Should I withhold from contributing to a 401K for now?
New to Real Estate · Delmont PA · Member since 2019 · 9 posts · 3 votes
Should I withhold from contributing to a 401K for now?
Most Popular Reply
Scott TrenchPro Member
Rental Property Investor · Denver, CO · Member since 2014 · 2k+ posts · 6k+ votesHi Jonathan - I feel that it is a great thing that you are starting to think about investing and conscientiously socking away capital. Here's how I approached this situation at the age of 24, perhaps similar to your situation:
At 24, I was making about $48,000 per year. I was very interested and eager to invest, and was reading a large number of books on the subjects of advancing my career, general self-improvement, sales, marketing, business, real estate, stock investing, etc. Because of this pattern and the clear priority I placed on the rapid accumulation of wealth, I supposed that at some point in the following decades, that I would be wealthy relative to my position at the time.
I also surmised that because I was going to get aggressive about accumulating capital, that my income would be in a higher marginal tax bracket at retirement than the one I was in at 24 - while making $48K. For example, if I were able to amass a several million dollar net worth over a 30-year career, my income might be over $100K per year at retirement. Therefore the decision for me was clear:
If I invest using a retirement account, I would use a ROTH IRA. The money goes in after I am taxed today, but grows and both the contributions and gains can be withdrawn tax-free at retirement age.
If, on the other hand, I were 50 years old earning $250K per year and expected to retire within 10 years and withdraw $75K per year from my accounts, I would make a different choice and choose to contribute in a tax-deferred 401(k). This would enable me to lower my taxable income while in a high relative tax bracket to where I expected to be at retirement age.
So, in my position at that time, and for the reasons stated, a Roth IRA is preferable. One thing that would have changed the dynamic for me would have been an employer match, but as you discuss that does not apply in your situation - those matches often occur only in a tax-deferred 401(k). (Incidentally, here at BP, we recognize this dilemma and offer to provide employer contributions either a traditional 401(k) or a Roth 401(k) in part due to this "problem" for some team members).
On to the next point however - about whether to contribute AT ALL to the retirement accounts. I think that the answer depends on how aggressive you want to get about accumulating capital. If you are going to save your way to retirement a few hundred bucks a month at a time, I think that accumulating capital in a retirement account, perhaps a Roth, might be a great way to go. However, if you are looking to rapidly accelerate towards financial freedom and invest in real estate, you may find yourself with a hard problem -- you will simply need to accumulate more capital (likely after-tax, but a minority of investors do use retirement accounts to buy property) at a faster rate.
I think that the initial reserves alone (which you need access to likely in an after-tax checking or savings account) for an investor getting into this business needs to be in the $10-$15K range. This is the minimum needed to cover an unexpected eviction, rehab, roof, etc. Anything less than this in reserves means that you can be hit with an unexpected problem. Based on your savings rate (but dependent on how much you currently have saved), this means you are YEARs away from being able to invest with a strong financial foundation.
Coming full circle - the answer to your question is likely that retirement accounts may be the way to go for now, until you have a plan for being able to accumulate $10-$20K over the course of a year or two with which to put towards a real estate investment. If you are able to get to that level of capital accumulation, you will be in a much stronger position to invest, and will then face the hard problem (but good one) about how much to allocate to your real estate investments and how much to allocate to your retirement accounts.
30 Replies
- CFA · Sanibel, FL · Member since 2016 · 31 posts · 52 votes7y
The only thing you would be giving up here really is the tax advantages that you receive from 401(k) accounts. I think an interesting strategy would be contributing to a Roth or Traditional IRA, outside your employer, with the idea of investing it in real estate down the road by converting it to a self-directed IRA. This gives you the best of both worlds if Real Estate is your goal, but it would be a longer road than just investing in real estate directly. I'm only 27, but I will tell you, your goals and objectives should drive how and where you invest, AND IT WILL CHANGE!
- New to Real Estate · Delmont PA · Member since 2019 · 9 posts · 3 votes7y
Thanks for the feedback. And I agree the tax savings are enticing and I would not mind the long road approach. My only thinking is as I am starting up it divides my funds and potentially slows the start of investing. I know there are many ways to invest with "little or no money down" so dividing funds may not be a bad option. Something I will ponder for awhile longer. Thanks again for the insight!
- 7yScott TrenchPro MemberRental Property Investor · Denver, CO · Member since 2014 · 2k+ posts · 6k+ votes
Hi Jonathan - I feel that it is a great thing that you are starting to think about investing and conscientiously socking away capital. Here's how I approached this situation at the age of 24, perhaps similar to your situation:
At 24, I was making about $48,000 per year. I was very interested and eager to invest, and was reading a large number of books on the subjects of advancing my career, general self-improvement, sales, marketing, business, real estate, stock investing, etc. Because of this pattern and the clear priority I placed on the rapid accumulation of wealth, I supposed that at some point in the following decades, that I would be wealthy relative to my position at the time.
I also surmised that because I was going to get aggressive about accumulating capital, that my income would be in a higher marginal tax bracket at retirement than the one I was in at 24 - while making $48K. For example, if I were able to amass a several million dollar net worth over a 30-year career, my income might be over $100K per year at retirement. Therefore the decision for me was clear:
If I invest using a retirement account, I would use a ROTH IRA. The money goes in after I am taxed today, but grows and both the contributions and gains can be withdrawn tax-free at retirement age.
If, on the other hand, I were 50 years old earning $250K per year and expected to retire within 10 years and withdraw $75K per year from my accounts, I would make a different choice and choose to contribute in a tax-deferred 401(k). This would enable me to lower my taxable income while in a high relative tax bracket to where I expected to be at retirement age.
So, in my position at that time, and for the reasons stated, a Roth IRA is preferable. One thing that would have changed the dynamic for me would have been an employer match, but as you discuss that does not apply in your situation - those matches often occur only in a tax-deferred 401(k). (Incidentally, here at BP, we recognize this dilemma and offer to provide employer contributions either a traditional 401(k) or a Roth 401(k) in part due to this "problem" for some team members).On to the next point however - about whether to contribute AT ALL to the retirement accounts. I think that the answer depends on how aggressive you want to get about accumulating capital. If you are going to save your way to retirement a few hundred bucks a month at a time, I think that accumulating capital in a retirement account, perhaps a Roth, might be a great way to go. However, if you are looking to rapidly accelerate towards financial freedom and invest in real estate, you may find yourself with a hard problem -- you will simply need to accumulate more capital (likely after-tax, but a minority of investors do use retirement accounts to buy property) at a faster rate.
I think that the initial reserves alone (which you need access to likely in an after-tax checking or savings account) for an investor getting into this business needs to be in the $10-$15K range. This is the minimum needed to cover an unexpected eviction, rehab, roof, etc. Anything less than this in reserves means that you can be hit with an unexpected problem. Based on your savings rate (but dependent on how much you currently have saved), this means you are YEARs away from being able to invest with a strong financial foundation.
Coming full circle - the answer to your question is likely that retirement accounts may be the way to go for now, until you have a plan for being able to accumulate $10-$20K over the course of a year or two with which to put towards a real estate investment. If you are able to get to that level of capital accumulation, you will be in a much stronger position to invest, and will then face the hard problem (but good one) about how much to allocate to your real estate investments and how much to allocate to your retirement accounts.
- Developer · Los Angeles, CA · Member since 2017 · 157 posts · 84 votes7y
Jonathan,
I am personally a big fan of Roth due to many tax advantages it provides. You should definitely invest enough money in your 401(k) to take full advantage of your employer's matching contribution. Use Roth 401(k) if you can. Here is my latest blog on 401(k) and IRA. https://www.biggerpockets.com/blog/401k-versus-roth-ira-pros-cons
You can use self-direct IRA later on to invest in investment properties if you like. Taking out loans from 401(k) to buy a personal property is also an option. - New to Real Estate · Delmont PA · Member since 2019 · 9 posts · 3 votes7y
@Scott Trench
Thanks for the thorough response and great insight! I really appreciate it. It speaks volumes to me as new member to hear directly from the biggerpockets team. Many great points I need to consider.
- Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes7y
Without a match, I'd do Roth and RE only. Max your Roth if you can. Contributions are flexible for withdrawal later if you need it and it grows tax-free.
- Investor/Agent/CPA · Columbus, OH · Member since 2015 · 249 posts · 207 votes7y
I think it all depends on your goals. I invested in qualified plans in my 20's and early 30's and wish I never did; I don't like having money locked up; I want access to my money. If you want to invest in real estate, then I would keep my money liquid and not put it into a qualified plan.
There are other vehicles that give your money tax free growth and you still have the ability to access it. Having liquidity and access to your capital is very important in my opinion; especially if you want to buy real estate.
Let me know if you have any questions. I personally think a lot of people are not educated on qualified plans; employers just make employees sign up on day 1; crazy. Thanks!
- New to Real Estate · Delmont PA · Member since 2019 · 9 posts · 3 votes7y
@Mark Welp
I am feeling that tension of having my money locked up. Thanks for the advice!
- Excelsior, MN · Member since 2016 · 52 posts · 27 votes7y
@Jonathan Newlin
I am in the same position as @Mark Welp that I socked away a lot in the early years and now wish I had that available without penalties and tax. But that is because right now I would rather have the cash flowing properties. Flip side is that that 401k has done well so diversification isn’t a bad thing.
Like others have and will say, it depends on what you are trying to achieve.
- 7yJim BlackburnBusiness MemberLender · Florida Based (48 states Puerto Rico) · Member since 2017 · 321 posts · 121 votes
@Jonathan Newlin
I would contribute at least enough to get your employer match… After that you have to look at your taxable income… And decide if the deduction is worth more to you than what the return would be that you could generate with the after-tax dollars that you would get if you didn’t put it into a 401(k).
Jim
Stairway Mortgage, a Division of NEXA Mortgage LLC597 Reviews - Austin, TX · Member since 2019 · 95 posts · 59 votes7yJust remember with a ROTH IRA, you have to make less than $137,000 per year (if single) to contribute with contributions beginning to phase out at $122,000.
- Real Estate Investor · Brooklyn, NY · Member since 2013 · 120 posts · 14 votes7y
Or why not a Self-Directed 401k since you’re already into RE?
- New to Real Estate · Delmont PA · Member since 2019 · 9 posts · 3 votes7y
That is an option in the future but the amount currently in my 401K is very small since I just started contributing. My question was regarding if I should take the cash and invest freely into RE or should I put cash into 401K and eventually use it the self directed 401K route. So basically should I divert funds and tie them up into a slow money generator or should I take the cash as I have it and hustle to produce a higher rate of return money generator. (Again that is assuming I will become a successful investor). Thanks for mentioning the Self directed 401k though that is definitely something to consider.
- Rental Property Investor · Syracuse, NY · Member since 2019 · 90 posts · 34 votes7y
@Jonathan Newlin no, always keep income/accounts in different places, going all in is not the safe play. Just my POV.
- Investor · Richmond, VA · Member since 2016 · 164 posts · 114 votes7y
@Jonathan Newlin I really second @Scott Trench when he mentions having a reasonable financial situation before investing. You'll need a down payment, cash to close, and some sort of reserve to even get through the lending process when you buy your first property. It has taken me years to save enough, but I am finally aggressively searching for my first local rental in my market now. And the longer I wait to find the right deal, the more I save towards REI. I contribute heftily to my 401(k), and am militant about cash savings every month. I have an automatic withdrawal from my checking into a savings account every month on paydays. As long as I stick to my personal budget, then my REI budget grows on auto pilot until I am ready to buy. As Robert Kiyosaki from the Rich Dad, Poor Dad books would say, "pay yourself first."
- New to Real Estate · Delmont PA · Member since 2019 · 9 posts · 3 votes7y
Thanks for the insight into your strategy. I agree with the cash to the side for REI budget. I would like to know though are you contributing more than what your employer matches in your 401K? And if so why? You say heftily, what percentage of your paycheck do you contribute. I am not against saving I just am unconvinced at this point that pouring funds into a 401K in my situation will help me save quicker to dive into REI. Again thanks for the insight and good luck finding your first deal!
- Investor · Richmond, VA · Member since 2016 · 164 posts · 114 votes7y
@Jonathan Newlin I contribute 12%/paycheck with a 3% employer match. I save another 12%/paycheck in cash for REI. My wife works and does the same. My family of three (soon to be four!) lives just fine on this. My wife and I love saving and treat it as a lifestyle rather than a burden. We are in great shape regarding our 401(k) now (we started at 22 with our first jobs). So my advice would be to be smart about saving for retirement now so that you can afford to take bigger investment opportunities comfortably later. Fast forward ten years from now to where you are holding rental properties but have nothing saved for retirement: that may be an anxiety-inducing scenario depending on your mindset. It would be for me. My attitude was to get responsibly stable in my 401(k), then my cash. Now we are eagerly looking for a rental property to add to our portfolio.
I use this phrase a lot: if you lost what you invested outside of your 401(k) how devastating would that be to your future? In my world, I need to be able to rely on the long term benefits of having a retirement plan while I try to enhance it through real estate, not the other way around.
That was long winded but I hope it is helpful!
- New to Real Estate · Delmont PA · Member since 2019 · 9 posts · 3 votes7y
@Michael A. That is great to hear you guys are on a healthy path! And congrats on the new child. We just had our second 3 weeks ago. Thanks for the detailed response its helpful to see others situations and how they tackle what is important to them. Best of luck to you!
- Developer · Cincinnati, OH · Member since 2018 · 1k+ posts · 3k+ votes7y
Originally posted by @Jonathan Newlin:
That is an option in the future but the amount currently in my 401K is very small since I just started contributing. My question was regarding if I should take the cash and invest freely into RE or should I put cash into 401K and eventually use it the self directed 401K route. So basically should I divert funds and tie them up into a slow money generator or should I take the cash as I have it and hustle to produce a higher rate of return money generator. (Again that is assuming I will become a successful investor). Thanks for mentioning the Self directed 401k though that is definitely something to consider.
Since there is no employer match, don't do the 401k. Start a Roth IRA instead - and make it into a SELF DIRECTED ROTH IRA. By doing that, you can actually use the Roth IRA to invest in Real Estate.
- San Diego, CA · Member since 2018 · 15 posts · 12 votes7y
@Christian Rojmar
A backdoor Roth IRA gets around that. Essentially, contribute post tax money to a normal IRA and the next day do a conversion into a Roth account.
- Investor/Agent/CPA · Columbus, OH · Member since 2015 · 249 posts · 207 votes7y
@Michael A.
Just one point to think about and one of your comments.
A lot of people on this site and in past history have had their rental portfolio be their retirement.
Real estate has been around 100+ years as a means to build wealth. Qualified Plans have only been around for 30 years or so.
Thanks,
- Austin, TX · Member since 2019 · 95 posts · 59 votes7y
@Michael D. interesting, I didn’t know that! Thanks!!
- Rental Property Investor · Los Angeles · Member since 2018 · 844 posts · 1k+ votes7y
Originally posted by @Michael A.:
In my world, I need to be able to rely on the long term benefits of having a retirement plan while I try to enhance it through real estate, not the other way around.
It's the other way around for me. The scarcity mindset of a 401k and the thought of using a wall street created vehicle (to help eliminate DB plans) terrifies me. I'm much more at ease at the thought of building my passive income and achieving true financial independence through real estate.
Not saying you shouldn't contribute to your 401k because I certainly do...but only because of the company match.
- Rental Property Investor · Los Angeles · Member since 2018 · 844 posts · 1k+ votes7y
Originally posted by @Mark Welp:
@Michael A.
Just one point to think about and one of your comments.
A lot of people on this site and in past history have had their rental portfolio be their retirement.
Real estate has been around 100+ years as a means to build wealth. Qualified Plans have only been around for 30 years or so.
Thanks,
I would take this a step further and say that building wealth through land ownership and real estate is something that people have been doing for thousands of years.
- Rental Property Investor · TX · Member since 2019 · 236 posts · 392 votes7y
@Jonathan Newlin
Something not being mentioned by many others is the benefits of not putting all your eggs in one basket. Diversifying is important. Is having everything in real estate safe? No. Is having everything dependent on Wall Street safe? No. I would still contribute a portion ( even a very small amount) to a retirement plan. One thing I hope we never have to talk about on this forum is how the winds changed and real estate investing is a bust and we all are broke with no other investments as backups.
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