Benefits of 401(k) over Property?
Investor · Katy, TX · Member since 2015 · 112 posts · 24 votes
My husband's and my goal is to eventually use rental income as our retirement income. We currently have one rental home and are looking to have ~10 within the next 20 years.
So the question is...what is the benefit of putting our money in a 401(k) over saving money for our next rental home? Obviously the 401(k) is sheltered from taxes until we are 59 1/2 (30 more years), but are there other benefits that I am not taking into account?
Long term average growth for the stock market is 9% per year. This also doesn't include the company matching that you might have. It's put in pretax, deferring tax until you retire and will be at a lower tax bracket. Because the money is pretax, you can set it at a level to maximize your company matching but not notice much of an impact in your take home...
If you're going to invest long term, you should always consider having multiple streams of retirement income.
Long term average growth for the stock market is 9% per year. This also doesn't include the company matching that you might have. It's put in pretax, deferring tax until you retire and will be at a lower tax bracket. Because the money is pretax, you can set it at a level to maximize your company matching but not notice much of an impact in your take home...
If you're going to invest long term, you should always consider having multiple streams of retirement income.
Most 401k plans have an employer match, which is essentially an immediate 100% return on your contribution. Many investors contribute enough to get the match and then invest excess capital in real estate.
Brianna, you are correct, when you put money into retirement account you get the tax break now and you can invest in tax-deferred environment. I understand your hesitation because you and I have no control over the stock market, which is the only investment options with conventional retirement accounts. However you should look into self-directed IRA, which would allow you to use your retirement funds to invest in alternative assets such as real estate, trust deeds, and much much more.
Great advice from @Christopher Phillips. For example, my employer matches up to 10% of my salary in 401k contributions, so I've always contributed the 10%. You can also always take the match, then take a withdraw penalty (consult a financial advisor before doing this).
I'm in a similar boat, since I'm saving for retirement (both 401k and IRA, with a mix of roth and traditional), but also am saving for investment properties. It doesn't always seem to be the best way, but I know one day the compounding interest** will really show AND I will have investment properties to go with my retirement savings.
**EDIT: not sure why I initially said appreciation haha
Long term average growth for the stock market is 9% per year. This also doesn't include the company matching that you might have. It's put in pretax, deferring tax until you retire and will be at a lower tax bracket. Because the money is pretax, you can set it at a level to maximize your company matching but not notice much of an impact in your take home...
If you're going to invest long term, you should always consider having multiple streams of retirement income.
Not all 401K are pretax, there is an option... roth 401(k), you contribute income pre-tax, and then pay taxes on the funds when you withdraw them during retirement. If your 401(k) is most likely from your retirement employer account, I'm afraid you can't use this as an investment without some sort of penalties.
We are maxing out his IRA and for a while, he's been putting about 10% in his 401(k) with a company match up to 2.5%.
I told him we should only put 2.5% in to get company match then put the other 7.5% in a regular stock account invested until we find another great deal on a rental. I just want to make sure that in doing so, we're not missing an opportunity through the 401(k).
If we can reach our goal, he won't be working at 59 1/2 anyways, so we would more than likely be taking the penalty anyways if we needed to withdraw.
Most 401k plans have an employer match, which is essentially an immediate 100% return on your contribution. Many investors contribute enough to get the match and then invest excess capital in real estate.
It might be a 100% "return on your contribution", but its not a 100% return on anything else, more like 2%. In other words, if you invested the same amount and returned a 5% annualized return, if you now invested that same amount with a 100% employer match, your return would be 7 %or less. The math has been done. Lets not get it twisted :)
Most 401k plans have an employer match, which is essentially an immediate 100% return on your contribution. Many investors contribute enough to get the match and then invest excess capital in real estate.
It might be a 100% "return on your contribution", but its not a 100% return on anything else, more like 2%. In other words, if you invested the same amount and returned a 5% annualized return, if you now invested that same amount with a 100% employer match, your return would be 7 %or less. The math has been done. Lets not get it twisted :)
Huh?
The benefit of a 401k whether invested in real estate or equities is that all the gains grow on a tax deferred basis.
Please correct me if I'm mistaken, but if with good planning you retire with an income stream that is close to your current earnings, you may very well pay more tax on 401k savings because you will have fewer deductions. Hopefully your home will be paid for (so no interest deduction), you won't have dependents, etc. Just something to consider.
@Brianna H. - Continue to invest some into 401K to have some money in case your real estate ventures doesn't play out. It's a solid vehicle to build wealth especially if you can get a company match.
However, if your goal is to use rental income for an early retirement, the 401K is an indirect way to achieve your goals.
Quick story - one of my mentors is in his 40s and a multi-millionaire. However, most of his money is in tax-deferred accounts. He doesn't love his job, but he continues to work because he has a daughter. He has accomplished what most people are after but he is somewhat stuck. Choose financial freedom over a big number on a computer screen that you can enjoy at 59 1/2.
I'm sure there are ways around this as I'm no tax expert, but I think people should invest for income replacement and cash flow. It's easier to transition and jump off to something else if you want to even if you give up some on the back end. Life shouldn't start at 59 1/2. It should be a fun journey throughout. My 2 cents.
If I had to do it over again I would never invest in a 401k. I can't touch the money until I'm 60 I have no control and in 2008 half of the value was gone. I would save money a 401k and invest it in vehicles you have control over. Whether that's real estate a business etc. I have $500k in my retirement account. Here are my options: quite my job, take a distribution and pay all taxes plus 10% penalty, leave it alone and wait until I become a senior citizen.
As you can see I'm stuck similar @Ian Tudor friend.
Everyone rocked the difference in growth in stock market v property.
Here is another thing I'd add-- I'm very pro real estate, but am trying to make sure I have a spread between the 401(k) AND property (many say the key is to be diversified on all investments. Some invest only in what they know, but I am a jack of all trades).
Say you go bankrupt (heaven-forbid). Chances are they can take your property (likely that most of us don't have non-recourse loans as they're expensive usually) BUT your 401(k) has the ability to stay intact (depending on how you file).
"401k and other retirement accounts that are qualified under the Employee Retirement Income Security Act (ERISA) are typically not part of your bankruptcy estate." Details here. (Since I'm not a lawyer / CPA, )
Now, you could just invest in property in an approved IRA I suppose, but I haven't looked into that. Also, property in an IRA doesn't have the same tax advantages as out of an IRA.
You'll want to sit down and talk with an attorney / CPA but that's something that crossed my mind when sticking my money in a 401(k).
Most 401k plans have an employer match, which is essentially an immediate 100% return on your contribution. Many investors contribute enough to get the match and then invest excess capital in real estate.
It might be a 100% "return on your contribution", but its not a 100% return on anything else, more like 2%. In other words, if you invested the same amount and returned a 5% annualized return, if you now invested that same amount with a 100% employer match, your return would be 7 %or less. The math has been done. Lets not get it twisted :)
Huh?
If you invested a given amount of money over a 30 year period. Then, you invested that same amount of money, in the same exact equities over the same time and had a 100% employee match.. you would produce roughly 2% more return in the latter case over the lifetime of the investment. So, while the "100% return on your capital" sounds nice, your actual returns on your investment would be 2% better, at best.
@Brianna H. - Continue to invest some into 401K to have some money in case your real estate ventures doesn't play out. It's a solid vehicle to build wealth especially if you can get a company match.
However, if your goal is to use rental income for an early retirement, the 401K is an indirect way to achieve your goals.
Quick story - one of my mentors is in his 40s and a multi-millionaire. However, most of his money is in tax-deferred accounts. He doesn't love his job, but he continues to work because he has a daughter. He has accomplished what most people are after but he is somewhat stuck. Choose financial freedom over a big number on a computer screen that you can enjoy at 59 1/2.
I'm sure there are ways around this as I'm no tax expert, but I think people should invest for income replacement and cash flow. It's easier to transition and jump off to something else if you want to even if you give up some on the back end. Life shouldn't start at 59 1/2. It should be a fun journey throughout. My 2 cents.
Bingo! This falls on deaf ears on here. People automatically assume they will be just as healthy, mobile, positive/adventurous spirit, or even alive, like they were in their 30s. News flash, likely you won't be (in the health, ability, and mobility regards).
Most 401k plans have an employer match, which is essentially an immediate 100% return on your contribution. Many investors contribute enough to get the match and then invest excess capital in real estate.
It might be a 100% "return on your contribution", but its not a 100% return on anything else, more like 2%. In other words, if you invested the same amount and returned a 5% annualized return, if you now invested that same amount with a 100% employer match, your return would be 7 %or less. The math has been done. Lets not get it twisted :)
Huh?
If you invested a given amount of money over a 30 year period. Then, you invested that same amount of money, in the same exact equities over the same time and had a 100% employee match.. you would produce roughly 2% more return in the latter case over the lifetime of the investment. So, while the "100% return on your capital" sounds nice, your actual returns on your investment would be 2% better, at best.
Your math is off...by alot.
Say I invest 5k of money (10% of salary) into my 401k per year.
Company matches up to 10% of salary (5k)
That's 10k in my 401k and we can assume that we get 10% return (minus 1% for fees) so 9% return on 10k.
$10,000 * 1.09 = 10,900
$10,900 versus $5,000 is not 2%, it's 118%
I actually stopped contributing to my 401K this year. Why, because I have very little control over my money inside the 401K and I can't touch it until I either quit or retire. If I quit then I get to pay a penalty on it when I do pull it out. Unless I want to wait until I am of age to avoid the penalty. I can also do much better managing my own money with far greater returns than what the company that I work for does.
Plus I figured out the taxes are a lot less if my money is invested outside a 401K. How is this, by having my money generate passive income.
I actually stopped contributing to my 401K this year. Why, because I have very little control over my money inside the 401K and I can't touch it until I either quit or retire. If I quit then I get to pay a penalty on it when I do pull it out. Unless I want to wait until I am of age to avoid the penalty. I can also do much better managing my own money with far greater returns than what the company that I work for does.
Plus I figured out the taxes are a lot less if my money is invested outside a 401K. How is this, by having my money generate passive income.
What's the penalty for withdrawing versus the money you put in plus the company match? And you can also always take a loan out on your 401k too...curious on both of these since I've never looked into either.
@Kevin Coggins Very good questions and I'll try to answer them the best I can. Before I do though, I am not a financial advisor at all so read at your own risk. Here it is and I hope it helps you increase your Financial IQ in some way.
A 50K cash out prior 59 1/2 could cost you 21K in penalties and taxes. I'm not a fan of giving Uncle Sam 21K of the money I saved just because I want to cash out. If you just withdraw some monies from your plan, it is taxed as ordinary income and may be subject to a 10% federal tax penalty if taken prior to 59 1/2.
As far as the loan goes, yes that is an option but you have to pay it back with after tax dollars. If you are in the 25% tax bracket and have a 401K loan, every $100 you borrow cost you $125 when you pay it back. If you are in the 15% tax bracket, it cost you $115 for every $100 you borrow when you pay it back. If you quit, are laid off or fired, you have to repay the loan back within 60 days. If not, the loan is considered a distribution, subjected to income tax and a 10% penalty if the borrow is under 59 1/2.
On the flip side, if you get to 70 1/2 and do not need your RMD you still have to take it or you get to pay the IRS 50% of the RMD for not taking it for that year. For me, it makes more sense to reallocate the monies I was contributing to my 401K to other investments that help me build passive income so I can enjoy the benefits of that money now instead of years from now.
Using the example you gave of investing 5K a year into a 401K. What if you were to take that 5K and use it towards a down payment on a property that has a ROI of 15% and it cash flows $150 a month with a 2% yearly increase. A couple of years later you decide hey, I want to buy more investment property. If you have been saving the $150 every month that your first property is cash flowing, you can use it towards the down payment on another property that generates the same returns. Now back to the first property, say it has appreciated 5K in two years and you have some equity in it. So you decide to do a cash out refi, pull your initial investment of 5K back out of it and use the rest plus the $150 a month you have been saving for the last 24 months as a down payment for another property or properties using leverage. At this point you have no money of your own in either property or properties but you are making passive income off of them every month. The ROI would be infinity since you are using no money of your own. This to me is so much better than a 401K where I have very little control over my money and the returns I get are based on what the market does or does not do for the year.
As @Alice K. wrote, ERISA makes it very difficult for creditors to go after a 401(k) account. With the exception of a few states, the money in your 401(k) account will likely enjoy far greater protection than money in your IRA or your properties. While you should do your own research, I personally think a 401(k) account is one of the best asset-protection tools available to most of us.
Some investors may not have the ability to max out their 401(k) accounts in addition to other investment goals (i.e. real estate, IRA, etc.). In those cases, you may decide that the best option is to not contribute to the maximum limit. But if you have the means to fund several investments each year, I personally cannot see a good reason not to max out your 401(k) contributions.
Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it as legal advice. Always consult with your attorney before you rely on the above information.
A good tech friend just told me the other day: "Gosh, dammit, why aren't you maxing it out the 401(k)?! It's so much less work than property!!! ONE shareholder meeting per year." @Chris K. - Completely agree with your reply and glad to know I wasn't just making things up!
I laughed, he had a point, particularly because he enjoys spending his free time not doing things that we here on BP like to do...
Property is something one has to be (or should be) "into". I feel like the bulk of normal citizens are better off with stocks (since normal people like to play video games, watch TV, etc...)
How much control and influence do you want to have over the way your money is invested?
@Kevin Coggins Very good questions and I'll try to answer them the best I can. Before I do though, I am not a financial advisor at all so read at your own risk. Here it is and I hope it helps you increase your Financial IQ in some way.
A 50K cash out prior 59 1/2 could cost you 21K in penalties and taxes. I'm not a fan of giving Uncle Sam 21K of the money I saved just because I want to cash out. If you just withdraw some monies from your plan, it is taxed as ordinary income and may be subject to a 10% federal tax penalty if taken prior to 59 1/2.
As far as the loan goes, yes that is an option but you have to pay it back with after tax dollars. If you are in the 25% tax bracket and have a 401K loan, every $100 you borrow cost you $125 when you pay it back. If you are in the 15% tax bracket, it cost you $115 for every $100 you borrow when you pay it back. If you quit, are laid off or fired, you have to repay the loan back within 60 days. If not, the loan is considered a distribution, subjected to income tax and a 10% penalty if the borrow is under 59 1/2.
On the flip side, if you get to 70 1/2 and do not need your RMD you still have to take it or you get to pay the IRS 50% of the RMD for not taking it for that year. For me, it makes more sense to reallocate the monies I was contributing to my 401K to other investments that help me build passive income so I can enjoy the benefits of that money now instead of years from now.
Using the example you gave of investing 5K a year into a 401K. What if you were to take that 5K and use it towards a down payment on a property that has a ROI of 15% and it cash flows $150 a month with a 2% yearly increase. A couple of years later you decide hey, I want to buy more investment property. If you have been saving the $150 every month that your first property is cash flowing, you can use it towards the down payment on another property that generates the same returns. Now back to the first property, say it has appreciated 5K in two years and you have some equity in it. So you decide to do a cash out refi, pull your initial investment of 5K back out of it and use the rest plus the $150 a month you have been saving for the last 24 months as a down payment for another property or properties using leverage. At this point you have no money of your own in either property or properties but you are making passive income off of them every month. The ROI would be infinity since you are using no money of your own. This to me is so much better than a 401K where I have very little control over my money and the returns I get are based on what the market does or does not do for the year.
But you can withdraw your money from your 401k tomorrow, with penalty, for better profit than that 15% in a year correct? Based on your example with penalties and taxes it's about a 42% penalty for an early withdraw. But if I had 10k and take the 42% penalty (seems high, but I guess depends on your tax bracket), I'd still be at $5,800 with 0 risk, and ready to invest it, while you would be locked into an investment hoping for a 15% return to get $5,750.
As far as borrowing, if every $100 borrowed costs me $125 when paying back, but every $100 gives me a free $100....seems like I'm still significantly ahead with borrowing out of the 401k. So I borrow $200 and it costs me $250 to repay, but I only deposited $100...I'm basically putting in $150 of my own money for $200.