“Wait- how much do I need to save for retirement!?”
Have you ever felt that way after learning how much money you think you need to retire?
I’ve certainly felt that way in the past.
The prospect of saving millions of dollars in order to retire can seem impossible, especially when you’re just starting out.
You may have even wondered, “How do people even come up with these retirement numbers?”
The most common answer to that question is the “4% Rule.”
Using the 4% Rule, you can calculate your magic retirement number and determine how much money you need to save for retirement to maintain your current lifestyle.
The 4% Rule suggests that you can safely withdraw 4% of your investments in year one of retirement. Then, you can safely withdraw 4% plus an adjustment for inflation in subsequent years.
If you do so, you can expect your money to last for 30 years.
Today, we’ll take it one step further.
Let’s explore how owning even a single rental property can further reduce the amount you need to save for retirement.
The results may shock you- in a good way.
How to use the 4% Rule to forecast your magic retirement number.
First, let’s look at an example using the 4% Rule to forecast your magic retirement number.
In some fun news, Bill Bengen, creator of the 4% Rule, just released a new book showing that it’s safe to increase your withdrawal rate in retirement from 4% to 4.7%.
Bengen’s new book is called A Richer Retirement: Supercharging the 4% Rule to Spend More and Enjoy More.
If you’re at all interested in FIPE (Financial Independence Pivot Early), Bengen’s book is a must read.
Bengen’s research is significant because it means you can safely retire with even less money. That’s because the higher your safe withdrawal rate, the less you need squirreled away to maintain your lifestyle.
In light of Bengen’s updated research, we’ll use 4.7% as our safe withdrawal rate.
Let’s say that your lifestyle costs you $10,000 per month, or $120,000 per year.
To figure out how much you would need in investments to cover your current lifestyle for 30 years, divide $120,000 by .047.
| Current Spending / 4.7% (.047) = Magic Retirement Number |
| $120,000 / .047 =$2,553,191.49 |
Based on the updated 4.7% Rule, you need $2.55 million to maintain your current lifestyle in retirement.
By the way, under the original 4% Rule, you would need $3 million in investments ($120,000 / .04 = $3,000,000.00).
See why people are excited about the updated 4.7% Rule?
Does saving $2.55 million for retirement seem like an impossible task?
Saving $2.55 million for retirement may seem like an impossible task.
If that’s your initial reaction, be sure to check out my ongoing series on investing. We cover everything you need to know to start investing with confidence.
You may be surprised to learn that If you start investing early and often, reaching $2.55 million is actually not that hard.
Even so, there’s another way to massively shrink your magic retirement number: owning rental properties.
Why would anyone want to own rental properties?
There are four main reasons why I invest in rental properties:
When these benefits combine, real estate investors can generate significant wealth over the long run.
Before we look at an example of how owning rental properties shrinks your magic retirement number, here’s a quick breakdown of each of the four main benefits.
For a more detailed description of each benefit, you can read my series on investing in real estate here.
1. Rental property cash flow is king.
With cash flow, you can cover your immediate life expenses. For anybody hoping to reach financial freedom, it is essential to have income to pay for your present day life expenses.
For my money, cash flow from rental properties is the best way to pay for those immediate expenses.
If your present day expenses are already covered, you can use your cash flow to fund additional investments.
That might mean buying another rental property or investing in another asset class, like stocks.
2. Long-term wealth through appreciation.
Appreciation simply refers to the gradual increase in a property’s value over time.
While cash flow can provide for my immediate expenses, appreciation is all about the long-term benefits.
Like investing in stocks over the long run, real estate tends to go up in value. The key is to hold a property long enough to benefit from that appreciation.
To benefit from appreciation, all I really need to do is make my monthly mortgage payments, keep my property in decent condition, and let the market do the rest.
3. With rental properties, other people pay off my debt.
When I buy a rental property, I take out a mortgage and agree to pay the bank each month until that mortgage is paid off. At all times, I remain responsible for paying back that debt.
However, I do not pay that debt back with my own money.
Instead, I rent out the property to tenants. I do my best to provide my tenants with a nice place to live in exchange for monthly rent payments.
I then use those rent payments to pay back the loan.
As my loan balance shrinks, my equity in the property increases. Equity is just another way of saying ownership interest.
When my equity in a property increases, my net worth increases.
4. Real estate investors earn massive taxes benefits.
When you earn rental income, you must report this income on your tax return. Rental income is treated the same as ordinary income.
However, the major difference between rental income and W-2 income is that there are a number of completely legal ways to deduct certain expenses from your rental income.
Common rental property expenses may include mortgage interest, property tax, operating expenses, depreciation, and repairs. We’ll touch on a few of these deductions below.
With all of these available deductions, the end result is that most savvy real estate investors pay little, or nothing, in taxes on their rental income each year.
Yes, you read that right.
I’ll say it again, just to be clear:
Most savvy real estate investors legally pay nothing in taxes on their rental income each year.
With these benefits in mind, let’s see what happens when we add a single rental property to your portfolio.
How owning a single rental property lowers your magic retirement number.
Let’s continue our example from above where your current lifestyle costs $120,000 per year. We learned that means your magic retirement number is $2.55 million based on the 4.7% Rule.
Now, let’s add a single rental property into the mix.
Let’s assume that you own a rental property that cash flows $2,000 per month. That’s a total of $24,000 per year.
Remember, your cash flow is the profit remaining after paying your mortgage, taxes, insurance, and any other costs.
To learn how to properly run the numbers on a potential rental property, click here.
With $24,000 per year generated by your rental property, you don’t need your investment portfolio to fund your entire $120,000 lifestyle.
Instead, your investments only need to generate $96,000 per year ($120,000 – $24,000 =$96,000).
So, let’s plug $96,000 into our magic retirement number formula:
| Current Spending / 4.7% (.047) = Magic Retirement Number |
| $96,000 / (.047)=$2,042,553.19 |
By adding a single rental property to your portfolio, you’ve lowered your magic retirement number by half a million dollars!
You now only need $2.04 million to maintain your current lifestyle in retirement.
What happens to your magic retirement number if you pay off your mortgage?
This example shows how your magic retirement number drastically shrinks with the addition of just a single rental property.
Keep in mind that in this example, we assumed that you have a mortgage on your rental property. That mortgage obviously reduces your cash flow.
But, what if you paid off that mortgage before you retired?
Let’s finish our example by assuming that you have a 30-year fixed rate mortgage and your payment is $3,500 per month. And, you make it a goal to pay off that mortgage before you retire.
Once the mortgage is paid off, you can add that $3,500 to your monthly cash flow.
That increases your monthly cash flow on this property from $2,000 to $5,500. Annually, that’s $66,000 in cash flow.
Continuing our example, you now only need your investment portfolio to generate $54,000 per year ($120,000 – $66,000 =$54,000).
Look what happens when we plug $54,000 into our magic retirement number formula:
| Current Spending / 4.7% (.047) = Magic Retirement Number |
| $54,000 / .047 =$1,148,936.17 |
By paying off the mortgage on this single property, you’ve now reduced your magic retirement number by $1.4 million dollars!
You now only need $1.15 million to fund your current lifestyle in retirement.
Have you considered adding a rental property to your overall investment portfolio?
The point of this post is to show you how owning even a single rental property can reduce your magic retirement number.
Think about what would happen if you owned two rental properties. Or, what about three rental properties?
If you can handle the job of being a landlord- which I’m betting is easier than your job as a lawyer or consultant or doctor- owning rental properties is a great way to accelerate your journey to financial freedom.
After seeing the math, you may want to consider adding a rental property (or two) to your overall investment portfolio.
Are you intimidated by the thought of saving enough for retirement?
Have you done the math with the 4.7% Rule to see how much you really need?
Have you considered adding a rental property to your portfolio to shrink you magic retirement number?
Let us know in the comments below.
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