Is Scott Trench Wrong? Retirement Plans vs Real Estate

Is Scott Trench Wrong? Retirement Plans vs Real Estate

Rental Property Investor · Edwardsville, IL · Member since 2017 · 18 posts · 15 votes

I just finished Scott Trench's book "Set for Life" and let me start by saying it is a awesome read and I fully recommend it to anyone and everyone.

In the book Scott bashes on typical retirement plans such as roth IRAs, 401k plans, and etc. and considers them a foolish investment that majority of Americans fall victim to every day. (he does dive into this idea more in the appendix about to take advantage of retirement plans properly and does not bash them completely but this is not the point of this post). 

I want to give two scenarios and get the opinions of others about which way is more effective at reaching financial independence. 

1.) For example, I am 22 years old with a college degree and an above average income of 55k a year (very similar to the income range Scott references in his book). Unlike many of my peers, I worked through college, lived at home, and currently have no debt to my name. My company offers a 100% 401k match that can either be a traditional or roth. The only thing is that if you choose roth 401k then the match will be put into a separate traditional 401k. With the max individual 401k contribution at $18k/year, I could potential put in 18k/yr and match 18k/yr from the company combining to a total savings of 36k/yr. 

I have learned that 401Ks throughout history have returned 8-10% (obviously with some variance and this post isn't to argue this return). From a simple spread sheet and figuring a 8% annual return on a 36k annuity, I would have roughly 773k in 13years which would return 54k per year and would be "financially independent" based on my current salary as this would yield $61,900/yr in interest minus the 10% early withdrawal penalty.

The downfall with this approach is that if I max this plan out then my take home pay is largely cut and hurts my ability to save and invest in real estate (which is my ultimate goal)

2.) Do not contribute to the 401k plan and save 15-20k per year to purchase buy and hold rental properties?

*I am stuck between these two because I understand all of the upsides of real estate investing but I see and immediate 100% return on my 18k/year "investment" with the 401k not including the 8-10% return the market could bring. I would love to hear peoples opinions on these approaches as my plan will start in 2018. I would also love to hear Scott's opinion on this (so fingers crossed that he reads this) as I am a full believer that people in general and especially millennials like myself are very under-educated in the subject of personal finance. 

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Scott TrenchPro Member
Rental Property Investor · Denver, CO · Member since 2014 · 2k+ posts · 6k+ votes
9y

@Kurt K. I wrote a book on how to go from $0 to several hundred thousand dollars in after tax wealth and several thousand dollars in passive income. The book is aimed at people that start in median income jobs with little to no net worth. 

I achieved this exact result. Prior to writing the book. 

Obviously, I intend to perpetually increase my income, keep my expenses low, and continue acquiring rental properties. Yes, the book is an additional income stream. I plan to continue writing, building BiggerPockets and other businesses, and continue to acquire rental properties. 

FYI, I close on my 8th unit at the end of next week. I still have not received a dime from my book launch (royalties paid quarterly), nor used the potential income from the book to help qualify for the property. At the time the book launched, I owned about $800K in real estate, and after this property closes will own about $1.2M in real estate, generating approximately $110K annually in gross rent, and approximately $40,000 in free cash flow (knock off $6,600 if you don't count the market rent that I pay currently to my own business). I have over six figures in liquidity as well. I will absolutely intend to continue my profession of building BiggerPockets, writing about real estate investment and wealth building, and yes, book writing, going forward into the future, so long as there are people that find value in what I produce.

The journey outlined in Set for Life is how to go from a standing start with little to no assets to a position similar to what I am in currently. After that, the journey is up to you. There are far better books for going from a few hundred thousand and a few thousand per month in passive income to millions of dollars in net worth, those are books for people in advanced stages!

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  • Scott TrenchPro Member
    Rental Property Investor · Denver, CO · Member since 2014 · 2k+ posts · 6k+ votes
    9y

    Thanks for the challenge! 

    I think that in this case you outline, that yes, the 401(k) is an excellent choice. You are getting a 100% match, and all but the very best real estate investors are likely to underperform a return of 100% compounding at 8% per year going forward.

    I go on to discuss this in the book, but I absolutely DO believe that most people should take the match with their employer. @Craig Curelop actually did this very strategy that you outline and accumulated over $100,000 in assets in a few years. 

    Once the match is maxed out however, I see little point in continuing to contribute to the 401(k) for a 20 something that is going all-out in the pursuit of early financial freedom, as they will have much more flexibility with after-tax wealth that they can deploy immediately.

    Furthermore, retirement plans and their effectiveness in the pursuit of early financial freedom are all about your INTENT in how you use them. If you go into it with the INTENTION of deploying them toward the pursuit of early financial freedom, then I believe that yes, folks can contribute to them and use them effectively toward the pursuit of early financial freedom as you outline.

  • New York City, NY · Member since 2017 · 17 posts · 20 votes
    9y

    @Cole Hagen take the match, it is guaranteed. After you build the balance of your 401k you can borrow against it to finance a real estate purchase down the line. In listening to recent BP podcast guests it may be beneficial to be on the sidelines at the moment anyway. Always good to have "dry power" aka cash when market cycles turn. My 2 cents. Good luck!

  • Investor · Portland, OR · Member since 2016 · 47 posts · 36 votes
    9y

    You sure its a 100% match?  That is an amazing deal if the case.  Take the match and max out your 401k.  You probably wont get that match forever.  My first job they matched 50%, so i maxed out my 401k, through the years the match amount dropped.  Two decades of work later, i get no match and have dropped my contributions to peanuts...  I did recently take out my first 401k loan to assist in funding my latest deal.  So build it up now while you get that match and borrower from it later. 

  • Guy with Great Hair · Austin, TX · Member since 2013 · 2k+ posts · 4k+ votes
    9y

    Take the match. Everyone should take the match! I assume it's 100% up to 6%, not 100% total. So put in your 6%

    If it's 100% total input (which I'm 99.99% sure doesn't exist anywhere, ever) then yeah, maxing that out makes sense, and the reason it doesn't' exists is because no where on the planet can you earn 100% ROI instantly LOL

    After your 401k match, put the rest in real estate.

  • Rental Property Investor · Malvern, PA · Member since 2016 · 1k+ posts · 936 votes
    9y

    Definitely max the match.  Your 401k funds (principle + earnings) are restricted until you are 55+ (or 59 1/2).  Withdrawing early incurs a 10% penalty.  You can borrow if your plan allows it up to $50k and pay yourself interest.  I did that with some section 506 investments as a high yield proxy for bond investing.

    Diversifying is a good thing. IRA and 401k investments give you exposure to the stock/bond markets and deferred taxes. That will help you if your real estate empire has a bad day. Likewise, real estate is somewhat independent of the stock/bond markets and can offset bears in those markets.

    Good luck!

  • Anthony GaydenPro Member
    Rental Property Investor · Omaha, NE · Member since 2014 · 2k+ posts · 3k+ votes
    9y
    Cole Hagen You are forgetting that you can't touch that 401K money for a very long time. It is stuck there until you hit retirement age. It doesn't matter if you are a millionaire at 35 if you can't touch that money for 30 years. You are at the mercy of some company executives who are making real profit on the money you have stuck in that 401K.
  • Cranford, NJ · Member since 2017 · 7 posts · 10 votes
    9y

    Why don't more people find it a little bit suspicious that the employer match on a 401k seems to be the only place in life where you get money for 'free'?  These qualified retirement plans allow us to defer taxes for a few decades to increase growth, but what will happen when the taxes come due on the back end?  The highest marginal tax rates today are relatively low compared to what we have seen historically, at some points the top rates were over twice what they are today.  When you combine this with ever-increasing deficit spending and the fact that continued inflation will tend to push people into higher income tax brackets, qualified retirement plans become a bit less attractive.  A lot of people are pushing a lot of money into these plans without thinking of who will ultimately be using these funds in the future.  You may find yourself splitting this money 50/50 with the government by the time you reach retirement age.

    Compare this to the inflation hedge provided by buy and hold rental properties.  While so many people are looking for returns in order to not only build wealth, but also to counteract the effects of inflation, anyone holding rental properties can simply increase rents to protect themselves.  Most people would say it's crazy not to take the company match on a 401k, but I think it's crazy to turn that money over to someone else to manage without considering whether it's really safe.  I know I'm in the minority, but I decided to forego the 401k and I have no regrets.

  • Rental Property Investor · Edwardsville, IL · Member since 2017 · 18 posts · 15 votes
    9y

    Thanks everyone for the input. @Alexander Felice & @Scott Radetich yes it is 100% up to the max contribution the government allows (18k). So for each year if I put in 18k they will match 18k. I was caught off guard when I learned about this match and I took this position partly based on this match (among other reasons) as I could have made 5-10k more per year on my salary elsewhere, I did not know of many other companies that offer a plan like this. 

    @Adam Anstatt you make a great point and is one reason why I am debating on putting my 18k into a roth 401k and then the match will be put into a traditional 401k. This way, at least my portion will be tax safe in the distant future if taxes were to get to 50/50 or even worse.

  • Investor · in, MI · Member since 2013 · 226 posts · 102 votes
    9y

    Not that it isn't full of great information but I'm just skeptical of reading "how-to" books by (or rather take advice from) people that "haven't done it" yet.

    No offense to the author but, how do you get "set for life"? You write a book called "set for life", telling people how they should do it.

  • JD MartinBusiness Member
    Moderator
    Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes
    9y
    Originally posted by @Cole Hagen:

    Thanks everyone for the input. @Alexander Felice & @Scott Radetich yes it is 100% up to the max contribution the government allows (18k). So for each year if I put in 18k they will match 18k. I was caught off guard when I learned about this match and I took this position partly based on this match (among other reasons) as I could have made 5-10k more per year on my salary elsewhere, I did not know of many other companies that offer a plan like this. 

    @Adam Anstatt you make a great point and is one reason why I am debating on putting my 18k into a roth 401k and then the match will be put into a traditional 401k. This way, at least my portion will be tax safe in the distant future if taxes were to get to 50/50 or even worse.

     No way can/should you pass up a match that generous. Even if they mismanaged the fund to the tune of 25% annual losses you would be earning a massive annual tax-deferred return on the employer-provided funds. The fund could lose half its value annually and you'd be no worse off than even. That's about as good as you're ever going to get for a guarantee in investments. 

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  • JD MartinBusiness Member
    Moderator
    Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes
    9y
    Originally posted by @Kurt K.:

    Not that it isn't full of great information but I'm just skeptical of reading "how-to" books by (or rather take advice from) people that "haven't done it" yet.

    No offense to the author but, how do you get "set for life"? You write a book called "set for life", telling people how they should do it.

     /gauntlet thrown!

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  • Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes
    9y

    Hmmmmm...so this seems to have either evolved or devolved to the accuracy of a 100% match.  But back to the topic at hand, I'm in the boat of looking at real estate and equities (stocks, bonds, etc.) as different asset classes.  I want both, I want to diversify, and I'm also not looking to live on that income (cash-flow) today.  When retirement comes and that "standard" income drops I can start pulling out that tax-deferred income out (401K) at a lower effective tax rate.  Now, if real estate that I own performs extremely well, I'll still be paying high taxes then.  I *hope* I'm paying high taxes then because that means I'm cash-flowing like a madman and would get taxed on the 401K distributions at a higher marginal rate.  But what if I want to pull money out?  Get more debt to lower my tax burden and get mortgage interest to offset it?  Now I can pull that retirement money out at a lower effective rate (again, post-retirement).  The point I'm making (likely inelegantly) is that I do get diversification from doing it.

    However, so much of this depends on your tax rate today, if you care about diversification, etc.  Would you rather have an effective tax rate of ~45% today or <20% in the future?  Will marginal tax rates change in the future?  What if I retire in Texas instead of California and don't get hit with a state income tax?  Will mortgage interest always be there as a deduction?  Who knows, all you can do is make an educated guess on the tax consequences and implications.  There's no "right" answer in the same way there's no right vs. wrong when it comes to cash-flow vs. appreciation.  o each their own but I that  higher margins.  

  • Investor · Kansas City, MO · Member since 2017 · 791 posts · 1k+ votes
    9y

    THIS IS NOT THE ANSWER FOR EVERYONE:  

    I don't have a dime in retirement or investment accounts.  I would have passed on free money with an employer match if it meant slowing my real estate accumulation.  Here's why:

    What's your target income to be financially free and live the life that optimizes for happiness?  I'm going to assume it is close to the magic number of $85,000 per year (studies show that's the the point where money and happiness cease to have much correlation). 

    There is a general rule of thumb in the investment world that a fairly safe annual withdrawal amount is 4% for indefinite retirement. This is the amount should be able to weather the ups and downs of the market safely provided there isn’t a big downswing right away. That means you need to have 25X your annual spending in an investment account to retire. It doesn’t matter what age you reach that amount at, you’ll be covered. If you are using traditional investing that means you would need $2,125,000 in your investment account to retire.

    That’s a scary number right? How on earth do you get to $2,125,000?! If you adjust the S&P 500 for inflation and dividends the historical average is a 7% return. Let’s assume you are starting from zero. If you can put $2,000 per month, every month, away into index funds in a tax-deffered retirement account, it will take 29 years to reach that goal. So at $24,000 per year invested and it would still take 29 years! What if you want to get there in the same ten years that I believe anyone can with investment real estate? You would have to invest $12,500 PER MONTH!! That’s $150,000 PER YEAR for a total of $1,500,000 of your own money invested. 

    THE MAGIC NUMBER WITH RENTAL PROPERTIES

    The interesting thing about the $85,000 per year number is that was almost the exact number my wife and I came up with when we budgeted for our ideal life. My wife and I took the time to reflect and think about the life we would want to live if we were financially free. We figured out the life that would provide us the most happiness and fulfillment. Then we calculated what that would cost per year it was almost exactly the magic number of $85,000 per year. We made it in UNDER SEVEN YEARS. 

    If we wanted to achieve financial freedom using the 25X rule, we would have had to invest $20,000 PER MONTH, $240,000 per year for a total of $1,680,000 of our own money.  What did it take us? About $150,000.

    So yes, I personally would choose to give up on the free money from the employer match on the 401k. I could make far superior returns with half the money in real estate. 

  • Investor · Denver, CO · Member since 2016 · 736 posts · 582 votes
    9y

    I have no match to my 401(k).  In my instance, it makes little sense to contribute.

    My research suggests buy and hold real estate appreciation averages 3% per year - very small and about matches inflation.  The power in real estate though is forcing appreciation by buying very low up front, fixing up the property, and then holding (or selling after two years for tax advantages).

    I'm not big on leverage - makes no sense at my age (I am much closer to retirement than you are)...but at your age and at Scott's age, it makes a bit more sense to leverage into multiple income producing properties in order to have that equity later in life.

    If I were you, at your age, I would max out 100% on the ROTH, allow for the 100% match in a Traditional, and then diversify between large cap stocks, small cap stocks, corporate bonds, international stocks, and some cash (CD's & Money Market type funds).

  • Scott TrenchPro Member
    Rental Property Investor · Denver, CO · Member since 2014 · 2k+ posts · 6k+ votes
    9y

    @Kurt K. I wrote a book on how to go from $0 to several hundred thousand dollars in after tax wealth and several thousand dollars in passive income. The book is aimed at people that start in median income jobs with little to no net worth. 

    I achieved this exact result. Prior to writing the book. 

    Obviously, I intend to perpetually increase my income, keep my expenses low, and continue acquiring rental properties. Yes, the book is an additional income stream. I plan to continue writing, building BiggerPockets and other businesses, and continue to acquire rental properties. 

    FYI, I close on my 8th unit at the end of next week. I still have not received a dime from my book launch (royalties paid quarterly), nor used the potential income from the book to help qualify for the property. At the time the book launched, I owned about $800K in real estate, and after this property closes will own about $1.2M in real estate, generating approximately $110K annually in gross rent, and approximately $40,000 in free cash flow (knock off $6,600 if you don't count the market rent that I pay currently to my own business). I have over six figures in liquidity as well. I will absolutely intend to continue my profession of building BiggerPockets, writing about real estate investment and wealth building, and yes, book writing, going forward into the future, so long as there are people that find value in what I produce.

    The journey outlined in Set for Life is how to go from a standing start with little to no assets to a position similar to what I am in currently. After that, the journey is up to you. There are far better books for going from a few hundred thousand and a few thousand per month in passive income to millions of dollars in net worth, those are books for people in advanced stages!

  • Investor · Denver, CO · Member since 2016 · 736 posts · 582 votes
    9y
    Originally posted by @Anthony Gayden:

    Cole Hagen

    You are forgetting that you can't touch that 401K money for a very long time. It is stuck there until you hit retirement age.

    It doesn't matter if you are a millionaire at 35 if you can't touch that money for 30 years.

    You are at the mercy of some company executives who are making real profit on the money you have stuck in that 401K.

    This is not true - talk to a financial adviser.  You can withdraw amounts from your traditional retirement plans prior to "retirement age" as long as they are "Substantially Equal Periodic Payments" - the rule is under IRS §72(t)(1).  You will need to pay income tax at your regular rate for these withdrawals.  Under a ROTH, you can withdraw following the "5 year rule".  It's not locked in for 30 years.

    Worst case scenario is you pay a 10% penalty on the withdrawals and (in the case of a traditional IRA/401(k)) you pay income tax on the transaction.

    The other alternative is once leaving the company, moving that money into a "Self Directed IRA" and using that money to invest in real estate (no company executives making a profit - just you)

  • Craig CurelopBusiness Member
    Real Estate Agent · Post Falls, ID · Member since 2016 · 1k+ posts · 1k+ votes
    9y

    @Cole Hagen - Two years ago, I was in almost the same exact predicament. Scott has it exactly right. If the Company is offering you a match, take it... it's free money! There are ways to leverage your 401k to gain access to that capital sooner rather than later. For example, you can take a loan out for up to 50% of it, which is essentially the capital you put in initially. 

    I do want to caution you that there few companies remaining that match the 401k. While you are lucky enough to be at one of those companies now, assuming you will both be at this job for 13+ years AND assuming they will continue to offer the match for this period of time is aggressive. 

  • Mark S.Pro Member
    Rental Property Investor · KY · Member since 2013 · 1k+ posts · 538 votes
    9y
    I'm shocked that they'll match 100% on the full $18,000. That's unheard of and, if true, likely won't be for long. Definitely take advantage of that.
  • Los Angeles, CA · Member since 2013 · 19 posts · 13 votes
    9y

    @Cole Hagen I'd just like to echo what others are saying... take the 100% match and max out for as long as they will match. 36K total towards your 401K will provide serious accumulation and compound growth given your young age of 22. Consider it your buy and hold strategy for equities/bonds.

    The argument of unknown future tax rates will be mitigated since you will have both a Roth 401k and trad 401k. When it's time to withdraw, and say you are at a very high income tax rate, you can withdraw from your Roth first which will be completely tax free. 

    So for your Roth only, if you maxed out at 18k for the next 38 years (until you are 59 1/2) at 8% returns, you'd have 4.1M tax free. The extra few million from your match in your trad 401K will be gravy and continue to exponentially compound... 

    I only get a measely 1.25% match through my employer lol

  • NYC, NY · Member since 2016 · 619 posts · 456 votes
    9y

    Many have said it.  

    Take the match.  Take it all.  And make sure you know your company's vesting requirements. But never leave company $ on the table.

    Also take advantage of your youth. There's nothing better than having time on your side. 

    If you fund in full for 5 yrs, the company matches in full for 5 yrs and you earn avg 6%, you'll have at least 220k at the end of 5 yrs.  If you don't add another dime, continue to earn 6%/yr you'll have $2m when you're 65 + whatever you create/save from yr 6 on. If you earn 7%, you'd have $3m.

    You're in an enviable position. Wish I'd known then what I know now.

  • Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    9y
    Personally I really like using a Roth IRA and a 401k contribution up to the match. For those funds I invest in low cost index funds through betterment. It's passive, it's simple and so far has worked well. Even if I can't touch that money for a long time, that's okay, as I still have enough money to invest in real estate. I'm only 23, so this money will be compounding for a very long time. I think having some exposure to real estate and the stock market is good for diversity reasons, but that is just my opinion.
  • Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
    9y
    Originally posted by @Anthony Gayden:

    Cole Hagen

    You are forgetting that you can't touch that 401K money for a very long time. It is stuck there until you hit retirement age.

    It doesn't matter if you are a millionaire at 35 if you can't touch that money for 30 years.

    You are at the mercy of some company executives who are making real profit on the money you have stuck in that 401K.

    There are methods where you could get to it prior to retirement. For example, if you retire early, you could institute a roth conversion ladder such that it is not taxed going in, not taxed coming out, AND you can tap the principal prior to retirement age without penalty. Add in free money from a company match, and that is about as close to a no brainer as you will find in personal finance IMO.

  • Investor · United States · Member since 2015 · 415 posts · 487 votes
    9y
    A 10% early withdrawal penalty isn't that bad. Is it possible to get the match, and then just pull it out the next year and use it for real estate? Then you would basically get an 80% match but have the money freed up.
  • Rental Property Investor · Edwardsville, IL · Member since 2017 · 18 posts · 15 votes
    9y

    Thanks everyone for the great advice. I like the idea of mitigating the risk of taxes by investing half in the roth and half in traditional @Kevin Nguyen. I fully plan to max the 401k out and have for a while but wanted to get others opinions. The early withdraw penalty of 10% isn't too bad if I factor that into my "freedom number" and if I wanted to retire earlier than 59 1/2 to pursue more advantageous  ventures then I can. I still fully plan to save as much as possible and invest in buy and holds. I am currently on the market for my first home to house hack. I am hoping that by doing this it will allow me to save enough to snowball into 1 per year for the near future (5-10 years). Depending on how this time period goes, my strategy may change. 

    I am also very interested in the many ways of borrowing from retirement funds in order to invest in real estate and the strategies for minimizing tax loss when early withdrawing if anyone has any options on this? 

  • Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
    9y

    @Cole Hagen

    I don't think that its a question of either or. It s an individual decision but I would take the match, I look at it as free money. Secondly, if you leave that employer you can always convert it including the free money into an IRA.

    Once in the IRA, it can be converted to a Roth IRA or kept in Traditional IRA but converted to a SDIRA. Then the SDIRA can be invested in real estate, and if a Roth SDIRA all income and capital gains would be TAX FREE forever.

    And if you really want to go crazy and be able to shelter money money, more income and more capital gains then there is the possibility of a SOLO 401K, which can be Roth or Traditional or both.

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