Pay the income tax or Save for FI

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Pay the income tax or Save for FI

Matt Pulkrabek
Hutchinson, MN · Member since 2013 · 5 posts · 3 votes

Here's a question I have been struggling with:  

Do I continue to save for retirement through tax deferred methods like a 401k, which grows my net worth 33% faster than a non retirement account? I am self employed, so there is not a company match (other than my S-Corp paying myself). However, the tax deferred retirement method does not make any progress towards FI prior to age 59.5 when the funds can be accessed without penalty.  (I am 38 years old)

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Steve Ipock
Investor · Independence mo · Member since 2011 · 165 posts · 49 votes
7y

Start yourself a self directed solo 401k. You can use that money to buy real estate. All expenses must be paid from that account & all profit must go back in that account. I set mine up online. I think it was 750 to set it up plus 125/year. They help you with everything each year. You have control of the check book but gotta follow the rules. 

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  • Randy Bloch
    Rental Property Investor · Minneapolis · Member since 2019 · 257 posts · 244 votes
    7y

    @Matt Pulkrabek I have asked myself similar question over the years....I am not self employed so it make sense for me contribute enough to get the company match...I have high W2 salary so tax deferral is valuable to me so i have continued to max out my 401k (18.5k) annual and invest in real estate after that.

    Keep in mind there is loop hole (Rule of 72t) that allows you take distributions from your IRA prior to 59.5. Google the rule of 72t and IRA and read through this. I am planning to get financial independence at 45...dont think i will use the rule of 72...i can probably create enough cash flow from real estate or side gig until 59.5, but it is an option. i plan to use my real estate equity and CF to get to 59.5 and then my 401K to get me to 67 (social security) and I assume I will make some money along the way doing something.

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  • Steve Ipock
    Investor · Independence mo · Member since 2011 · 165 posts · 49 votes
    7y

    Start yourself a self directed solo 401k. You can use that money to buy real estate. All expenses must be paid from that account & all profit must go back in that account. I set mine up online. I think it was 750 to set it up plus 125/year. They help you with everything each year. You have control of the check book but gotta follow the rules. 

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  • Syed H.
    Developer · NY/NJ/PA · Member since 2018 · 758 posts · 935 votes
    7y

    if you are self employed I would absolutely keep putting money in. It is a business expense and you are sheltering away $55,000/year. That is one of the biggest benefits of being self employed. 

    If you are like me, I wouldn't use your 401k to invest in RE IMO. My day to day is to heavily invest in RE. I use my 401k to invest in everything else. Diversification is a good thing.

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  • Matt Pulkrabek
    OP
    Hutchinson, MN · Member since 2013 · 5 posts · 3 votes
    7y

    Thanks for the feedback. 

    - Steve I have considered the self directed 401k route, but was advised by a neutral third party that there is quite a bit of maintenance and annual appraisal requirements from the IRS to stay in compliance.  Not to mention, if you can't use any of the profits, it still delays FI until 59.5 like any other retirement account, correct?  

    -Syed, This has been my approach.  I have maxed out my 401k annually for the last few years and have seen great growth!  It has also allowed me to defer over $15k year in income tax.  


    I have seen my net worth grow exponentially, but realize this isn't making much progress toward FI before 59.5.


    Lastly, I will mention that I do have 5 rental units (10 total with a partner) and we are slowly growing that portfolio 1-2 units/year.

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  • Scott JensenPro Member
    Financial Advisor · Blaine, MN · Member since 2014 · 478 posts · 387 votes
    7y

    @Matt Pulkrabek

    It sounds like you would benefit from doing a Roth Conversion Ladder.

    Pre-Tax IRA/401(k) investments that are converted to Roth can be withdrawn after 5 years without additional taxes or fees.

    So, if you are in 32% tax bracket now, go ahead and contribute to a pre-tax account to get the full 33% deduction.  Once you "retire" if you're planning on being in the 12% or 15% tax brackets do a conversion to Roth every year and pay the 12% or 15% tax. In 5 years you will have a stream of income that is tax free.  So, you just need to have other funds to access during the first 5 years.

    It requires a bit of planning, but the benefits can be pretty meaningful.

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  • Daniel HymanBusiness Member
    CPA · Milwaukee, WI · Member since 2016 · 2k+ posts · 1k+ votes
    7y

    I agree with @Steve Ipock. The solo401k may not speed up the retirement process, but it could potentially give you a larger nest egg once the time does come.

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