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  • Nate Carter

Case Study 2: Retiring at Age 50 with College Aged Kids

There are many ways to achieve financial freedom. The key is finding a mix of investments that provide enough retirement income to outpace inflation while also matching your appetite for risk. Adding in some enjoyable side hustles or part-time work increases your income without the stress of a full-time job. The case study of Jess and Malcolm below explains this process. They minimized risk through asset diversification but ensured their returns were high enough to mitigate inflation risk. They chose investments that gave financial freedom and the ability to sleep at night.

The Plan: Jess and Malcolm set a goal to reach financial freedom by age 50 and to pay for a college education for their two kids. Like most households seeking to retire early they live below their means, avoid lifestyle inflation, and find ways to increase their income without adding stress to their lives. What is unique about their plan is Jess chose to buy a deferred annuity when she was 25 years old and paid for it with a part-time job at a restaurant. In addition, Malcolm took a lower paying job that offered a traditional pension, a benefit that is increasingly rare among today’s employers. They diversified their portfolio with rental properties and investments in stocks. Some of these stocks are held in pre-taxed retirement accounts like Roth IRAs and Roth 401ks to provide tax free withdrawals in retirement. They also moved to Florida because there is no State income tax, to reduce their tax obligations.

Deferred Annuity and Part-Time Restaurant Work: When Jess turned 25, she bought a deferred annuity that pays $12,000 in annual income at age 50. Her annuity payments increase each year to keep up with inflation. A deferred annuity was less expensive for Jess than buying an immediate annuity at age 50 because the payments did not begin for 25 years. But the investment is a bit of a gamble because if Jess were to die before age 50, she would have received nothing. Jess likes the guaranteed annuity income in case there are downturns in the stock market or real estate vacancies.

After Jess landed her first full time job, she kept working at a restaurant part-time to save for the annuity and bought it without relying on the income from her day job. She also used the restaurant income to build up an emergency fund equal to six months of expenses and to pay off her student loans early. This work sacrificed some nights and weekends for a few years, but quickly advanced her retirement goals.

Real Estate and Child Care: Jess and Malcolm bought a duplex soon after they were married, living on one side and renting out the other. After they had their first child, they rented out their unit, too, and bought a single-family home with a yard. A single-family home increased their housing expenses and combined with childcare costs, dramatically reduced their savings rate.

No Tax on Capital Gains: After living in their home as a primary residence for two years they could sell it without paying capital gains taxes on up to $500,000 in appreciation. Individuals can avoid paying taxes on gains up to $250,000. They sold the single-family home and rolled the profits into another duplex with a yard. Between the two tenants in their first duplex and the one tenant in the new duplex, they were back to lower housing expenses and a higher savings rate again.

Reducing Child Care Cost: To reduce their childcare costs both Malcolm and Jess adjusted their work schedules to work from home one day a week which meant they only needed full time childcare three days a week. They hired a retired neighbor to help on the days they worked from home. This saved on childcare expenses and allowed them to make additional principal payments on the duplexes.

Rentals Paid off at Age 50: Both rental properties were paid off when they reached age 50. After deducting for repairs, future maintenance, property taxes and insurance, they expect the three units to generate a combined $1,800 in monthly cash flow which adds $21,600 in rental income per year. They expect to be able to raise rents in the future to keep up with inflation.

College Savings and Bold Move in the Great Recession: Jess and Malcolm set up a Coverdell Education IRA and a 529 college savings plan when their kids were born. They set up regular monthly deposits in a S&P 500 stock index fund. However, when the global financial crisis occurred in 2007-09 they made a bold decision to invest a large portion of their available cash savings and emergency fund into the college savings accounts. They thought the stock selloff was the chance of a lifetime to buy great companies at a steep discount. The decision paid off and the accounts are enough to pay for a public university education for their kids. They have since rebuilt their cash savings and emergency fund. For more information on saving for college see How to Pay for College.

4% Withdrawals from Retirement Plans: Jess and Malcolm both contributed enough to their traditional 401k accounts to get the full employer match and contributed the balance to their Roth 401ks and Roth IRAs. (See here to learn more about 401k accounts.) When they reach age 59.5 they expect to have a total of $600,000 in these accounts and to withdraw 4% from their portfolios each year. This will provide them $12,000 per year in tax free income and $12,000 in taxable income.

Pension and a Side Hustle: Malcom's annual pension is $30,000 and is indexed for inflation. He also retained his employer's health insurance for his family in retirement, reducing his long-term health care costs. During his career Malcolm helped a friend who owned a small business building decks and doing outdoor landscaping. The extra income helped fund his Roth IRA account and to make extra mortgage payments on the duplexes. Malcolm is getting back into this work he enjoys now that he is retired.

Moving to Florida and into Retirement: When Jess and Malcolm moved to Florida they rented out their side of the duplex increasing their total annual rental income to $28,800. They are now renting a place in Florida but have $25,000 saved for a down payment to buy a property. They don’t mind working part-time to save more for the new house and until they can begin drawing on their retirement accounts. When they reach their full retirement age of 67, they will begin drawing Social Security Retirement Benefits which will boost their income. They do not include this part-time income in their totals below as their passive income covers all their expenses. Their annual expenses are $68,000.

Financial Freedom by the Numbers and by Age

Combined Retirement Income: Annual Jess Deferred Annuity $12,000 Malcolm Pension $30,000 Rental income after all expenses $28,800 Retirement income now age 50: $70,800

Once they reach age 59.5 their income will increase:

Roth Retirement Accounts $12,000 Traditional Retirement Accounts $12,000

Retirement income at age 59.5 $94,800

Once they reach age 67 their income will increase:

Social Security Retirement Benefits $24,000 Retirement income at age 67 $118,800

They expect an effective Federal tax rate of nearly 9%* on their current income and no State income tax as residents of Florida

* Federal taxes are higher on wage income because these earnings are subject to a Federal Insurance Contributions Act (FICA) tax of 7.65%. FICA tax does not apply to many types of retirement income such as annuities, Social Security Retirement Benefits, pensions, 401k distributions and IRA distributions.

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