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to this thought process is that the funds are not available until 59.5, and that they are taxed when they are withdrawn.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

@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.

@Scott Trench If I can make 20%+ on my real estate investments and less than half that in a 401k, why would I invest in the 401k? Money now is worth much more than money later. I would rather take the cash now and invest it for 20%+ than wait, even if I'm not taxed...The return will trump the tax free benefit. For these reason, while I was in corporate and put the absolute minimum in my 401k and invested as much as possible in real estate. This is one of the reasons why I retired from corporate America last year.

I'm pro-401k but I'm also pro-real estate investing.

@Scott Trench, You really created a lively discussion with this question. I am a strong proponent of using the gift of tax deferral to grow retirement wealth. Because the contributions you make a 401(k) are pre-tax (or potentially Roth), and because the investment gains are generally not taxed until you take distributions in retirement, the amount of wealth you can acquire is significantly boosted. Think of the tax sheltering in the same way you would leverage on a real estate deal - it supercharges your cash-on-cash returns. The comments about employer matches are spot-on if you work for an employer. Free money is good, period. If you are the employer, and have no employees, a Solo 401(k) is a wonderful tool as well. With a self directed Solo 401(k), you can have the best of both worlds - the ability to set aside income into the plan on a tax deferred or Roth basis as well as the freedom to invest in real estate and achieve the types of superior results we all like to brag about here on the BP forums. Many of my clients have a 401(k) through their employer as well as a Solo 401(k) sponsored by their personal real estate business. They contribute just enough in the employer plan to max out the employer match, and then defer some of the income they receive from flipping houses personally into their own Solo 401(k), thus reducing their tax exposure in that enterprise. The employee contribution limit of $17,000 for investors under age 50 or $23,000 is split across the two plans, but the Solo 401(k) can accept profit sharing contributions independently of what may be occurring in the other plan. The icing on the cake is when they take the tax-sheltered funds in the Solo 401(k) and put those into passive real estate investments such as rentals or notes. I must, however, throw a bit of cold water on comments touting the benefits of taking a loan from your 401(k) or other qualified retirement plan in order to invest in real estate. The factor most folks miss is that you are giving up on the initial savings achieved when you made pre-tax contributions to your 401(k). Sure, you can borrow from the plan without taxes or penalties at a low interest rate, but you are repaying the loan with after-tax dollars. If you are in the 28% tax bracket and borrow $50,000 from your plan, it effectively takes $69,000 of new earnings to repay the note - not including the interest. Most hard-money lenders charge a lot less.

Self direct! Current plan won't let you? Start a business and roll it into a self directed solo 401k.

You can build wealth in pre-tax accounts. About 9,000 U.S. taxpayers have each accumulated at least $5 million in individual retirement accounts. This doesn't include 401(k)'s. which have higher contribution limits and often more employer matching. Google "Mitt Romney IRA" to get a sense of what is possible with a strategic approach. An IRA or 401(k) isn't an investment, but are pre-tax vehicles in which to hold investments, including real estate in some cases. This may be obvious, but some posters are implying that they exclude real estate.

The employer match in a 401(k) makes it extremely compelling. What other investments can give you 100% return on your money immediately? If you don't like the investment options in your 401(k), roll it into a self-directed 401(k) in the future, and then invest in real estate. That's what I've done.

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?

Are you Pro or Against 401(k)?

Jonathan Cope

Professional · Jersey City, NJ · Member since 2014 · 154 posts · 87 votes

11y

@Scott Trench

I am pro 401k.

Long term, dollar cost averaged, deferred tax, S&P 500 index fund investment seems a fine way to build a stream of wealth on the effort of American industry that one can not touch day to day and should worry little about.

Set it and forget it, as I learned from late night TV.

I see it as insurance and likely as a way to estate plan.

I hope not to use more than its required minimum distributions when I am in my 70s.

By then I'll have rolled it in to a Roth IRA, paid the necessary taxes, and set it up as my grandchildren's inheritance.

If the rules are the same then as they are now, they will have a small, annual, tax free, required minimum distribution to take over their lifetime, after my passing, with which to enjoy life and remember their grandparents.

I also agree with @Dawn Anastasi

We are also pro real estate.

We'll invest more time in building our real estate business for sure.

Real estate should be the larger portion of our estate.

But I see no reason to avoid a 401k.

We'll just enjoy both streams of wealth generation.

Thanks for asking the question,

Jonathan

Are you Pro or Against 401(k)?

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