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?
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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 The money goes in after I am taxed today, but grows and both the contributions and gains can be withdrawn tax-free at retirement age.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-$20K over the course of a year or two with which to put towards a real estate investment. If you are able to get to that level of capital accumulation, you will be in a much stronger position to invest, and will then face the hard problem (but good one) about how much to allocate to your real estate investments and how much to allocate to your retirement accounts.
30 Replies
- New to Real Estate · Delmont PA · Member since 2019 · 9 posts · 3 votes7y
@Keith A. That is good insight and easy for me to forget. I know the value of diversification and plan on contributing to some other form of investment other than real estate but I need to keep that in the front of my mind. Thanks for the input!
- Flipper/Rehabber · Cincinnati, OH · Member since 2017 · 19 posts · 10 votes7y
@Jonathan Newlin do not stop contributing. If you are Accustomed to not having the money. You will not miss it. In the long run it will be worth it
- Rental Property Investor · Rancho Cucamonga, CA · Member since 2019 · 1 post · 0 votes7y
@Jonathan Newlin
You can invest in a Roth IRA and at anytime after 5 years account ownership take out the principle contributions you have made since you already paid taxes. So you can save at least 30k if you max out in the next 5 years and reap some interest over that time. Then pull out only the base contributions of 30k$ to help fund a down payment. Now you're diversified in real estate assets and traditional savings vehicle. I did it to fund escrow and closing costs on my first home. Now I'm looking to self-direct IRA now so I can access all of it.
Eric
- Investor · Longmont, CO · Member since 2016 · 185 posts · 156 votes7y
I'm in a very similar boat. I discovered REI about 2 years ago but at the time had recently decided that I wanted a career change. So I was still in college getting my degree, didn't know much about REI, and was tapped out financially all while changing career fields. I graduated a little over a month ago and my plan was to start looking for my first property after I graduated. I have about 32k in REI savings (high yield account), 5k emergency fund, and roughly about 2500-5k in my checking at all times. I have zero money invested in a retirement account because I wanted to save up enough cash for RE. In hindsight I wish I would have put a few hundred a month away into a Roth IRA while saving. Sure I may not have the 30k I do now, but now that it's time to pull the trigger and I'm a little more educated. I realize I'm not quite ready financially like @Scott Trench mentioned. When I hit 45k (end of this year) I'll be looking to acquire my first deal.
My point is, diversify where you put your money within your available means at the given time. Maybe you put your tax return (if you get one) into a Roth every year? That's my plan. Additionally, any pay increase/bonuses I get automatically will be going toward a Roth until I max out. The closer you get to the time of being able to purchase a property the more your true desires/risk tolerance will reveal itself. Turns out I'm quite heavily risk adverse to using leverage without sufficient reserves on hand.
Hope this provides some perspective from the same boat for you.
Best of luck!
- Rental Property Investor · Orlando, FL · Member since 2019 · 105 posts · 71 votes7y
@Jonathan Newlin
There is good advice here.
I contribute up to where employer matches.
My focus is acquiring assets. To buy your first property doesn’t have to take years if you find the right lenders.
Or finance creatively and build equity. I think you should push to get better at finding acquisition strategies. The need to save every dollar needed before I invest is a myth. I have acquired many properties in the past that were creatively financed with great terms, sold those assets and cashed in on equity. “The smartest people will never out pace those that are creative in business. Creatives will hire the smart ones to count the beans!”
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