyes to look at that) and cutting your budget at the same time can lead to some realistic projections.

It may be more than two years.  It may be less.  It may be that retiring tomorrow is realistic.  Most of us drastically pull in our FIRE dates once we see progress and improvements (I've seen many people cut their FIRE time from an original 20 year estimate to 15 to 10 or less).  You may think you're two years out, then discover you can be done in just 18 months.  But it probably won't come at a "keep spouses' full time job and get an extra 4k passive income on top of that" scenario, based on where you're at now, barring some unique circumstances.

In other words, I think there's some things you can do, but I also see a lot of mistaken assumptions in your post.  Stick around some of the various ER forums (and probably check out some real estate forums) and you'll probably look back on this post in a year and chuckle.  I know I look back at some of my early posts on other various forums and laugh.  :)

(Also: cashing out a 401k to pay off a mortgage is quite shortsighted.  I'd highly recommend against it in the vast majority of circumstances.)
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DoNorth

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Re: Rat Race Retirement Strategy
« Reply #3 on: September 24, 2014, 05:12:15 AM »
That 2.25% does go back into your 401k under 401K loan rules.  You essentially borrow the funds from yourself and pay yourself back with interest.  It can be a useful tool if you know what you're doing.  Considering that the Dow and S&P are at all time highs, taking some of your 401k off the table after significant periods of appreciation can be helpful IF you are reinvesting the funds.  In other words, it's a form of rebalancing your portfolio.  You would hope there are some dips over the next 1-3 years during your repayment period so you can repurchase the 401K shares at lower prices and not miss out on significant appreciation during a big run-up.


I have about $215k in my 401k.  My spouse has about the same.  I cannot withdraw from my 401k at all (the rules don't allow it), but I can take up to a $50k loan @2.25% over 5 years which all gets paid back to my 401k.  If I quit the loan comes due immediately.  I have recently reduced our 401k contributions to just get the company match and now am saving/investing in regular taxable accounts to give us some more options when it comes to saving/spending.  But it will take years to build up the same amount of money in a regular taxable account.  I do not want to take anything from DH's 401k, as I'd like it to continue to grow.


Your mortgage is at 3% so you'd only save 0.75%? Seems pointless to risk the 401K. Also I highly doubt the 2.25% that you pay back goes to the 401K, that almost always goes to the lending company, they just use your 401K as collateral against you defaulting on the loan. Also if you lose you job/quit/get fired/laid-off/default etc... It'll be considered a early distribution and you'll have to pay the 10% penalty on top of taxes on the amount borrowed. I would leave the 401 alone and find the 50K somewhere else.

yddeyma

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Re: Rat Race Retirement Strategy
« Reply #4 on: September 24, 2014, 05:35:24 AM »
Quote
I think you may be approaching the whole thing backwards
Quote
In other words, I think there's some things you can do, but I also see a lot of mistaken assumptions in your post.

Can you be more specific? I understand you're questioning my real estate numbers, but feel like that's for another post.  I have consulted local experts (guys doing this 20 years or more) and am comfortable with my projections.  Of course, time will tell.

What other assumptions are faulty?  What should I be doing differently?  My real question is if I should leverage my 401k to buy more properties or pay off my house.  You say this is shortsighted.  Why?  I wish I had never put the money in the 401k to begin with, I wish I had saved it in a regular taxable account where I have access to it.  I've run the numbers, my spouse's 401k is plenty big enough to generate income (even if we don't put another penny in, even if I don't contribute any late life income) once he retires at 60 (we're only 32 right now).  Other than losing the 10%, what reasons are there to keep it intact if I can't use it for anything and I don't need it to grow and be there at the end of my life?  I call baloney on keeping my mortgage around for a tax deduction (you want me to pay $10k in interest a year to save $2500 on my taxes?), but accept that that is a common concern.

dude

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Re: Rat Race Retirement Strategy
« Reply #5 on: September 24, 2014, 05:41:25 AM »
"I cannot withdraw from my 401k at all (the rules don't allow it), but I can take up to a $50k loan @2.25% over 5 years which all gets paid back to my 401k.  If I quit the loan comes due immediately."

If you quit, not only does the loan become due immediately, but it might also be taxed by the IRS as ordinary income, depending on the timing.  See, e.g., http://www.foxbusiness.com/personal-finance/2011/09/15/taking-out-401k-loan-be-ready-to-repay-if-lose-your-job/

Better make sure to consult with an accountant first.

boarder42

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Re: Rat Race Retirement Strategy
« Reply #6 on: September 24, 2014, 06:26:16 AM »
i'm with arebelspy you're approaching this in the wrong way.  figure out the numbers you need to retire then based on that figure out how many years you have to work.  its not rocket surgery.  and you're trying to make it that. 

we would all like to say lets retire tomorrow.  but you're not setup for that or for 2 years from now unless you greatly cut your spending.  you have 215k in a 401k.  and you pull in 800 a month from a rental so using a 4% SWR and accounting for max 401k contributions at 7% growth over the next 2 years puts you at 283k you can spend 11320 per year at the 4% rate plus the 800 a month from your rental at 9600.  puts you at 20k basically

But the withdrawal penalties... so you dont want to do that ... you want to create a bridge with some income while you use the Roth IRA conversion ladder.  so you need a way to come up with that 11k a year.  for 5 years then you can live off your 20k till you die.  so save an additional 55k somehow and use that to bridge you. or spend less.

thats how you retire in 2 years. 

boarder42

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Re: Rat Race Retirement Strategy
« Reply #7 on: September 24, 2014, 06:27:50 AM »
your name says engineer.  this is just a math equation and a pretty simple one at that.

EscapeVelocity2020

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Re: Rat Race Retirement Strategy
« Reply #8 on: September 24, 2014, 07:07:43 AM »
Also, don't forget to add in whatever benefits your job provides.  Sounds like DH will continue to work, hopefully you currently use his healthcare?  There's also your vacation/sick time, the SS you company pays for you (not sure what your age is, but those first 10 years of work history are quite valuable, if you've never looked at what OASDI provides), 401k match...  Don't just look at net salary, sometimes the benefits package adds another 1k/mo or more in 'unseen' compensation...

But why do you want to cover 4k/mo anyways?  Most ER folks are saving 50 - 75% of income, so it's almost never the target to replace 100% of your net active income, just the spending to some extent. 

secondcor521

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Re: Rat Race Retirement Strategy
« Reply #9 on: September 24, 2014, 07:02:03 PM »
1.  Do not cash out your 401k.  You will pay a 10% early withdrawal penalties and income taxes at your marginal rate (which may be rather high if you have your ordinary job income from you and your husband plus the ~$215K in 401K withdrawal).  Depending on which state you live in, you could easily see $100K of your ~$215K go to taxes.

2.  Depending on how you account for your income taxes between you and your husband, you may not need to replace all of that $4K per month net, because you may be able to either (a) reduce your tax bill by reducing your regular W2 income, and/or (b) reduce your tax bill by having some of the income come from real estate (where you can have depreciation and other writeoffs.

3.  Make sure you either (a) own 51% of your real estate business, or (b) have a well thought out partnership agreement which spells out how disagreements, exits, additional funding, etc. will be handled.  Many partnerships fail - I'm sure yours won't, but it's good insurance I think.

4.  I wouldn't borrow against your 401k either.  Here's why.  Imagine $1 that you use to pay back the 401k loan.  First, it starts off at your employer or in your real estate business.  You take it home, and pay 40 cents in taxes.  Now you have 60 cents left.  You pay back your 401k loan so the 60 cents goes into your 401k.  You eventually bring your 401k home by perhaps rolling it to an IRA.  When you withdraw it from your IRA, or roll it to a Roth, you pay income taxes again.  Maybe you're in a lower bracket then, so let's say you pay 20% or 12 cents in taxes.  So now you have 48 cents in your pocket.  People do not get wealthy by turning dollar bills into 48 cents.  This analysis doesn't even mention the risk of having a loan out and leaving your job.  It also doesn't consider the opportunity cost of having money out of your 401k when it could be growing at 10% tax free inside it.

5.  Good on you for the elance stuff.  That's exciting!

6.  I agree with everyone else about it not being very sensible to pick a 2 year time frame and then say the numbers don't work.  Although what I bet you can do is figure out what the numbers do say (maybe 4 years, or whatever), then keep evaluating your plan and trying to improve on it.  I bet you can do that -- you seem pretty smart.  There does seem to be some magic about setting out written goals and figuring out how to achieve them...I've had that happen in my own life and there are studies out there that written goals are achieved much more often than random wishes.

Good luck!

yddeyma

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Re: Rat Race Retirement Strategy
« Reply #10 on: September 24, 2014, 07:20:38 PM »
Thanks secondcor521!

I did not even think about the "double taxation" part.  Thanks for pointing it out.  And you're right, one I wrote out my goals, it was a lot easier to evaluate everything.

The other big assist I've gotten is several people mentioning to figure out what major milestones I need to hit and to keep improving both my income/expense numbers if I want to shift those milestones further to the left (or closer to my arbitrary two year mark).

I think for me that means getting rid of a few key expenses (that I've already started to reduce), as well as hitting monthly income milestones with my freelance and rental income.  If I ditch those expenses and take my rental/freelance income at face value, I could retire right now w/o accessing my 401k.  But I'm a conservative person and  freelancing is new for me right now.  So I will probably set some milestone goals for that to make sure I can actually pull in reliable (if not steady) income before I pull the plug.

mozar

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Re: Rat Race Retirement Strategy
« Reply #11 on: September 24, 2014, 07:34:12 PM »
Just making sure you do know you can access the 401k if you do a Roth pipeline. With 200k will get you 8k a year at 4% withdrawel rate but you need the five year bridge. Also it could be that an amazing freelancing opportunity opens up in March. You never know, but that's the nature of freelancing.

yddeyma

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Re: Rat Race Retirement Strategy
« Reply #12 on: September 24, 2014, 07:39:16 PM »
Thanks Mozar, I'm adding the Roth pipeline to the plan, now that I've decided I don't really need the 401k money.  I'm not sure how much I'll convert, but found lots of good info here: http://www.madfientist.com/retire-even-earlier/

arebelspy

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Re: Rat Race Retirement Strategy
« Reply #13 on: September 24, 2014, 09:05:35 PM »
So... not to try and convince you to take the 401k loan, because you shouldn't, but because I don't like FUD: double taxation on 401k loans is bullshit.  It's a myth propagated that frankly isn't true.

The first few links on google when searching for 401k double taxation:
http://thefinancebuff.com/401k-loan-double-taxation-myth.html
http://vanguardblog.com/2009/07/24/401k-loans-are-you-really-taxed-twice/
https://www.reddit.com/r/personalfinance/comments/1bbqp8/psa_401k_loans_are_not_double_taxed/

You still shouldn't cash out your 401k, but don't believe the FUD around double taxation of a 401k loan.
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secondcor521

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Re: Rat Race Retirement Strategy
« Reply #14 on: September 24, 2014, 10:30:01 PM »
I totally agree with ARS about avoiding FUD.  I read some of the links and encourage OP to do the same.  At first blush I'm not convinced personally, but I'll think about it more.

yddeyma

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Re: Rat Race Retirement Strategy
« Reply #15 on: September 25, 2014, 11:01:45 AM »
I agree there's no double taxation on the principle part of the loan.  If you just focus on your 401k loan, then you have to look at it not as "paying back with new money", but rather "paying back the money you already took out".

So, let's say I borrow $50k from my 401k to buy a rental property.  And then let's say I decide I hate being a landlord so I pay the $50k back.  The money I borrowed never got taxed (whether I spend it on something else or not).  So I am repaying myself with pre-tax dollars.  If you borrow $50k from your 401k, you can use it however you want.  You donít pay taxes on it. Youíre just returning money you borrowed.  So I agree on that point that your principle part of your 401k loan is not double taxed.

But the interest part is a little more tricky to me and I'll have to contemplate.  I have to pay back my original principle, plus the interest.  The interest IS being paid with after tax money.  It will go into my 401k, and then I will owe income tax on the earnings when I withdraw at retirement.  I'm not sure how you can get around the double taxation to me for this one.

Lots of those articles seem to mention the bank paying interest on investments that then end up in your 401k anyway, so its a wash.  But I'm not sure I buy that.  It may be negligible from some global perspective, but I'm not sure you can say its a wash at my level.