Why do I keep hearing 401(k)’s are garbage?

Question

I currently work at your typical 8-5 office job. They offer 401(k)s with a match just like every other corporate job. Since being interested in REI, I’ve heard from multiple different sources that 401(k)s are not the best financial vehicle. Does anyone have any insight into this?

Account Closed · Answer

@Cody Brown you’re on a real estate forum, the majority of answers will be they are terrible in some form or another.

I contribute the required amount to my 401k to get the max employer contribution. I maxed my 401k out at 19,000 this year and my company contributed another 11,000 and change to it.  That’s a 57.8% return on my investment the second I put my money in. Also that 19,000 I get to deduct off of my taxes. Which in my tax bracket saves me roughly 4,750 in taxes.

So yes real estate is great to invest in, why would someone give up free money and a tax break today just because they can’t touch it until 59.5?  Yes that seems like a long time, but it comes faster than you think.

Now I’m not saying don’t go into real estate also, but take the low hanging fruit of employer matching contributions and then start working on real estate... there’s even books on how to do it with low or no money down by @Brandon Turner so it isn’t like contributing to your 401k is going to not allow you to do real estate. Diversification works for a reason.  And so does buying consistently over time.

Brian Eastman · Answer

@Cody Brown

An employer match is 100% instant return on investment.  Likewise, when you contribute to a tax-deferred plan, you essentially get a match from the government that equals your tax bracket.  You should take advantage of these benefits to build savings.

Whether you contribute beyond what your employer matches is a different discussion that you should have with a licensed financial planner (not a stock sales agent or an internet forum).

Keep in mind, once you change jobs you can move the savings you have accumulated in a 401(k) into a self-directed IRA and put that tax-sheltered money into productive assets such as real estate and private lending.

Tom S. · Answer

@Taylor L. @Greg Scott  Good points on the non-401k side too.  I'm both, I max out my 401k and buy rental properties.

A few other points, although 401k money can't be touched without penalty, there are loans, and even untouched, it counts toward reserves when qualifying for a loan.  Also retirement money generally can't be subject to bankruptcy or lawsuits.  Of course, no one plans to go bankrupt, but stuff happens!

Holly Williams · Answer

@Craig Jeppesen if you have a Roth option then that’s a game-changer.  Big difference.

Taylor L. · Answer

"Compared to what" - music to my ears!

It depends on your goals. Real estate has a ton of tax advantages, but it also takes quite a bit of work to actively invest in real estate and maximize those advantages. If you want to passively invest and retire eventually, then low cost index funds in a 401(k) are not a bad idea. If you're creative and set things up right, you could even transfer some of the 401(k) in to a Solo 401(k) plan at some point and start directly investing in real estate.

Craig Jeppesen · Answer

I max out my allowed 401k option. You get free money from the company match and I have a Roth option so my funds grow tax free. I only invest in stock mutual funds in my 401k. I hope to retire with a few million in liquid stocks mutual funds and a few million in cash flowing real estate and will not be paying much in taxes if any at all when I do retire.

I also have used loans from my 401k to rehab properties that I have flipped.

There are definitely benefits to both stocks and real estate and I believe you should do both.

Greg Scott · Answer

@Cody Brown @Brian Eastman @Tom S. @Taylor L.

OK, I"m going to challenge conventional thinking.  We've talked about "compared to what".  Now let's talk Opportunity Cost.

So, yes, matching sounds like free money. (That you get to pay taxes on later, I might add)  But, you are also now constrained to keeping that money in your employers mutual funds.  I can't buy a mutual fund at 10 or 20% below market like I can in real estate.   If I take money out of that 401K I can't do it without paying taxes. (Well, I could make a loan to myself and then have to pay it back.)   And, what happens when I die?  The taxes are terrible.  Almost half goes to Uncle Sam.

With real estate, I have an asset that appreciates.  My tenants pay down the mortgage.  I can defer taxes through a 1031 or bonus depreciation.  Any time I want, I can do a cash-out refi and grab a big pile of cash, tax free.   And, even better, when I die my heirs get all that real estate at a stepped up basis and NOBODY pays the tax!

BTW, my biggest financial regret is that for 28 years I fully funded my 401K.  Ironically, I would already be retired if I had put it in real estate instead.   What is your opportunity cost vs tax-free investing in real estate?

Christian Rojmar · Answer

@Cody Brown Many 401(k)s allow you to take a loan and so it is not necessarily true that you cannot touch the funds until you retire. But be aware that there are certain restrictions and disadvantages with taking a 401(k) loan. For example, there are circumstances when you may have to repay the entire loan in a lump-sum and if you can't, you will be penalized. With that said, real estate is often considered better than saving in a 401(k) due to at least (and I am probably missing certain advantages and disadvantages so do more research):

- Real estate tends to give you more control - You have more control of how you invest the money (location, forced appreciation, rent properties and build long-term passive income, etc.). There are self-directed 401(k)s that allows you more freedom but not utilized by many.. You can also sell real estate at any time or take the cash flow from a rental and use the funds for whatever.

- You can use leverage with real estate

- Tax benefits - both 401(k) and real estate have tax benefits (can defer real estate taxes through 1031 exchange while 401(k) contributions are pre-tax and deferred until withdrawing the money).  But with real estate you have depreciation and interest expense deductions. Can also be tax free for heirs when you pass away while 401k will be paid out and taxed to beneficiaries.

- Rent increases with inflation.

401(k) obviously have the matching contributions which is nice.

It is never a bad idea to diversify rather than putting everything in one asset class. As such, it may make sense to at least take advantage of matching contributions. My wife and I used to max out both of our 401(k)s but after learning about real estate, we now only take advantage of the match - the rest goes towards real estate. We are also likely going to take a loan from the 401(k) accounts for a property in near future.

Brent Paul · Answer

I only put enough in my 401k so that they match.  The rest I split between real estate and another investment account.  Always a good idea to diversify.

Greg Scott · Answer

Compared to what?

Compared to lotto tickets, they are much better.   Compared to real estate, they are terrible.

Real estate is the most tax-favored asset class and allows you to make money multiple ways and get money out multiple ways.   A 401K you put money in and are not allowed to touch it until you leave your job or turn 59 1/2.  Plus, you have very little choice of what investments you can choose.  Then, you get to pay taxes when you take out the money.

Why do I keep hearing 401(k)’s are garbage?

Most Popular Reply