Reduce 401K Contributions and Redirect to REI?

Question

Good afternoon.

Just wanted to get some opinions regarding raising additional capital for REI.  I'm pretty new to the whole REI adventure, been here on Bigger pockets for 3-4 months and learned a lot.

My biggest barrier, is raising capital to dive in and give this a real shot.  I'm trying to boost my savings so I can get in the game quicker, when I came up with the idea of redirecting some of the funds I allocate to my 401K towards REI.

Admittedly, the stock market craziness is what got me thinking, but in addition to that my employer matches up to 5% and I'm putting in 10%. I thought I would keep investing the 5%into my 401K, but redirect the additional 5% to an investment account where I can save for a potential down payment on an investment property.

I understand there are ways to invest with little or no money down, and yes I have read Brandon's book.  However,if I were able to do that, it's still vital to have a reserve fund for repairs, unexpected fixes, etc.

Interested if others have gone this route, or can share what roads they took to raise capital for their investment properties.

Thank you,

Claudio

Edward B. · Answer

@Claudio Golia,

There are definitely people who will disagree with me here so you are going to need to do the research and ultimately figure out what is best for you.

Personally, I max all of my retirement and tax advantaged accounts first. The main reason for this is that you are restricted to how much you can put into these investment vehicles each year. So if you get a financial windfall (inheritance, killer investment, win the lottery, etc.) you can always pay off debt or dump into an investment, but you can't make up contributions to your tax advantaged accounts that you didn't make in previous years. Taxes are likely to be your single greatest expense throughout your lifetime so anything you can do to minimize them is to your advantage.

After that, look to ways to take advantage of those accounts. Explore the possibilities of a self directed IRA. Look into opportunities to take out loans against your 401k. Your 401k may have a program to take loans against it (a la the TSP mentioned above), but if not it is a liquid asset that some lenders will accept as collateral for a loan.

These questions have been asked before and I saw a guy celebrating cashing out his 401k, paying the taxes and penalties, and now making a killing in real estate. Two problems with that. One, if this was 2007 he may seriously...seriously, regret having done that in a year or so. Two, if he had transferred that money to a SD IRA and figured out how to do his investing there, he could be making all that money tax free. Instead, he reduced his investable capital by paying the taxes and penalties, and the better he does, the more he pays in taxes. That takes a huge chunk out of his reinvestable income.

There are circumstances where it makes sense not to maximize these accounts but I would explore every other possibility first. Tax advantaged accounts are hard to beat when compounded over a lifetime.

Claudio Golia · Answer

@Steve Katuska Everything you point out is valid and my contributions to my retirement accounts between my 401K and Roth would still total just about 10%.  I try to keep my contributions around that number if not more.

My preference would not be to cut my 401 K contributions at all, but being I'm still at about 10% I can live with it. Especially if the cash I'm diverting will be aiding in building capital for an investment property.

In addition to the above, I am making changes to my spending and have begun managing my finances under a microscope. There are savings to be made there, so any cuts in my 401K may not have to be as much as previously mentioned.

It's not that I'm missing out, I haven't even really begun making legitimate offers on any properties, because I want to have that capital for a down payment.  Alternatively, if I did employ a creative financing technique, I would still need a cash reserve of some sort starting out to handle the unexpected.

Appreciate the feedback.

Steve Katuska · Answer

I think you're right to definitely not lower past the point of employer match - that's free money that you really have to capitalize on! As for the additional contributions above that, I personally think that 10% is a reasonable contribution, and will be nice to have that asset growing tax-free inside that account for years to come. That said, if you're finding that there are great deals that you're only missing out on because of lack of available capital, then diverting might be a good way to go, but I would personally try to maintain that 10% as a minimum and more slowly build up that capital (see what other areas of your spending can be cut / trimmed?), as well as try to employ creative financing techniques, rather than cut contributions to what is a very valuable account.

Peter Dascoulias II · Answer

I found a property I wanted to buy and took a TSP loan (Federal 401K)  for $40,000 for the down payment.  The loan repayment come's right out of my check.  I don't regret it at all!  The ROI is much better from the rental than it would have been in stocks.

Mark Nolan · Answer

@Claudio Golia

I think your plan of reducing the 401k contributions to a percentage where you will still get the full match from the employer makes sense because obviously your employer won't allow you to invest your 401k in real estate.

Reduce 401K Contributions and Redirect to REI?

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