Why keep money in your 401K?

Investor · Houston, TX · Member since 2019 · 50 posts · 23 votes

If your 401k provides a low rate of return and you know you can invest your money at a higher rate of return than the fees associated with withdrawing your money plus the opportunity cost of leaving your money in the 401k, why would you keep your money in a 401k?

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Taylor L.

Rental Property Investor · RVA · Member since 2016 · 5k+ posts · 4k+ votes

"401(k) provides a slow rate of return" has very little to do with the 401(k) and far more to do with what you invest it in. We can invest 401(k)s and IRAs in basically anything, including real estate (with caveats), so there's less need to take that tax hit and pull the funds out.

The tax savings when contributing to a 401(k) are enormous. It's very difficult to make up for that big tax hit if you're in a high tax bracket. You're essentially putting yourself behind right out of the gate. For high income earners, deferring the tax bill gives us far more capital to invest, which numerically ends up in a much greater final result. Then when we retire and are in a lower tax bracket, we can take distributions.

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Taylor L.
Rental Property Investor · RVA · Member since 2016 · 5k+ posts · 4k+ votes
6y
"401(k) provides a slow rate of return" has very little to do with the 401(k) and far more to do with what you invest it in. We can invest 401(k)s and IRAs in basically anything, including real estate (with caveats), so there's less need to take that tax hit and pull the funds out.

The tax savings when contributing to a 401(k) are enormous. It's very difficult to make up for that big tax hit if you're in a high tax bracket. You're essentially putting yourself behind right out of the gate. For high income earners, deferring the tax bill gives us far more capital to invest, which numerically ends up in a much greater final result. Then when we retire and are in a lower tax bracket, we can take distributions.
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Steve Chan
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Investor · Houston, TX · Member since 2019 · 50 posts · 23 votes
6y
@Taylor L. Thank you for the response! Why would you invest your 401(k) in real estate if you if you are properly accounting for depreciation? If your real estate produces passive losses every year, why would you want it in a tax sheltered account? Also, what if you're planning to have a higher taxable income when you are eligible to withdraw your funds without penalty?
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Taylor L.
Rental Property Investor · RVA · Member since 2016 · 5k+ posts · 4k+ votes
6y
Originally posted by @Steve Chan:
@Taylor L. Thank you for the response! Why would you invest your 401(k) in real estate if you if you are properly accounting for depreciation? If your real estate produces passive losses every year, why would you want it in a tax sheltered account? Also, what if you're planning to have a higher taxable income when you are eligible to withdraw your funds without penalty?

I've had conversations with a few CPAs who have advised me that passive losses wouldn't be a net benefit to me in the end. Depreciation is ultimately recaptured, so in my opinion its value as a long-term tax advantage is a bit overblown. It's one component of an overall strategy and can be advantageous.
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Jaspreet Baveja
Lender · Palo Alto, CA · Member since 2017 · 142 posts · 91 votes
6y
@Steve Chan - Why does Real Estate investing have to be owning physical Real Estate? Notes, Lending, Syndications etc are all valid methods of passive investment!
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Steve Chan
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Investor · Houston, TX · Member since 2019 · 50 posts · 23 votes
6y
It's not recaptured if you keep rolling it for the duration of you life, correct? I'm under the impression that you can keep rolling your depreciation into new investments through a 1031 exchange, and then your heirs can inherit your assets on a stepped-down basis.
Also, the other factors that I'm considering in my original question are tax brackets when I retire, the time value of money, and the overall state of our economy. What if the government decides to increase taxes when you are able to start taking your distributions? What if the dollar continues to devalue over time? What if our economy enters a recession/depression when I retire and I lose a percentage of my 401(k) when I'm dependent on those funds?
Our rising national debt and The Fed's massive injections of cash into our economy seem to be very strong economic indicators that are concerning when considering future taxes and inflation. Also, I can't control the year in which I turn 59 1/2, so if a 401(k) is my primary retirement vehicle and we are in a recession/depression at that time, then I've put myself in a tough position by depending on my 401(k).
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Steve Chan
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Investor · Houston, TX · Member since 2019 · 50 posts · 23 votes
6y
@Jaspreet Baveja As far as I'm aware, investing in a real estate syndication as either a limited or general partner is a form of owning physical real estate. I have not explored notes or lending through a 401(k). How does that work?
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Jaspreet Baveja
Lender · Palo Alto, CA · Member since 2017 · 142 posts · 91 votes
6y
@Steve Chan - If you have a ROTH or Self Directed ROTH IRA, you can lend those funds out to investors, as a secured loan, backed by Physical Real Estate, for any duration / rate you may choose (beware of usury laws), and then keep making that chosen rate of return into your IRA. When you're an active employee, you can't take out the 401k funds anyways, or even if you do with the fines etc (as you mentioned), you REALLY need to be sure that the alternate investment vehicle is going to generate more returns and have a LOW probability of default/failure. You can do the lending from your regular personal / business, checking/savings accounts as well, and just counts as an "Ordinary Income" or 1099-INT on your tax returns.
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Steve Chan
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Investor · Houston, TX · Member since 2019 · 50 posts · 23 votes
6y
@Jaspreet Baveja Thank you, I did not know you can lend funds to investors through a ROTH or Self-Directed ROTH IRA and I completely agree with your warning about paying the fees to withdraw from your 401(k) in order to reinvest. That is a strategy that must be employed with a great plan in order to forecast a greater outcome than investing through your retirement account; however, I will say that borrowing from your 401(k) to reinvest does seem like a prudent strategy for a sophisticated investor.
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Jaspreet Baveja
Lender · Palo Alto, CA · Member since 2017 · 142 posts · 91 votes
6y
@Steve Chan - you're welcome. I would confirm your specific situation with a CPA and a custodian you're considering for your SOLO or Self Directed or other IRA accounts to confirm this approach. I am a Private Money Lender myself, and my goal is to help others place their funds in this investment vehicle as well. I have been educating a lot of people in this space recently, have helped quite a few friends and family invest in it, and always looking to grow this network of like minded people who may find this passive income strategy attractive enough to become an investor! The lenders I bring to the table leverage anything from HELOCs to Retirement funds, Credit Cards to Savings to invest in this amazingly passive investment vehicle with a secured lien and ample layers of recourse to recover your principal investment at the bare minimum. Best of luck and stay safe everyone!
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Chris SeveneyBusiness Member
Moderator
Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
6y
@Steve Chan
I assume you are basing this on a 9-5 job 41k plan where it is managed by larger companies like a fidelity.
Having money grow tax free is always a bonus. Remember if you make 10% and pay 30% tax you need to make almost 50% to make that up.
If you can self direct it, as others mentioned I prefer to invest in notes as those maybe considered ordinary income if taxed so it provides better tax benefits and I can get double digit returns. You can also get that in the markets or other investments not just real estate. I would say it’s best to diversify a portfolio with stocks, bonds and alternative investments like real estate as you want to maximize reward with minimal risk (modern portfolio theory)
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Steve Chan
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Investor · Houston, TX · Member since 2019 · 50 posts · 23 votes
6y
@Chris Seveney You are correct. I'm basing my questions on a W-2 job, but I'm appreciating the feedback about the self directed options. Thanks for your input.
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Chris SeveneyBusiness Member
Moderator
Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
6y

steve

I did a podcast last week with an advisor who mentioned a loophole in the covid situation whereas if you were affected (again this is step 1), people could take money at of their corporate 401k and put it in a self directed Ira. Then you could invest that money as you see fit

one thing to realize also is most people are not real estate investors or savvy enough to manage (nor should they) their own finances

Originally posted by @Steve Chan:
@Chris Seveney You are correct. I'm basing my questions on a W-2 job, but I'm appreciating the feedback about the self directed options. Thanks for your input.

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Allan C.
Rental Property Investor · Member since 2018 · 826 posts · 810 votes
6y
@Steve Chan yes, step-up basis after passing to heirs or 1031 until you step-up are ultimate differentiators in RE investing to utilize depreciation to tax shield your positive earnings.
As to your question on why still leave money in other securities through your 401k, I do it for diversification. Diversification in the long run enables stability - whether its asset class, growth vs value, geographic location, or other means of diversification.
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Steve Chan
OP
Investor · Houston, TX · Member since 2019 · 50 posts · 23 votes
6y
@Allan C. Thanks for catching the stepped up versus stepped down error, but I’m not sure that I follow your point about diversification. If you pull money out of a retirement account, you can diversify that money as much as you please. Are you referring to diversification in terms of multiple retirement accounts?
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Raul Carrillo
Rental Property Investor · Los Angeles, CA · Member since 2020 · 26 posts · 19 votes
6y
@Steve Chan I see your point... but personally, I'm contributing enough to my 401k to get my employer match then down the road when I'm financially independent, make use of the roth conversion ladder tactic.
2 Reply
Mark H. Porter
Investor · SC NC, VA · Member since 2020 · 1k+ posts · 756 votes
6y
You would need to be maxing your 401k at $26K ( I’m over 50) for this conversation to matter. If your contributing 10% and make a $100K a year are you really no going to not touch that money for a few years to buy into this game. you’ll be putting this money in a savings account because it is planned for something else, earning what, a couple of percent? Things will change drastically in four years (marriage, children) and that money for you RE investment could get scooped up. That, in itself, is a risk to be considered.
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Terrell Garren
Rental Property Investor · Concord, NC · Member since 2016 · 1k+ posts · 3k+ votes
6y
Old guy perspective. By blind luck, I started buy/repair/hold REI around 2008. It allowed me to quit my W2 job 10 years later. It would have been smart for me to start REI sooner, but a W2 job, family and life kept me busy. I invested in a matched 401K for 35 years and the $ are still sitting in an IRA, usually earning money. My reasons - low risk diversification and risk mitigation (e.g. a pandemic). Sure, I could take the $ out of the IRA and invest it myself. However, you have to remember a quote from Dirty Harry - "A man has to know his limitations"
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Dave SpoonerPro Member
Rental Property Investor · Cincinnati, OH · Member since 2020 · 869 posts · 823 votes
6y
@Steve Chan 1031 Exchanges are also not a guarantee. In contrast, the tax shelter a 401k provides is.

@Jaspreet Baveja had some good insight. Sounds like a self-directed 401k could provide the best of both worlds for you. You'll likely need to talk to your employer about it though. Good luck!

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1 Reply
Brit F.
Rental Property Investor · DFW · Member since 2017 · 143 posts · 120 votes
6y
I'm with you, @Steve Chan. It infuriates me that I have money tied up in a 401k; my one and only financial regret is my 20 yr old self listening to the 'smart' people telling me to max out my 401k. I now only do enough to get the employer match. I have every intention of being in a higher tax bracket when I retire, which calls into question the value of the 401k.

All that said, the silver lining of this pandemic is the relaxed rules on 401k loans, which I'm using to fund remaining rehab on a project instead of taking a draw against a LOC.
2 Reply
Cody Kauzlarich
Des Moines, IA · Member since 2015 · 45 posts · 28 votes
6y
@Steve Chan Every investment vehicle I utilize is tax advantaged. We invest through our 401k and get an employer match, we invest through an HSA and receive an employer contribution, we invest through a Roth IRA and we invest in mostly buy and hold RE. Notice how I said "through", you don't invest in a 401k/Roth/HSA, I invest in ETF's and index funds through those accounts. 401k and HSA decrease your current taxable income, Roth decreases your future taxable gains, and you should be aware of the numerous tax advantages of RE.
The point your trying to make of being in a higher tax bracket at retirement befuddles me. You should be positioning yourself to require almost no income to live once you're retired, your house is paid off, you're not investing into those multiple accounts, you have a fat HSA to cover medical expenses. You should have RE income and then you could subsidize with retirement accounts as necessary.
I'm going to diversify and I'm going to continue to invest in the stock market and in RE. So I'm going to take advantage of the tax benefits of what's offered to me. If you don't want to invest in the stock market, then no, you probably shouldn't worry about a 401k.
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Mark H. Porter
Investor · SC NC, VA · Member since 2020 · 1k+ posts · 756 votes
6y
@cody - I agree. I’ve maxed out my 401k for 23 years, even adding the Over-50 extra when that happened. We’re in a comfortable 7 figures and haven’t suffered terribly through the is downturn. We really could care less, we’ll probably never need it.
And as for being in a higher tax bracket, what the heck? I’m in a realized 4% right now due to all the depreciation I’m taking using someone else’s money (about 48% leveraged). retiring next year at 60 will be a breeze.
2 Reply
Marlen Weber
Specialist · Plano, TX · Member since 2020 · 2k+ posts · 861 votes
6y
@Taylor L. great info on 401(k).
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Lawrence Brooks
Rental Property Investor · Northern Virginia · Member since 2018 · 5 posts · 0 votes
6y
@Chris Seveney most brokers don't manage self directed IRAs. Could you recommend where I could research this? Also, I understand you'll need a custodian to manage the account to keep you clean with the IRS. Have you found any reputable custodians?
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Stefanny Gonzalez
Flipper/Rehabber · Los Angeles CA (los angeles, ca) · Member since 2020 · 23 posts · 1 vote
6y
@Steve Chan
Hello all, 401K is definitely a long term play but it still requieres strategy. Splitting your 401k investments with ETFs, or other more progressive portfolios could help though. For example, I just split my 401k with VOO at 50%. Half of my contributions go to VOO and half to standard TRs. I jumped 6% in net profit within a 2 day time span by doing that. If this is something you would consider, I recommend buying when an ETF/Stock of choice is lower than its trend. Hope this helps!
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Ray Johnson
Irvine, CA · Member since 2016 · 545 posts · 614 votes
6y
@Steve Chan Not all 401k's provide low rates of return, especially over the long-term.
Like other high W2 earners have mentioned, the 401K is used strategically. I also get a 7% employer contribution of free money. At my income level, that's more cashflow into the account than most if not all SFR rental properties.
I'll also point out another strategic use of my 401K, every time I purchase a RE asset I submit my 401K balance as the proof of reserves to acquire the asset with the bank. Had I pulled those funds to invest in a single property, I would not have been able to acquire assets as quickly. Whether it's good economic times or bad, bank tightening has zero effect on you when you have a great balance sheet with those funds as reserves.
The one thing I learned from dealing with millionaires, and billionaires in the Private Equity sector is not one single wealthy person we EVER encountered invested in a single sector. Even people who became wealthy through a majority of RE holdings, had significant diversification as they all know how important diversification is.
These are just a few of many reasons why I would have money in the 401K, and not solely in RE.
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