Max out Roth or save for real estate?

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Max out Roth or save for real estate?

Tyler Hogan
Rental Property Investor · Austin, TX · Member since 2016 · 18 posts · 14 votes

Hi guys, I wanted to get some outside opinions on something I’ve been thinking a lot about over the past year or so. 

I have a goal of reaching financial independence by 30. I am 25 years old, married, have a mortgage on my home and a heloc that I used to invest in an apartment syndication. Currently in the 24% tax bracket.

My father has always told me “max out your roth no matter what!”. I’ve been doing this and I realize the long term potential, however I feel like contributing $12,000/year slowing me down in the short term. I'm currently maxing out my roth and focusing on paying down the heloc with any other money I can come up with. If I stopped maxing out my roth I would pay the heloc off in less than a year and continue saving until I found a good rental property to purchase using my heloc and any additional cash I've saved. My thoughts are that if I repeat this process over the next few years it could expedite my journey to FI.

In short, should I continue maxing out my Roth or should I pause for a few years to pursue more real estate investments?

Thanks in advance.

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Cassi Justiz
Rental Property Investor · Edmond, OK · Member since 2017 · 1k+ posts · 1k+ votes
7y

If you haven't read @Scott Trench's book Set for Life it may be a good place to start. He has some solid advice. I am not personally putting money into any retirement accounts right now. All extra money is getting pumped into real estate. Once we have built up enough passive income from real estate to feel comfortable without W2 income, then we will re-evaluate the strategy. 

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  • Account Closed
    Rental Property Investor · Jacksonville, Florida Area · Member since 2016 · 106 posts · 48 votes
    7y
    @Tyler Hogan I see Investing in a Roth is as a win or loss. Investing in real estate, is a win or LEARN, in my opinion, because we have more control over the investment. I personally try to contribute as much as I can to my 401k & Roth, but I do reduce or increase my contribution levels, depending on my goals and market conditions. This makes due diligence that much more important to me, when deciding to pull the trigger on a real estate investment. Both investments are very important, and I would try to balance the two. I'm not sure how much higher the stock market will go from here, and I keep hearing that we are long overdue for a correction.
    1Reply
  • John MorganPro Member
    Rental Property Investor · Grand Prairie, TX · Member since 2018 · 2k+ posts · 2k+ votes
    7y

    @Tyler Hogan

    That is correct. Once you pull out the money you’ve put into it over the years, you can’t put it back. You can still put in the max per year if your income isn’t too high. And I think you might need to have a Roth for at least 5 years to be able to pull money out like this tax free so double check on that. 

    Here’s why I did this. I knew it would take a few years to build up enough money to use it for a big purchase in real estate. So I was patient and would rather have my money work for me and grow tax free while I waited. I bought and sold several stocks and built up a nice nest egg in our Roths. I put in a total of 92k over the years and it grew to 320k. I also wanted it for emergency money in case something happened and I needed money right away without any tax hits. You never know if something like that comes up! So I didn’t have much of a personal savings account for emergencies earning only 1% in a taxable savings account  I let my money multiply in our Roths buying stocks instead.

    I pulled out 62k for my first real estate investment four years ago tax free and it took only two or three days to be wired into my bank account. This helped me get started in real estate. Making a cash purchase for your first property gives you a lot of options. Then it snow balls from there.

    I’m up to 6 SFRs now generating 3k/month in passive income. Some people may argue and say never touch your retirement investments until you retire. I disagree. As long as you have a 401k or something else other than real estate, you’ll be fine as far as diversification. And our Roth’s still have about 300k in them today (from our original 92k that we put in over the years minus the 62k we pulled out) which is better than nothing. We haven’t been able to contribute to them in five years due to income level being too high. But I’m guessing it’ll be worth 1.5 million tax free when I retire, so it’ll still help in retirement when that happens. 

    5Reply
  • Tyler Hogan
    OP
    Rental Property Investor · Austin, TX · Member since 2016 · 18 posts · 14 votes
    7y

    @John Morgan thanks for sharing, I like this method. It sounds like you chose some great stocks and had great timing to get such a big ROI on $92k invested. I probably wouldn't be so lucky haha

    0Reply
  • Mark Welp
    Investor/Agent/CPA · Columbus, OH · Member since 2015 · 249 posts · 207 votes
    7y
    @Tyler Hogan This is all personal preference, but if one wants to buy RE or follow the FIRE movement, then why store money in tax qualified plans? If one wants to work a corporate job forever, then qualified plans make sense. All depends on your goals. Look into high cash value life insurance, borrow against it to buy income producing assets. Not the best idea to put rental property in a SDIRA; they are tax shelters by themselves, especially with the new tax law. Thanks!
    2Reply
  • Anthony Wick
    Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes
    7y

    @Tyler Hogan

    I can only tell you what I’ve done, and what I do now. I max out my 401k from day job ($19k in 2019). And I invest in real estate and a Vanguard brokerage account. I use the brokerage account for investments until I find a real estate purchase. I stopped doing a Roth in 2018 because I realized that I’m not waiting until 59 1/2 to retire. It’s not a plan for everybody, but since the stock market took a down turn, it’s working for me at the present.

    0Reply
  • Alvin Johnson
    Flipper/Rehabber · Phoenix, AZ · Member since 2018 · 3 posts · 0 votes
    7y
    @Tyler Hogan Is there any possible way you can increase your income and invest in both? The top successful people in the world have 7 income flows on average. If you can educate and familiarize yourself with 2 income flow simultaneously you will be farther ahead when everything does come together...
    0Reply
  • John Nachtigall
    Santa Rosa, CA · Member since 2017 · 325 posts · 701 votes
    7y

    Honestly this is just a math problem.   It is not really about opinion.   I think it is very hard to beat the tax advantaged returns of a 401k.   In my case, I have a traditional, not Roth, but to use an example

    I invested 18,500 last year and was matched with 5,029 from the company.   So $23,529 total.   

    S&P 500 has returned 10% (dividends reinvested) for the last 100 years.   but lets just use 8% to be conservative.   oh and you can find S&P index with 0 fees now FYI.  

    Just that 1 year worth (23,529) with 30 years (which is still short of your retirement) of 8% returns assuming 3% inflation is still worth $236,764, so a 10x ROI. The compound interest with no tax taken out is just almost impossible to beat. 4 years of investment is a 1,000,000 account in 30 years.

    https://www.bankrate.com/calculators/retirement/ro...

    I am sure people are going to tell you you can blow away 8% return in RE, and that is true some of the time.   But how much do you need to blow it away to get 8% after taxes?   In a 401k you pay taxes at the very end when you withdraw, so all the money works for you the whole time.  In Real Estate, those tenets rents are taxed every year.   Granted there are some great things like depreciation to offset the taxes, but they are not 100% for 30 years worth of returns.  It is also a ton more work than the 401k route which is as passive as you can get.

    I would suggest just doing the math and making a decision.   I think you will find that the compound interest offered tax free in the 401k is just almost impossible to beat with a taxed investment.  

    1Reply
  • Marcus Johnson
    Investor · Saint Paul, MN · Member since 2015 · 663 posts · 512 votes
    7y

    @Ali Boone

    You’re mistaken. Roth ira’s are pre-taxed, not post taxed. So knowing that the government loves to tax at a high rate, Imagine not bring required to withdraw any of the money and pay no taxes. Plus it’s very simple you simply dollar cost average and nothing else very little time spent. My Roth IRAs have averaged almost 15% in the past 12 years.

    1Reply
  • Marcus Johnson
    Investor · Saint Paul, MN · Member since 2015 · 663 posts · 512 votes
    7y

    @Ali Boone

    … Forgot one huge advantage. You can take out any of your contributions tax-free. So your money isn’t trapped you could use it to buy real estate.

    1Reply
  • Alan Grobmeier
    Rental Property Investor · Phoenix, AZ · Member since 2013 · 919 posts · 911 votes
    7y

    @Ali Boone You can BUY real estate with a self-directed IRA/checkbook controlled LLC. You do not pay taxes on withdrawals from those accounts that are formerly Roth IRA accounts. ;-)

    Personal Example: I purchased a property, all cash, in 2012 with a self-directed IRA/checkbook controlled LLC (rollover from a 401k plan). Purchase price was $175k. I've rented it for 6 years, at about $1000 a month positive cash flow. Since I'm not 59 1/2, the money has built up to about $250k value for the property PLUS about $70k cash for rents. Not a bad return. My plan is to keep the property as long as I live for residual income.

    The best part is that this is not my only  retirement investment.  ;-)

    Granted, I will have to pay taxes on these distributions, when I take them.  But if the property was purchased by a ROTH account, I could take the $1000 (at 59 1/2) tax free!  And I still have the property in the event of some type of financial catastrophe.  

    For those who are 'late' to the retirement party, this IS a way to insure some income besides social security AND hedge against inflation.  

    1Reply
  • Mark Welp
    Investor/Agent/CPA · Columbus, OH · Member since 2015 · 249 posts · 207 votes
    7y
    @John Nachtigall That is great about your 401k! I would just be cautious about the traditional or pre tax option. Yes you are saving taxes today, but tax rates are the lowest today in history and they are probably going to go way up! And withdrawals from your 401k are taxed at ordinary rates. I would think about converting to Roth now as taxes rates are extremely low. Talk to your advisors. Thanks!
    0Reply
  • Peter Baudendistel
    Rental Property Investor · Knoxville, TN · Member since 2018 · 36 posts · 36 votes
    7y
    @Tyler Hogan I'm in a similar boat. 30 years old, established a fair bit within retirement accounts to this point. Maxed my match in 401k over the last ten years, maxed my Roth IRA contributions as well. By going this Roth IRA route I've been able to capture earnings via the market but retain access to the funds when I need them. I am now liquidating what I can without penalty (Roth IRA contributions, not earnings) to jump start my RE investing and use it as my down payments. I closed on my first remote turnkey property last month (we will see how that goes), and am looking at some more local deals currently with what is left over. I will continue to contribute to the Roth as a holding account until I've got enough built up on the next deal. There's risk in that I could lose money, sure, but I'd rather that than sit in a bank at essentially no interest. I'm also looking to take a loan out on my 401k to provide the down payment on a fourplex that would cashflow the loan payment back on a monthly basis.
    2Reply
  • Mindy JensenPro Member
    BiggerPockets Money Podcast Host · Longmont, CO · Member since 2014 · 7k+ posts · 10k+ votes
    7y

    @Tyler Hogan, you can only contribute to a Roth IRA when you have a job, so now is the best time to contribute to it. The contribution limit is $6,000. When you say you're putting in $12,000 do you mean into your wife's Roth, too?

    [email protected]Podcast Guest on Show #261
    BiggerPockets
    0Reply
  • John Nachtigall
    Santa Rosa, CA · Member since 2017 · 325 posts · 701 votes
    7y
    Originally posted by @Mark Welp:
    @John Nachtigall That is great about your 401k!

    I would just be cautious about the traditional or pre tax option. Yes you are saving taxes today, but tax rates are the lowest today in history and they are probably going to go way up! And withdrawals from your 401k are taxed at ordinary rates.

    I would think about converting to Roth now as taxes rates are extremely low. Talk to your advisors.

    Thanks!

    i would have converted a long time ago, but I make more than allowed.   I have been above the income limits for a long time.   So traditional is my only choice unfortunately.    If I could I would be in a Roth, especially in 2009 when I had that great drop in value.  Still, I am happy to have maxed out my 401k since my 1st year working.   So now 21 years in I am very well positioned and I still have 15-20 years of contributions left.  

    0Reply
  • Kelsey Dineen
    Professional · Fort Myers, FL · Member since 2017 · 2 posts · 2 votes
    7y

    I usually max out my HSA first as I qualify with a HDHP in place. My HSA is self-directed through Midland (my employer), so I can use it to fund real estate deals if I wish. HSA funds can be used in retirement or withdrawn now to pay medical expenses. Having a HDHP also means I have lower premiums for my healthcare (the cash I save I put into the HSA to cover me if I have to make a claim and pay a high deductible). The HSA is a pretty cool tax hybrid. It combines the tax-deductible contribution feature of the Traditional IRA (hello tax refund!), with the after-tax advantages of the Roth (income/profit builds up tax-sheltered, and I can withdraw tax-free for health expenses at any time). If I play my cards right, I never have to pay Uncle Sam any tax money on those funds. With Traditional vs Roth its when do you want to pay the taxes (going in or coming out of the IRA/401k). With the HSA its you NEVER have to pay the taxes if you plan correctly.

    2Reply
  • Ali Boone
    Real Estate Coach · Venice Beach, CA · Member since 2012 · 6k+ posts · 3k+ votes
    7y
    Originally posted by @Alan Grobmeier:

    @Ali Boone You can BUY real estate with a self-directed IRA/checkbook controlled LLC. You do not pay taxes on withdrawals from those accounts that are formerly Roth IRA accounts. ;-)

    Personal Example: I purchased a property, all cash, in 2012 with a self-directed IRA/checkbook controlled LLC (rollover from a 401k plan). Purchase price was $175k. I've rented it for 6 years, at about $1000 a month positive cash flow. Since I'm not 59 1/2, the money has built up to about $250k value for the property PLUS about $70k cash for rents. Not a bad return. My plan is to keep the property as long as I live for residual income.

    The best part is that this is not my only  retirement investment.  ;-)

    Granted, I will have to pay taxes on these distributions, when I take them.  But if the property was purchased by a ROTH account, I could take the $1000 (at 59 1/2) tax free!  And I still have the property in the event of some type of financial catastrophe.  

    For those who are 'late' to the retirement party, this IS a way to insure some income besides social security AND hedge against inflation.  

    I definitely agree about not relying on social security and inflation! Ooh, both give me shivers. And good info on how you've structured it. Just to clarify--when the property purchased with the IRA makes money, that money goes directly back into the IRA so you don't have immediate access to it but you do have access to it at 59 1/2 and can pull whatever you want from it. Is that correct?

    So here's a question (for you or anyone), and maybe I'm getting a bit overanalytical here. If you already have money in a roth or an IRA or a whatever and you can invest in real estate using that, I definitely see the perks in doing so. But long before the roth is started, and you have the choice then to either start the roth or just invest directly in real estate...what is the specific advantage to going the roth route?

    A confusion I have about it is the taxes. If I put money into a roth, I pay taxes on that money upfront. Then whatever the amount of it is that it builds to, I don't pay additional taxes on that amount (I believe, correct? Or do I pay taxes on it as it goes into the roth...so like with your rental property, do you pay tax on that income upfront as it goes into the account?) Then in thinking of just investing in straight real estate, at least with rental properties the income I make on those essentially becomes tax-free income because of all the write-offs. So in theory I never really pay taxes on those. 

    I'm curious on that front--the tax situation of each situation. It seems like with the real estate route over the roth route, I have access to my funds the entire time and pay little to nothing in taxes on the income. But the roth ties up my funds until a certain age and I'm paying some level of taxes, so what is the advantage of going that route? 

    Those are actual questions as I don't know enough about it all... they aren't rhetorical. :)

    0Reply
  • Tyler Hogan
    OP
    Rental Property Investor · Austin, TX · Member since 2016 · 18 posts · 14 votes
    7y

    @Mindy Jensen , I have been maxing out my own Roth IRA to date and was planning to max out my wife's starting this year. My job is commission based, so there is more income potential there and I recently started bringing in extra income with a side hustle. My wife is self-employed, so we are both working to dramatically increase income and hopefully max out our Roth's AND save for a down payment once the HELOC is paid off.

    By the way, I want to thank you and @Scott Trench for introducing the concept of FI to me. I can't get enough of the podcast. I'm sad I have to wait until new ones come out now that I'm caught up. Ya'll gave me hope once I realized I don't have to be "stuck" in a job forever. I am so fired up about pursuing FI and cannot wait to see where this path takes my wife and I. Ya'll are truly inspiring and changing so many lives.

    2Reply
  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    7y

    @Ali Boone. If you go buy rental real estate, and show taxable income after all deductions and depreciation you pay taxes on that. (For leveraged residential property you usually show a tax loss)

    For a Roth, any money you put in there is taxed on the front end and then any gain you have while it’s in the Roth is deferred. Then that gain is taxed as ordinary income when it’s withdrawn (anytime after 59 and 1/2). You can always withdraw your principle in a Roth tax and penalty free. Roth’s work because you can get decades of tax free growth, but yes it takes decades.

    compare a Roth to a 401k. A 401k is not taxed when the money goes in, so the principle and gain is taxed when you withdraw. If you withdraw a 401k early you pay taxes and 10 percent penalty.

    No tax advice given

    0Reply
  • Alan Grobmeier
    Rental Property Investor · Phoenix, AZ · Member since 2013 · 919 posts · 911 votes
    7y

    @Ali Boone I have access to the rents/cash WITHIN my self-directed IRA. I can invest that money, partner with me personally or even someone else. To say I don't have 'access' to the money is not correct. I just don't have access to it 'personally' unless I take a distribution.

    Roth deposits are made with after-tax monies.  You have already paid tax on it. 

    With my example, I paid no taxes upfront as it was a 401k rollover.  I WILL pay taxes when I start taking distributions.

    If the property was purchased using a Roth, I would never have to pay taxes.

    I hope that helps.  If not, let me know.

    Thx,

    Alan

    1Reply
  • John MorganPro Member
    Rental Property Investor · Grand Prairie, TX · Member since 2018 · 2k+ posts · 2k+ votes
    7y

    @Ali Boone

    You don't get taxed putting $ in the front end of a Roth IRA. Well, technically the money you take home from a paycheck is taxed so any money you make has been already taxed. When you take your money out at 59 1/2 from a Roth you don't get taxed at all. That's why this is such a good deal. Everyone should load up on a Roth IRA and do the maximum amount per year of 6k if you can swing it.

    You can also take whatever amount you put in (the basis) at any time for any reason. So I recommend using a Roth as an emergency fund. In the meantime, invest in stocks and let that money grow in that Roth IRA. It'll do much better than having it waste away in a savings account barely earning any interest.

    And if you want to grab a chunk of it like I did to buy real estate, you can without paying any taxes as long as your not taking out any more than you’ve put into it over the years. 

    0Reply
  • David Katz
    Member since 2018 · 46 posts · 31 votes
    7y

    Definitely a good idea to max out Roth IRA, especially at your age. I wouldn't hesitate to do that if you are able to do so. It wouldn't prevent you from investing in real estate, and its a really smart move for your future.

    0Reply
  • Christine C.
    Flipper/Rehabber · Indianapolis, IN · Member since 2013 · 61 posts · 43 votes
    7y

    For those who are self-employed (and without f/t employees), you may want to look into the Solo 401(k), it's basically setting up an employee retirement plan (for yourself!) It's perfect for investing in real estate for the long-term. The annual contributions are way higher than an IRA or SDIRA (about $59k/year), you can buy real estate, be a lender, take loans against your asset balance, buy into syndicates partner up with other businesses on investments, and a host of other things, as long as it's PASSIVE INCOME (ex, no buy/sell type transactions.) All income and expenses flow into/out of the trust and it's not subject to UBIT. You can start one "fresh" or rollover an old IRA or 401k plan (though not a ROTH) It does not require a "custodian", you administer the Trust yourself. That's the gist, I'm probably leaving a bunch of benefits out.

    1Reply
  • Robert Leonard
    Rental Property Investor · Greater Boston Area · Member since 2018 · 258 posts · 105 votes
    7y

    @Tyler Hogan I am not a CPA, so you should consult one before making any decisions, but I have spent 8 years studying and implementing personal finance and stock market investing strategies (investing mainly through retirement accounts). My personal opinion is that you should:

    1. Invest AT LEAST up to your companies match in a Roth 401k - you cannot leave free money on the table.

    1a. If you have a long time horizon/you won’t be retiring for 20+ years, put it in the most aggressive low-cost fund your plan offers. I currently have an S&P 500 fund through my plan for 0.015%. There might be some other funds that have better “expected returns”, but the fees are over 1%, and that’s just unacceptable for me.

    2. Save 6-12 months of expenses in an emergency fund in a high-yield savings account - preferably separate from your day-to-day banking.

    3. Contribute as much as your comfortable to your Roth IRA. With a Roth IRA you are able to withdraw ANY and ALL contributions (NOT gains) at ANY time. You cannot withdraw any gains from holding securities/funds, but you can withdraw the contributions penalty free. You can invest some of the money into stocks/funds in your Roth IRA if you find good opportunities, or you can leave it in cash until you find a great real estate investment deal you want to pursue. Once you find the deal, you can withdraw it to use.

    If you contribute it, you can always take it out penalty free. If you don’t contribute, it might be too late and you can’t make up for those missed contributions.

    If something were to happen and you didn't want to use the money for real estate, at least it's still in a Roth IRA to use for retirement. If oh do continue with real estate, you still have that option.

    Hope this helps.

    2Reply
  • Kyle Baker
    Winthrop, ME · Member since 2018 · 11 posts · 2 votes
    7y

    @Tyler Hogan I figured I'd weigh in on this, as I'm in sort of a unique position not as common as some. I'm 32 years old, and still a very new RE investor. First, I cannot say enough good things about the Roth IRA. It is simply the best retirement plan out there, bar none. Before I started doing some RE investing (I specialize currently in self storage) I tried to fund my Roth as much as possible. The last two years I have focused on RE and have (regrettably) not been able to contribute anything to the Roth. However, because of my full-time work as a Firefighter/ Paramedic, I will have the benefit of state retirement. One of my part-time Paramedic jobs ALSO affords me a state retirement plan with a town match. My plans are defined-benefit plans, which basically means that I will get the same pension amount every year with COLAs until I croak! So that's an added benefit I have which makes me worry a little less about my Roth.

    All this being said, I'm a big fan of investing across a diverse array of options. In addition to RE investing and retirement, I also do some robo-investing via Wealthfront and Fundrise (I really like Wealthfront). Wealthfront has performed BETTER than my Roth (by a considerable amount), and I have access to the money any time if absolutely needed. I think you have the income to "spread it around" and do a bit of everything. I disagree that you can't really "dabble" in real estate. You can if you pick the right types of properties. I think you're on the right track continuing to "max out" your retirement accounts while you have the opportunity. If you eventually want to go full steam ahead with real estate, you still won't have regretted socking away all that retirement cash!

    Thanks, and great question! 

    Kyle

    1Reply
  • Kody Stowell
    Flipper/Rehabber · Treynor, IA · Member since 2018 · 1 post · 2 votes
    7y

    Grant Cardone would tell you to put your money in real assets such as real estate. 

    2Reply
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