Baby Boomer Retirement Plan
January 11, 2008
(This appeared in the Daily Reckoning on January 7, 2009. We got some nice responses too.)
People sometimes ask me: "what should I do with my retirement account?" I often tell them to consider ways of retiring that are not dependent on financial abstractions and various corporate/government promises, such as Social Security or corporate pensions. This usually gets some puzzlement because they've been trained for decades to think only in terms of financial products.
Let's look at a specific example. This is for my own parents, who turned 65 last year. (That puts them just before the Baby Boomers.) They live in a nice suburb outside of New York City, on the coast of Connecticut. Like many older people, they would like to stay in the house they have owned for about 20 years now, in the community they are accustomed to, and near the friends they have. It's not so easy to start over when you're over 65.
Even people who have been able to accumulate significant assets, pensions etc., might be a little nervous. Trying to depend, for the next 20 or even 30 years perhaps, on financial abstractions and government promises would be a little scary. I usually tell them that they should be scared! Or, at least don't put too much faith in various Wall Street promises (and pensions are ultimately Wall Street promises too). You aren't going to make a smooth 8% per year in your 401(k) just because some Financial Advisor told you so. But, I guess you've figured that out now. Anything can happen. Particularly as we are sort of in a depression right now. Owning a big house in a nice neighborhood is not cheap, even if it is 100% owned with no mortgage. The annual costs of a house look something like this:
Property tax: $8000 (and that could go up)
Insurance: $2000 (could be higher)
Maintenance: $2000 (could be higher)
Utilities (phone, internet, cable, electric, trash collection) per month: $200 or $2400/year.
Heating oil: $2000 per year (could be higher).
Total: $16,400. That is probably on the low side. So, let's just budget it at $18,000.
Then, you've got a car and all the other expenses of living. And what happens when you get a little frail, and want living assistance?
Have you seen the prices for nursing homes?
It's not that these burdens are unbearable. It's rather that they are burdensome. Just house-related costs could chew up most of your Social Security check right there. And, if things really go to hell in the future, they might become unbearable. Who knows what things will look like in 20 years? Only your Financal Advisor knows for sure.
Let's look at it from the financial side. Maybe you can get 3% of cashflow from a "safe" muni bond portfolio, or dividends from stocks. And, you have to take into account inflation ... over the next twenty years. How do we "take into account" the unknowable? What happens if there's not enough fifteen years from now, and I'm still alive? To get $18,000 of income would take $600,000 of muni bonds. And, muni bonds are looking kinda risky these days. Dividends from stocks might take more than $600,000, because you have to pay taxes on dividends. Stocks go up and down a lot too. Sickening.
Now, like I said, they've been living in the area for a while and have some good friends, who are about the same age and in similar circumstances.
So, here's the plan:
You get together with your friends. You say: "We're all retired now. I've got a big empty house. You do too I suppose. Maybe we can think of living together. That would help reduce our living expenses. Plus, it might be fun, and it would be a good way to keep an eye on each other. That can be important when you're getting older."
Everyone is repulsed at first, because we Americans are all taught that we have to live as far away from each other as possible. But, they remember that, when they were in college, they used to share houses, and it was kind of fun. Also, everyone is older now and a lot better behaved than when they were in college. And, it is true that it might be good to have someone keeping an eye on you.
So, everyone decides to move into one house, owned by the Owner. The people who move in, two other retired couples, are the Renters. The Renters pay the Owner $1000 a month to rent a bedroom, and agree to pay 1/3 of the utility and heating bills. The Renters' cost of living looks something like this:
Rent: $1000 * 12 = $12000
Utilities: $100/month = $1200
Total annual costs: $13,900.
Now, indeed renting turns out to be cheaper than owning the big house, even when the big house is fully paid for. They could sell their big houses if they wanted to. But, they are nervous about just selling the house they have owned for twenty years, and moving in with someone else. It might not work out. Let's not burn any bridges. So, instead of selling their now-empty houses, they rent them out.
Rent: $3500 per month = $42,000 per year (typical, actually a little low).
Heckuva lot cheaper than paying the mortgage on a million-dollar house. Just
the thing for a Wall Streeter with a family that needs to downsize quickly.
Utilities are paid for by the renters.
Property tax: $8000
Maintenance: $3000 (higher with renters)
Net cashflow: $42,000 - $13,000 = $29,000.
Now, they're getting $29,000 in rent net of property expenses. Then, they pay their $13,900 it costs to live in the shared house.
$29,000 - $13,900 = $15,100.
Now, look at the renters:
Before: $18,000 per year of housing costs.
After: Housing and utilities are paid for, and an extra $15,100 per year of free cashflow, plus probably some tax benefits.
Wow, all of a sudden, you're living for free, and getting paid too! You just created, out of thin air, the equivalent of a $1,000,000 muni bond portfolio. Maybe more, if you consider tax benefits (rental properties can charge depreciation.) And, you still own your house.
For the Owner, it looks like this:
House costs: $13,000
Utilities: $1200 (1/3)
Heat: $700 (1/3)
Rental Income: $1000 * 2 * 12 = $24,000
Net cashflow: $24,000 - $14,900 = $9,100.
So, the Owner is also living for free! However, their cashflow is not as high as the Renters. That's probably the way it should be, because the Renters will probably want a little extra incentive to move out of their house into someone else's.
So, now where are we? All three couples are now living for for free, and getting some extra cash on top of that. And, there are things you can do in a shared house, like splitting cooking duties. Instead of cooking every night for two, the cook can cook twice a week for six. That's a lot easier, and would probably result in a more ambitious menu, and would resolve the question of how three people can cook in one kitchen. If the men are smart, they will encourage a little friendly competition among their wives, to "keep up the pace" for their two dinners a week. You can finally use that formal dining room every day. Then, everyone has a house's worth of furnishings. The antiques, boutiquey stuff, art and heirlooms, and the grand piano, all goes into the house where everyone is living. The more generic, replaceable stuff can go into the houses that are being rented out. Maybe you can charge an extra $500 a month for a furnished house. $500 a month is $6000 per year. That's another $200,000 muni bond portfolio-equivalent, that you created out of some used furniture. You would have had to save $400,000 before income taxes, to get a $200,000 portfolio after taxes.
After a while, in a shared house, there is always the issue of who does what house chores, and do they do it adequately, and so forth. The easy way to solve this problem is to get a housekeeper to come in one day a week, and do the vacuuming, laundry, bathrooms and all that. It's $100 a week, or $5,200 a year, or $1,735 per couple per year. Covered by their extra cashflow. Over time, people are over 70 and a little frail. Maybe they would like a little more help with shopping or even cooking, or they are no longer able to drive safely by themselves.
So, they get a live-in full-time housekeeper. The housekeeper lives in the fourth bedroom. The housekeeper gets room and board and use of a car, plus $1,000 a month in salary. Not a bad deal for a housekeeper. That's $12,000 per year or $4,000 per couple. That is also within their net cashflow. So, now everyone has their housing and utilities and a live-in housekeeper paid for. Make it $2,000 a month and you could get a registered nurse, probably. Now you've got a private nursing home.
Being older with lots of free time, it would probably be good to get outside for some light exercise. The house sits on two acres, of which perhaps there is one full acre of lawn. Instead of growing grass, let's grow some vegetables. This is prime farm country, or it was in the colonial days. You can grow a lot of vegetables on a full acre. Heck, you can grow a lot of vegetables on a tenth of an acre. A tenth of an acre is 4,356 square feet, or 43 feet by 100 feet. Not a small garden, that. So, you drop some seeds in the ground, and have fresh vegetables all summer. You even do some canning and put some away for winter. It's all organic, you get some exercise, and no more big-ticket trips to Whole Foods.
So, now, instead of paying out $18,000 a year in housing expenses, you're living for free, with your friends, with a live-in housekeeper, with some extra cashflow on top of that, and a lot of your food costs are covered as well. What is there to be worried about? Pass the 401(k) on to your kids. Don't worry about the corporate pension. Consider the Social Security check to be your entertainment budget. If there's inflation, just raise your rents.
And all it took was a little cooperation among friends, to make better use of what they already own.
* * *
Obama: $1000 tax cut. The "tax cut" sounds like a variant on the check-in-the-mail. As I've said, mailing out checks is functionally equivalent to Social Security checks, even if you label it a "tax cut." There might be an exception if, for example, there is a $1000 "rebate" on payroll taxes, in effect reducing payroll taxes for the lowest earners. However, this would likely have an effect only if it is permanent, in which case it might incentivize a few more people to work or hire others. A one-time "tax cut", even if you call it a "payroll rebate" or something like that, has no real effects (beyond the obvious money-in-your-pocket effects) on people who are already employed, because it has no particular effect on future behavior. Still, $1000 can be important for those with the lowest incomes, so why not. Like I said earlier, sometimes the most important thing about a "tax cut plan," even if it amounts to little more than empty rhetoric and a free giveaway, is that it prevents the discussion of a "tax hike plan" that might otherwise take place.