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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Mike Dymski
Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
6y
To get the employer match...plus it's completely passive and provides diversification from real estate. And contrary to many posts on BP, it's available prior to retirement (Roth conversion ladder, 72(t) payments, pay penalty).
6 Reply
Tony Kim
Rental Property Investor · Los Angeles · Member since 2018 · 844 posts · 1k+ votes
6y
Originally posted by @Steve Chan:
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?

I don't consider a 100% guaranteed return low....which is what I'm currently getting from my employer.
Also, it's not your 401K that is providing the return...it simply provides an avenue for tax deferral. The return generated in your 401k will be dependent on how you invest the money.

2 Reply
Storm S.
Real Estate Agent · Santa Barbara, CA · Member since 2016 · 518 posts · 283 votes
6y
@Steve Chan move your money into REIT's they preform better than private real estate in the long run unless your doing value add or developments.
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Matthew Terry
Rental Property Investor · Mesa, AZ · Member since 2019 · 138 posts · 144 votes
6y
@Steve Chan
I agree with you.
Considering we have the lowest taxes in decades and now with the trillions of dollars in debt from the pandemic, I think it is a losing bet that taxes will be lower in the future.
Also, I don't intend to be poor at 59.5. I don't see how I'll be in a lower tax bracket.
Also, with the massive amount of inflation probably incoming, buying power will get decimated and the stock market will not keep up with the real rate of inflation.
I just put in enough for matching.
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Christine C.
Flipper/Rehabber · Indianapolis, IN · Member since 2013 · 61 posts · 43 votes
6y
My fiancee and I converted our traditional (me) and roth (him) IRAs into self directed retirement funds (these were from our old W2 jobs/invested in stocks/mutual funds) We now both work for ourselves, so were able to roll over to a SOLO 401k and invest in real estate. As a broker/wholesaler/flipper, I feel more comfortable trading in this realm than stocks and funds! lol. It's great for buy & hold but can also be used for flips (with discretion). We used Sense Financial @Dmitriy Fomichenko and it was easy breezy to set up our "trusts" and get going. Its checkbook/debit card based so we manage all of the financials, as the trustees. We haven't gotten into lending yet (just buying RE) but that's on my radar so I'd love to connect with anyone doing this through their retirement account! Thanks.
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Tom Makinen
Member since 2019 · 226 posts · 115 votes
6y
everyone’s financial situation so different, but it’s pretty a reckless to say 401k is garbage. For someone with a regular w2 job, the 401k is the only way to decrease your agi. Someone making 100k a year will save a few thousand at the end of each year, depends on your state and deduction. If you really want the money, borrow 50% from it at some point after you have put money in tax free.

I highly recommend tax planning. Sometimes you can make more by paying less to the government.
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Justin Thorpe
Member since 2020 · 437 posts · 675 votes
6y
@Steve Chan
I pulled a few into an IRA and that has compounded at 45% a year for the last 7 years.
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Derrick F.
Rental Property Investor · Washington, DC · Member since 2020 · 17 posts · 4 votes
6y
@Steve Chan Capital preservation.
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Afsheen S.
Investor · Saint Louis, MO · Member since 2020 · 20 posts · 10 votes
6y
Originally posted by @Steve Chan:
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?

Above a certain income level ($150k i think), there aren't many options to shelter W2 income from taxes. Passive losses from real estate and elsewhere are "suspended" unless you have REPS (real estate professional status). For some people, maximizing 401k contributions is one of the primary ways to lower their taxable W2 income.

Additionally, an "employer match" is essentially free money. For example, my employer puts $2 in my retirement account for every $1 I contribute (2:1 match up to 10% of income).

Why would I keep the money in my 401k in the long run? .... Mostly for diversification. I only invest in passively managed low cost index funds. Historically, the S&P 500 long-term inflation-adjusted average return is ~ 7-8%. I wouldn't say that's bad. But I guess you can never predict the future so who knows how the next few decades will play out.

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Gina Cook
Investor · Long Island, NY · Member since 2019 · 34 posts · 22 votes
6y
@Jaspreet Baveja
Can you explain more about this? How can I use my 401k to be a private money lender and what are the benefits?
1 Reply
Steve Chan
OP
Investor · Houston, TX · Member since 2019 · 50 posts · 23 votes
6y
@Raul Carrillo I also contribute enough to get my employer match. Over the past 15 years, it has served as a great vehicle for saving money due to its automated nature. There are other pros to the plan, but I believe exploring your options with it is a valuable exercise.
1 Reply
Michele King
Investor · Longmont, CO · Member since 2019 · 46 posts · 23 votes
6y
@Cody Kauzlarich I agree 100%. I like you use all of these same strategies not only for diversification now, but to place myself in the best possible tax position later. RE is fantastic, but it is not the only way to increase wealth. There is no get rich quick scheme. Strategy and calculated investments along with patience wins the race.
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Steve Chan
OP
Investor · Houston, TX · Member since 2019 · 50 posts · 23 votes
6y
@Terrell Garren thanks for the perspective. As you get closer you get to 59 1/2, the less attractive paying a fee to access your funds becomes.
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Jorge Lopez
Rental Property Investor · Miami, FL · Member since 2020 · 25 posts · 9 votes
6y
@Steve Chan I would get a loan on my 401K and not pay any tax !!
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Steve Chan
OP
Investor · Houston, TX · Member since 2019 · 50 posts · 23 votes
6y
@Jorge Lopez I think taking a loan from your 401(k) and repaying yourself the principle and interest is one of the biggest advantages of the 401(k), if you deploy that money into a vehicle that earns a higher rate of return than what your 401(k) is generating.
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Anthony Wick
Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes
6y
"If your 401k provides a low rate of return..."
That's like saying; "why invest in real estate if the prices go down". Well, that's not really the goal.
My story:
-Max out 401k first (get the matching and greatly enhance my tax savings right now), invest in real estate (long term buy and hold), Invest in Vanguard Brokerage (VTSAX). And I do not actually take any profits from my rental business right now. They either get rolled into buying more units, or I invest the profits in Vanguard Brokerage account (with enough of a reserve account set aside as well).
Diversification. I would never put all my eggs in one basket. And, since I work a W-2 job, just yanking out my 401k is simply not even a possibility, if I wanted to do that. Last year earned me 26% in my 401k and 31% in Vanguard investments. Other than 2020, my 401k has not had a "low rate of return" since 2008. And all those losses were made up by the end of 2010. I'm straight up Warren Buffet thinking. Dollar cost average over the course of 30-35 years, and never sell (until I need/want funds in retirement).
I suppose I could also mention that I will be retiring early in 3 years at age 54, with a pension. "Retiring" from my W-2 job. Hard telling what comes after that. I have more than a few ideas.
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Steve Chan
OP
Investor · Houston, TX · Member since 2019 · 50 posts · 23 votes
6y
@Cody Kauzlarich I also have a 401(k) that I contribute to, to take advantage of my employer match, as well as an HSA to pay for my family's health care with pre-tax dollars. I'm not advocating to eliminate or avoid these programs, although I can see why you'd assume that by my line of questioning. What I am advocating is to create a strategy that does not make your 401(k) your primary retirement vehicle. I believe that planning to save a predetermined amount of money for your retirement is risky because of inflation, potential changes to the tax code, and the simple fact that you may outlive your savings. Also I think mutual funds are more susceptible to systemic economic changes due to their diversification across multiple industries. In my opinion, real estate is the ultimate hedge against inflation because you can borrow money at a low, fixed interest rate, and repay that fixed amount over time as the dollar becomes less valuable.
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Steve Chan
OP
Investor · Houston, TX · Member since 2019 · 50 posts · 23 votes
6y
Rather than saying, "low rate of return", I'll just use numbers.

Let's say you have $100,000 in your 401(k) and it returns 6% on average over 5 years. At the end of 5 years, the balance should be $133,823:

If you instead, pay the 10% fee and you're in a 24% tax bracket, then you'll have $68,400 to reinvest:

If you invest this $68,400 and earn 17% IRR, 8% COC, and a 2X equity multiple over a 5 year hold period, then your net income should be $136,800 and now you have cash that you can reinvest, rather than that portion of your money in a 401(k). If you've invested this money in real estate, the $114,912 that you receive upon sale will be taxed as capital gains, which is lower than your 24% tax bracket in this scenario.

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Nate R.
Real Estate Investor · Austin, TX · Member since 2015 · 214 posts · 234 votes
6y
Originally posted by @Steve Chan:
If you invest this $68,400 and earn 17% IRR, 8% COC, and a 2X equity multiple over a 5 year hold period,

Sounds like some souped-up syndication pro forma that might have little basis in reality. Are they underwriting rent increases during a depression? Can you get your money out before the sponsor decides to sell?

I think this is a great question. I love real estate, but I can see the reasons why some might contribute to an employer-sponsored retirement account that is used to invest in publicly traded securities, too. To summarize:
- Diversification across asset classes
- Diversification of tax treatment
- Take advantage of employer match
- A truly passive investment
- Liquidity
Comparing stock market returns in a 401k with private real estate is like comparing apples-to-oranges. At least you still retain control and have access to the money in a qualified plan (there are many ways to access the money prior to the official retirement age). Stocks, ETF's, and mutual funds are highly liquid, should you need the money tomorrow. You can't say the same about RE, directly held or passively through a syndication or private fund.

I am in a number of syndications myself and all but one have stopped paying distributions due to Covid-19 (that is their stated excuse, I should say). I'm not certain what the future holds for these deals once the stimulus money runs out or whether I will ever get my capital back.

While we are staring at a tidal wave of foreclosures in residential and commercial real estate coming in the next few months, the stock market has recovered its losses, partly due to the leadership of companies that are actually benefitting from lockdowns. Some companies zig while others zag. That is the benefit of true diversification.

This question partly comes down to individual attitudes towards risk. Some people believe in putting all eggs in one basket and watching that basket closely. Others believe in owning multiple types of assets. As we have seen during past crises, black swan events can decimate portfolios that are highly concentrated in one asset class.

Also, there are probably advantages to tax diversification as well, since tax rates and the tax system itself might change. It seems like having assets with different kinds of tax treatments could provide some tax planning benefits in the future.
2 Reply
Mark Braun
Rental Property Investor · Monterey, CA · Member since 2014 · 23 posts · 11 votes
6y
@Steve Chan..... that all being said, if you were going to withdraw from a retirement account. Seems like now would be the best time to do it. Check with a pro, but I think the Feds are waiving 10% penalty, and tax on withdraw can be spread over the next 3 years. Talk to a CPA.
0 Reply
Steve Chan
OP
Investor · Houston, TX · Member since 2019 · 50 posts · 23 votes
6y
@Nate R. great response. I think the most important factor when investing with a syndication group is vetting the general partnership team.
In all of the multi-family business plans that I've reviewed over the last few years, the 17% IRR, 8% COC, and 2X equity multiple over a 5 year hold seems to be fairly common projections. Also, to answer your question, the most recent business plans that I've reviewed have projected annual rent increases. I can imagine you must be very frustrated by not receiving your distributions. To me, passive cash flow is one of my favorite elements when investing as a limited partner.
In regards to the PROs you listed about 401(k)s, I agree 100%. That's why I still have a 401(k). It's just not my primary retirement plan. I think everyone needs to build a plan based on their circumstances and risk tolerance.
1 Reply
EJ K.
Quad cities iowa · Member since 2019 · 104 posts · 78 votes
6y
@Steve Chan I calculated that if I max out my and my wife’s 401k we would have 4.5 million in it assuming standard returns. Assume a 4 percent draw down and that’s 180 k a year. I also would only get to see about 65 percent of the money that I didn’t put into the 401 k if I didn’t. The 401k is supreme to me over real estate given me w2 Job and the value is brings. Real estate is a hobby and just icing on the cake. Also a good tax shelter. It’s nice to buy expensive appliances and say they are for rentals.
Not doing 401k is a mistake.
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Aaron Hunt
All Over, USA · Member since 2017 · 689 posts · 756 votes
6y
@Steve Chan
Because our HHI is ~$400k as W2 employees, and my 401k allows us to invest in individual companies.
So since the market bottomed, I was able to load up on individual hotel + cruise stocks, and flip them for a 20% gain in a matter of weeks.
How long might it take me to do that with my rentals?
1 Reply
Justin WindhamPro Member
Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
6y
Originally posted by @Christine C.:
My fiancee and I converted our traditional (me) and roth (him) IRAs into self directed retirement funds (these were from our old W2 jobs/invested in stocks/mutual funds) We now both work for ourselves, so were able to roll over to a SOLO 401k and invest in real estate. As a broker/wholesaler/flipper, I feel more comfortable trading in this realm than stocks and funds! lol. It's great for buy & hold but can also be used for flips (with discretion). We used Sense Financial @Dmitriy Fomichenko and it was easy breezy to set up our "trusts" and get going. Its checkbook/debit card based so we manage all of the financials, as the trustees. We haven't gotten into lending yet (just buying RE) but that's on my radar so I'd love to connect with anyone doing this through their retirement account! Thanks.

Congrats on getting checkbook control of the traditional IRA funds! Did you opt for checkbook control of the Roth IRA funds too or are those held with a custodian?

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EJ K.
Quad cities iowa · Member since 2019 · 104 posts · 78 votes
6y
@Justin Windham
How much could I shelter in your program if I moonlight As a physician? Could I contribute everything as an employer? Thought would be to maximize the tax shelter
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