Are you Pro or Against 401(k)?

197 Replies

A recent article that I wrote on the BP blog received some criticism because I suggest that a 401(k) is one of the best ways to increase your net worth.

This strategy was criticized by a couple of readers and I thought I'd move the debate over here.  So here's my argument:

A 401(k) allows you to invest and grow your net worth tax free.  It reduces tax liability now, enabling you to have a huge portfolio to invest that will achieve outstanding returns for the lifetime of the account.  In my opinion, this is absolutely critical and its a real shame that someone would forgo the opportunity to take advantage of this tool.

The main counterpoint to this thought process is that the funds are not available until 59.5, and that they are taxed when they are withdrawn.  

What do you think?  Would you rather build up a ton of net worth through the 401(k) or have less assets to manage, but make them usable sooner?

I vote for the 401(k) and increasing my total assets under my name as much and as rapidly as possible.

I'm pro 401(k) when there is an employee match on offer.  No one who has an employee match through their employer should ever contribute less than that which is required to get the match; that is just giving away money.

As for the tax deferral question, I am personally more in favor of the Roth approach.  Yes, my tax bracket is higher now than it will be after retirement.  But I have no confidence that our current (pretty reasonable) brackets will still be in place in 25 years.  To take advantage of a tool that eliminates future tax liability entirely strikes me as a very, very good bet.

More broadly, I have noticed that BiggerPockets is full of fanatics.  Diversification is almost a foreign concept here, and there are quite a few people who will tell you that putting money into anything but real estate is foolish.  I think some of those people are very, very sophisticated real estate investors who do this full-time and with great success, and that most if not all of the rest are fools.

 I personally plan on working productively and earning a high income until after 59, and living WELL PAST 59, so the withdrawal issue is fine with me.

Mainly due to the employer match, I am a fan of the 401k.  My wife and I both contribute....previously 15% of salary with each employer adding 6% but about a year ago I reduced our contribution to 6% each (min amount to get the full employer match).  Tax free growth is fine, but the limited choices and higher expense ratio of the 401K has made me favor it less.  It was about this time also, that we decided to get more aggressive with our real estate investing. 

We both still max out our Roth IRA each year but have no plans to contribute anything more to the 401K unless our employers up their matching requirements. I would rather put additional income into real estate which is fairly tax friendly to buy and hold investors like us.

If you stick everything in a 401K, you almost have to wait until you are done working to access any of it.  If you get enough income producing real estate, you can replace your paycheck and still have some invested funds waiting for you when you are able to access the funds without penalty.

Most people on this forum will tell you to avoid the 401K because it definitely sucks up capital that could be used for REI.

That said, for the average person who is not involved in RE or who wants to maintain a balanced asset allocation and be involved in equities/fixed income, a 401K is a no-brainer, particularly if you get employer-matching which is literally free money.

Moreover, if you are interested in retiring early, you can always do a 72t to get your income a lot sooner and penalty-free. You can also use IRAs to invest in real estate.

If you are completely focused on real estate, and if your employer offers no match, the 401k is less attractive.

I work a corporate job and have taken advantage of employer matches for 16 years. It definitely adds up. I also never understood why people don't contribute to a 401k that offers matches. I also agree with you that it reduces your tax liability.
When I started out, I played with the contribution numbers and saw what my paycheck would be like with and without my contribution. It became a no brainer to me to contribute.

Now, I also want to invest more in real estate and I have all this money in my retirement accounts and it would be nice to be able to get access to that cash in a way that does not cause a big tax hit. The concept of buying and holding in a SDIRA might not make sense for me either. 401k's have other downsides. There are not great investment options(I don't like mutual funds), most employers screw you on fees, and there are proposals floating out there that 401k's over $3 million dollars get taxed in some way over and above 401k's under that number. I think a person should do both if possible because investors need to be diversified. It also depends on your style. Real estate is more hands on and allows for more leverage. Also, after 2008, aren't most stock investors institutional investors? I don't know if most people trust the stock market.

Its foolish not to have a diversified portfolio that includes stocks, bonds, RE,  ?gold, and cash.  It's sad that people don't trust the stock market, or RE for that matter.  Neither market is fixed or rigged,they are just cyclical.  If you see the dips in markets (stock or RE) as buying opportunities then you will be ahead of the game when it's time to cash out and retire.  

Another item is that the stock market has historically beat inflation while real estate appreciates at inflation. Maybe this does not matter if you flip or buy at extreme discounts. I think you need to do both.

My feelings are much the same as @chris simmons.

If you have a full time job and your employer provides a 401(k) company match, then at a minimum you should be contributing enough to get that employer match. To avoid fees and in an attempt to preserve your capital the smartest move is to invest your 401(k) money in index funds, unless you have the knowledge and risk tolerance to make better choices inside your 401(k) plan.

Too often the choices available in 401(k) plans are really bad and if you are not careful you can do poorly with that investment.

That was the case for me. I had several 401(k) plans with past employers that I just let sit in their plan because I was lazy. It ended up costing me some growth. Recently I rolled over all those old plans into a self-directed IRA at Charles Schwab and now my returns are much healthier and the fees have dropped as well. I still have some "rogue" IRA's that I will consolidate into another self-directed IRA for REI purposes.

Investing is a state of mind and each person has their own level of risk and ideas as to what is a good and bad investment. Diversification is not as rosy as Wall Street people would have you believe. It is better than nothing, but if you have the tools and education you can target your investments. One of the best books I ever read was One Up On Wall Street by Peter Lynch.

Investing in REI is also challenging and rewarding. It does not have to be an all or nothing proposition.

Good luck to all!

I agree with  @Richard C. about using the Roth part of a 401k.

Secondly, since you can invest in what you want with a solo 401k it is silly for any REI to not use this tool. It is easy to meet the requirements of having a solo 401k. Self employed, and the only employee. Most investors can do that easily. And if you have any standard IRA, or 401k accounts not from a current employer you can transfer the funds. Unfortunately, for some odd reason you can't transfer Roth IRA funds to a 401k.

That does not necessarily mean a Solo 401k should be used for purchasing rentals, or flips, but it does mean you have control over what investments it is used for, such as notes.

I'm pro 401k, because of the employee match which is 6.75%, but it isn't my favorite investment due to the fact that I have less control over the outcome and the fees are generally high. I prefer Roth IRA, because the expense ratios are under .05% and my index funds have generated 18.7% in the past six years and average 11% over the past 15. I also love the idea that I just contribute money and do nothing at all and it's tax free at withdrawl time. I also love REI and have a duplex that is rented with tenants and cash flowing me $400 a month, but the one thing about REI is that it requires a ton of upkeep and if suddenly there is a major problem that you didn't expect or a roof that needs replacing it eats into your return more then any other investment.

@Walt Payne  

I am 100% in agreement with your post. One point you make is that most investors can easily have a solo 401(k), and that this money can be transferred from an employer 401(k). This is huge. It means that you can save big on taxes during a working career, and still employ funds when you decide to go out as a full time REI!

It's the fastest way, in my opinion, to build a sizable portfolio to begin an REI career!

@Richard C.  

Thanks for the comments! With regards to the Roth IRA, I personally think that the math works out better for most Americans with the 401(k) contributions first. It's the difference between a dollar towards net worth now, vs a dollar later. The 401(k) immediately reduces your tax bill.

That said, a Roth is also a great way to invest, I've just personally prioritized the 401(k)  because my goal is to rapidly accumulate as much net worth as possible today.

I'm pro-401(k), but it's not an "either/or" proposition for me as you stated in your post.  I'm actively putting money into my 401(k), but I'm also growing my liquid assets so that they're available for other investment vehicles (like real estate investing). From a tax advantage stand point, 401(k)s are great vehicles to stash some of your net worth.  

Sound financial planning is all about diversification (or, in other words, don't put all of your eggs into one basket.)

@Scott Trench  I think this is great topic for a discussion! 

The beneficial facts of the employer contributions have been addressed above I just have to add that in my opinion it would be just foolish to give that up. This is free money! I am convinced that it would be the best choice for most people to maximize 401k contributions up to the limit of the employer match.

Example: If the employer matches 50% up to 6% of your salary and that is equivalent to $5,000, then the employer contribution portion is $2,500. That is guaranteed 50% return on your money!

Next, you can grow your wealth in the tax-deferred environment! That is the key and main difference versus investing under your own name. Now, since rental real estate offers tax-benefits (depreciation) which can't be used in an IRA or 401k, it might be best to own real estate in your name and use those tax benefits, while tax-deferred accounts can be used to invest in other assets such as trust deeds, private lending, hard money loans, etc. Would you rather be taxed every year and loose the investment power of your dollars or defer the taxes for a future date? By deferring taxes you have the ability to grow your wealth much quicker!

And lastly it’s Roth 401k. It allows you to pay taxes one time now and then invest tax-free forever! Who can give me any arguments why I should not invest in the tax-free environment??? 

@Scott Trench   You are thinking like the typical investment adviser wants you to think. That you will be in a lower tax bracket when you retire. Consider what that implies. That is because they use the stock market as a vehicle, and they know how poor it performs overall. And they know how undisciplined the average American is about saving and investing. They also know that on average, we don't save or invest until we are in high tax brackets. Do it sooner, at a younger age, and Roth makes even more sense because your tax rate will only climb.

Do you want to have more, or less income when you retire? I am almost there, and trying hard to make sure my income far exceeds current. I want to do things, go places, enjoy life when I retire. And, considering the cost of health care, I want to be able to afford quality medical care. I am shooting for DOUBLE my current income, not less! And I want that to still have growth so that the real value never goes down.

Now to answer those who say that the funds are locked in until 60 and that is disadvantage.

If you are not planning on living past 60 years old than retirement account might not be for you. But if you think you will live past your 60-th anniversary, then you will need funds to live on at that time (unless you think that social security will be there for you and it will be enough for you to live on comfortably).

No one is saying that you should take every spare penny and put that into tax-deferred account. If you have some financial goals that need to be accomplished prior to age 60 – then don’t use tax-deferred accounts for those goals. It’s quite simple.

It is prudent practice to set some of your earnings aside for the future. The wise man once said:

“The wise man saves for the future, but the foolish man spends whatever he gets.” Proverbs 21:20

Government gives us these benefits and it would wise to use them to the extent we can, applying skills and knowledge we have. That is where self-directed IRA or 401k plays very good role.

My preference is contribute 100% of the employer match to your 401k. Choose an investment vehicle fit to your risk tolerance. If you don't have access to a low fee index fund then target funds are the way to go. If you leave the job you are at then roll over to self-directed IRA or traditional IRA. Make sure these accounts have access to the broad stock market so you can at this point choose a low fee index fund like a Vanguard S&P 500.
I work for a company which reports institutional investors portfolios. They all took a hit during the financial crisis in 2008 but now have made up their losses and much more. We are in a secular bull market which can go much higher. We will have another major dip at some point in the future but as you continue to contribute while the market is low you will make up losses and more.
If you are nearing retirement then you should choose a risk free investment vehicle like government or municipal bonds.
Real Estate is a great way to build wealth and I am excited to continue to build my portfolio, but if your employer is willing to give you free money, I don't see how you can turn that down.

There seems to be two points of contention here.  

1) The all or nothing idea. Personally, I won't ever put everything into anything. My 401k will remain invested in those asset classes. There will never be a self directed IRA for more real estate. Won't happen.

2) Roth vs traditional IRA/401k. Like everyone else, I can only speculate about future tax policy and my eventual tax bracket relative to where it is today. But, by sacrificing a small tax break today, I can get not only the ability to earn tax free income in the future, I can access my capital contributions whenever I need to without asking permission or paying any penalties. People talk all the time about asset protection from creditors, lawsuits etc. This does that. I can lock my money away safely where no judgment can attach to it, access better, cheaper investments thang 401k and still access my capital contributions before 59.5 years without so much as asking permission.

For that, I will go with the max Roth every year before I put another dime in my 401k. 

If I were a W2 employee for another company, I'd be pro 401k to defer the taxes.

If I were young enough and/or in a low enough tax bracket, I'd be pro a Roth 401k.

I've been self-employed for over 30 years and am pro sheltering over $100k per year for my wife and I in an SD 401k. If I made less, I'd be pro sheltering whatever I could.

The closer you are to retirement, having watched your money grow tax free or tax deferred for several decades, the more pro 401k you will become. Don't believe me? Just wait a few decades.  It comes sooner than you think. I know many educated professionals who chose not to go this route, wonder where the money went, and now how they will retire.

Simple time value of money calculations show how fast money grows when the government doesn't take 20% to 40% of it along the way, and no I am not naïve enough to think that I will be in a lower tax bracket anytime soon after I retire. What is retirement anyway?

We will continue to have investments until our last days. Nothing prevents us from investing in real estate or any other permissible vehicle in or out of our plans.

I don't understand the controversy. In my view, the real question is why are you working for anyone but yourself?

I have never had the luxury of having a 401K, as a federal employee we have a Thrift Savings Plan (TSP) with no fund matching. I would think that the fund matching from an employer would be seen as free money, sure it is just a percentage but anything is better than nothing (I know about the nothing). Even though I have never had a 401K I think I would contribute up to what my employer would match. Seems to me like a little savings account that even though I can't really access will be there when I retire.

It depends where you are in tax brackets and life in general. Also depends on what you would do with that money otherwise.  I would say at least the employer match limit everyone who can afford to put the money in should and if you get used to putting it in you don't miss it.  Personally I max it out because it is the only tax advantage we have and even then with small companies your 401k contribution is sometimes limited. That being said if you leave a company roll it over to something private the choices are better.  Where do such big companies get such lousy investment choices for their employees? Makes you wonder how they ever became successful.

I don't put all my eggs in one basket,  diversify. I consider a 401k one arm of my investment strategy, real estate another, personal saving a third. Am I always going to have the energy for tenants, maybe not, and certainly RE is not very liquid but the 401k is like cash in the bank and everyone needs some of that.  And yes you will pay tax on it one day but frankly I am resolved to the fact that we are turning into something worse then Europe in the tax department and we are  just going to have to live with that.

From the traditional view-point of a 401(k) where one invests his/her money mostly in stocks and mutual funds - it ain't for me.  I spent several years working in big-corporate-world (sometimes called cubicle-world) and I was able to see first-hand about how stupidly most of these big companies are run.  So, I choose not to invest my money in them.  Besides, the stock market has been said to average about 13% a year over the long term, and I think that I can make more money on my own in real estate.  But, to each his own.

I am pro-401k, as I have one. When applying for loans, the lenders like to see a healthy balance and it helps me get approved just because I have it. Not because I dip into it. That being said, I don't agree that "one of the best ways to increase your net worth". I am pro-REI more than I am pro-401k.

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