Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes
I have never been a big fan of 401k and retirement accounts in general that are invested in mutual funds. I have always thought of it as a "life deferral plan", you put money in, that is money that is lost from your life, does not pay you every month, poof gone.
Plus, most people have no idea what they are investing in. I love real estate precisely because of the control it gives me, and the monthly income. My RE investments already cover my basic monthly income.
However, after researching mutual funds for the last 6 months, and getting a lot of feedback, I decided to start contributing again to the TSP/401k. Every single physician colleague I have talked to, basically said I should be doing it as a way to lower taxable income, and diversify into a different class. The argument is, if you are a high income earner, it would be easy to contribute to a 401k/IRA and invest in real estate.
So against my better judgement, I have decided to take about $15K out of my last 3 paychecks of 2017 to fund the TSP. My real estate has returned 20-30% IRR since 2013, yet I am sitting trying to diversify a little into equities.
I wanted to know what you guys think: about 401k in general, my situation, and your own situation. Is it really a scam? If I wanted to retire around 40yo, are my funds in retirement accounts "stuck? I still see it as 'lost money' that I don't get to spend now, but enough clinical colleagues have convinced me to do it.
A 401k retirement plan is certainly not a scam. It is a powerful vehicle for building future wealth.
When you contribute to a 401k or TSP style plan, you benefit in 3 ways:
1) in some cases you may receive an employer match. This is free money or a 100% return on investment, depending on how you want to look at that.
2) You receive a tax deduction for the income contributed in the year in which you make the contribution, reducing your tax bill. This is also effectively a return on investment on the money you contribute equal to your combined state & federal tax rate.
3) By contributing to the plan, you also reduce your overall taxable income, which may drop your tax bracket on the money you do pay income tax on.
So, on the front end, lots of positives.
Investment choices in many conventional retirement plans are limited. That is a potential negative. That said, even a moderate return compounded over time can add up significantly.
Earnings to the plan are tax sheltered. So, instead of diluting your return with taxation, you are accelerating the rate at which your money compounds.
Money in a qualified retirement plan will be locked up until you are 59 1/2, at which point you can begin to take distributions. The idea is that by deferring the taxation up front and on the earnings over time, you can balloon a small amount of annual contributions each year into a large sum from which you can support yourself in your retirement years once you have stopped working.
This is, of course an oversimplified version, but should clearly illustrate the benefits of tax-deferred retirement savings.
You can add to the above the ability to make contributions on a Roth basis and create tax-free income, as well as the ability once you change jobs to move an employer retirement 401k or TSP to a self-directed plan where you can invest those tax-sheltered dollars in things like real estate.
If you are a physician, I would assume you create reasonably significant income, even if you work for the government. I strongly suggest that you have a sit down with an independent financial advisor and/or tax strategist. I'm talking about a financial consultant, not a stock salesperson. You can chart a path that includes a mix of conventional retirement plan and outside investments such as real estate, and create multiple sources of income with different tax exposures.
15k out of your last three checks. That is a bad idea.
Like you, I don't believe in using the TSP as a method to build wealth. However if you insist on doing it, you should do it right.
The first 5% that you contribute to the TSP is matched by the government. If you contribute $5000 on three checks you lose out on the match for the other pay periods. Instead you should spread that amount out.
Why is that a "bad idea"? Employer-matching doesn't kick in until 1/1/2018 for active duty anyway. So I just put 50:50 to traditional:Roth TSP to get close to the limit since I haven't contributed in 2017 yet.
If you only have a short period to try & reach your max amount allowed for 2017 then you will have to do it this way for now. However, in the future you want to make sure you are investing using "dollar cost averaging". Buying a fixed amount on a regular schedule (monthly). This way when the market dips, you win because you are now buying more shares. This is the best way to win in any market.
I don't see it coming down to TSP vs SD IRA/401k. They both are good a things the other isn't. For non sexy broad index investing you can't beat TSP.
In terms of what the market will do in the next 3-5 years I'd tend to agree with you that it will be pretty flat; that is what has happened after most boom cycles. That being said, market timing isn't for me. There is upside to regular old dollar cost averaging and getting the median return on a portion your assets. Reversion to the mean can be a kick in the pants...
Investor · Gaithersburg, MD · Member since 2013 · 660 posts · 441 votes
9y
A 401k is what it is. Investing in the stock market without any effort on your side. I have one and so does the wife. We also get matches. My view of it is this. If I didn't have money to invest in RE because I was contributing to my 401k, I would choose RE. However, the 401k is just one of my investment vehicles. I'm fortunate in that I have the money to invest in multiple vehicles (especially since I'm getting a match). I currently invest in my 401k only to the point that maximizes my match. When I am old enough to withdraw from it it will provide what I call surprise income. My other investment vehicles will allow me to "retire" well before I can withdraw from the 401k without penalty, but if RE totally implodes (unlikely as it may be), I still have other vehicles to fall back on. Worst case, I work until I'm 60+ but what I can't afford to do is put all my money into RE and have nothing if that doesn't pan out and work until I die.
so if you have the money, yes, I'd invest in a 401k.
Rental Property Investor · Baltimore, MD · Member since 2016 · 153 posts · 158 votes
9y
Congrats! If you can pull $15k out of just 3 paychecks, I think you can easily afford both 401k contributions and RE investing. Good to diversify IMO as your 401k is basically making you roughly 30% gains immediately.
Investor · Ridgecrest, CA · Member since 2017 · 247 posts · 120 votes
9y
I don't know how your 401k works but mine is definitely a scam. Even with a 10% contribution from my employer I stand to get a better ROI in one year from my first SFR than from my entire 401k portfolio has done in the past 2 years.
Sure you don't pay taxes on your 401k deposits but you pay them when you withdraw on top of that you pay fees and mine even has me pay out of state income taxes because the company that holds my 401k is in Florida. I stopped contributing to my 401k in July this year and never looked back.
I am currently looking into an IRA that allows for self investment. That way I can use it as a tax deferred high interest savings account and use the money to invest in real estate.
South Bend, IN · Member since 2015 · 180 posts · 93 votes
9y
For me it depends purely on employer match. If you are offered an employer match then you should contribute enough to receive the match. My employer matches 5% so I would be a fool to not contribute 5% as it is an instant doubling of 5% of my income. Where else can you get a sure fire, consistent return like that with very little risk?
Gilbert, AZ · Member since 2017 · 119 posts · 101 votes
9y
@Tom R. I don't think you did your math right. If your contributing 10% and your company is contributing a matching 10%, you have immediately made 100% return... Not to mention your taxable income is decreased, so add another 20-30% savings there on the income you contributed.
I definitely agree though that the Investment firm in charge of your 401K can make or break it. I think I paid like 0.01% in fees, but I'm with a BIG firm (Fidelity). Year to date, I've paid $13 in fees and I've had a 14.9% return. My wife on the other hand has a small provider with few options, and has trailed the S&P500 in return and has paid more fees, even though my account has about 10X her value.
As for the state tax thing, that is pretty shady. Once you're done working for the company that you have your 401K through, I would roll it over to an IRA before you start taking distributions. That way you won't have to pay Florida Tax. You shouldn't be seeing that tax now though since you aren't taking distributions...
Investor · Ridgecrest, CA · Member since 2017 · 247 posts · 120 votes
9y
@Paul G.I don't think you understand. They match 10% of my contribution and they only contribute up to a total of 6% of my gross income. IE If I contribute $100 they contribute $10. Also the whole tax thing is BS. You are still paying taxes on that money just not today. It took me 9 months to save up enough for a down payment for my first property the estimates first years cash flow from that property is at least $3000. That's money I can reinvest in more properties. In order to get that kind of return on my 401k I would have to contribute 30k. The total down payment including fees on my house was only 25k. I should make another $3000 year after year from the same house with no further investment on my part. My 401k is not going to do that for me unless the stock market consistently sky rockets.
Gilbert, AZ · Member since 2017 · 119 posts · 101 votes
9y
@Tom R. Yikes, so that's a pretty terrible company match. Better than nothing, but not great.
The whole tax thing is NOT bs. But that depends on what kind of earner you are right now. If the person contributing is in a 15% tax bracket, then yes, I agree. 401K isn't very beneficial from a tax standpoint because one of the main advantages of a 401K is to shelter money when you're in a higher tax bracket and receive it when you're in a lower one. If the contributor is in the 15% bracket, they probably will be in the same or higher at retirement, where you lose that advantage. The author is in a 28%+ tax bracket, where it absolutely does make a difference.
My plan is to be able to withdraw from my 401K in retirement (and before with rule 72(t) without penalty), and only show a taxable income of under 75K, which would put me into the 15% tax bracket. While actually bringing in 2-3X more than that. At which point, I would see a tax savings of between 13% and 28% from my 401K based on current tax rates and whether I can show those to be capital gains (at which point I will be taxed at 0%).
No one here is saying REI is a bad investment. We're on a REI blog. What we're saying is diversifying with a 401K is a good thing to do. Especially if you've been through a downturn cycle. I personally haven't, but I know if it does happen again, I can handle long vacancies and a drop of 30% in price. Heck, I can even use my 401K to buy more property if I want because I can take a loan of up to 50K on it, being my own bank.
I'm not sure what you're saying about your 401K. Just because you can't pull out the cash immediately, doesn't mean it isn't there. If you contributed 33K (30 of yours and 3 of your company)to a 401K (this would obviously have to be over 2 years as max contributions per year are around 18K) and didn't touch it for 30 years, with 8% average market return which is historically accurate, you would have 332K.
The downside to that is you wouldn't be able to leverage that money out and purchase more properties, that is true (though most plans will let you take a 401K loan for anything you want...). That is a definite negative to 401K. Now, say you add an extra 5K a year throughout the 30 year period. At the end of 30 years, you'd have 898K. Again, not as great as you could possibly get with real estate, but that's a pretty decent safety net for only putting in 5K a year. That would leave you with about 20-25K + Real Estate Investment income a year to buy more property if that is what you choose to do. So, why wouldn't you do both?
Is 5K a year or $192 a paycheck (bi-weekly) a lot to ask for as a safety net? According to your numbers, it won't cut in too much to your savings habit... Only you can answer that question though. Some people that is a LOT of money. Some people, it's peanuts.
It's of use to note that the 5K income deduction would only affect your paycheck by about 3.5-4K a year due to tax savings. So really, it would be 3-4K less per year in take home pay that you wou;dn't be able to invest in real estate.
Santa Rosa, CA · Member since 2017 · 325 posts · 701 votes
9y
my $0.02. I think 401k is a good individual choice and good public policy. Like all things, however, it can be screwed up when not used correctly
Individual:
Unless you don't plan on making it to 60 years old, you are going to need money when you get there. So the argument that you "don't get the money now" is not really relevant. The average man lives 72 years at this point. Women even longer.
It uses pre-tax money and grows without tax, so the argument about "paying tax eventually" misses the point. If you like the 1031 exchange then you must like the 401k because the tax benefit is the same....you get to use all your money to grow the pile and pay the tax later. So if you put 18,000 (current yearly max) in a 401k, you invest 18,000. If you did that outside a 401k you actually invest 12,000 to start with and pay tax along the way on the earnings.
The match provides an even better return. So if you invest 18,000 you get more depending on your employer. Even if it is 10% (which is pretty low) that is an extra 1800 for free. So you are really investing 19800, instant 10% return with 0 risk.
s&p 500 index has grown (dividend reinvested) at a real rate of 7% since 1928. So run the math on 19800 invested yearly at 7% for 30 years and you get....2.1 million (compounded yearly which is again worst case). To get an equivalent return on a taxable investment (30% fed and 5% state taxes and a 7% real return) is $31,000. That would be 3.3 million earned but 1.2 million in taxes for the same 2.1 million return. Who cares if you have to pay taxes on your 4% withdrawl on your 2.1 million 401k, at that point you deferred the taxes for so long the compound interest made you a winner. 18,000 a year vs 31,000 for the same return....pretty easy choice.
Public Policy
Locking up the money is a feature not a bug. Most people don't have the discipline required to save, so making it hard to use the money before retirement forces people to make better long term choices. In my opinion they should eliminate the loans for homes and medical. The conservative in me says that we should not force people to be responsible, but the practical person in me pints to the 2/3rds of Americans who cant pay for a $1000 expense without borrowing money. You are still free not to contribute, so your rights are not inhibited.
It allows for individual investment, so I can buy index funds but someone else can buy bonds. People are free to adjust their risk as they see fit.
Of course it is not an either/or choice. You can do both.
Rental Property Investor · Torrance, CA · Member since 2016 · 724 posts · 1k+ votes
9y
I view my 401K as icing on the cake. If I play my cards right I won't need it to retire, but no point in leaving money on the table. My employer actually gives a bonus 3% when I contribute 6% or more. So I'm putting in 6% and they give me 9%. Pretty sweet deal if you ask me.
Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
9y
Solo 401k has been mentioned, and that is a good option if you have or could create some self employment earned income in order to qualify. I would also add that even if this is not the case today, investing in a 401k might still be a great idea ... in addition to the benefits already mentioned, if/when you do part ways with your current employer, then at that point the 401k could be rolled either into a solo 401k or if you don't qualify for that then into a IRA LLC with checkbook control, and then invested in REI, notes, etc. This is exactly what I did ... in fact it was a Roth IRA LLC, so tax free rental income and capital gains ... worked out great for me. So, the idea would be to build it up while you are employed with them, then later when you are not roll it into self directed and invest it in RE or whatever else you like in a tax advantaged manner. RE notes are a great option for those IMO ... even though I bought rental property, and it turned out great, if I had to do over again i'd likely lean towards notes with self directed retirement funds. Also, some employers offer self directed options where you can choose individual stocks .... maybe not with a TSP, but if you have this option then research dividend growth investing (DGI) ... similar to rental properties you can live off the stock dividends, never have to sell, and be less reliant on what happens to stock prices. Also like rental properties you can choose stocks with higher immediate dividend yield but slower growth, or lower immediate yield and higher growth in earnings, which in turn leads to higher capital gains and dividend growth ... you can also buy REITs in these plans.
Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
9y
For middle America, the best route is 401k up to the match, then ROTH IRA contributions, then 401, 403, TSP, etc if you have anything left to contribute. The worst is deferred comp.
I would be ok doing 401/403/TSP up to the match and maxing Roths, then RE all the way. The back-door ROTH for higher earners is still an option, but a loophole I imagine will be closed at some point.
For high income earners, the tax deduction for contributions is obviously more of a benefit than for the rest of us. Hopefully when withdrawn, your tax rate will be lower.
Accountant · Lihue, HI · Member since 2016 · 52 posts · 24 votes
9y
I clicked on this post confident I was going to give some good, sound, financial advice.. but after reading the comments, I realized that I'm just a mere mortal amongst you Legends. Thanks to everyone for contributing their experience and knowledge. I learned a lot reading this comments.
15k out of your last three checks. That is a bad idea.
Like you, I don't believe in using the TSP as a method to build wealth. However if you insist on doing it, you should do it right.
The first 5% that you contribute to the TSP is matched by the government. If you contribute $5000 on three checks you lose out on the match for the other pay periods. Instead you should spread that amount out.
Why is that a "bad idea"? Employer-matching doesn't kick in until 1/1/2018 for active duty anyway. So I just put 50:50 to traditional:Roth TSP to get close to the limit since I haven't contributed in 2017 yet.
If you only have a short period to try & reach your max amount allowed for 2017 then you will have to do it this way for now. However, in the future you want to make sure you are investing using "dollar cost averaging". Buying a fixed amount on a regular schedule (monthly). This way when the market dips, you win because you are now buying more shares. This is the best way to win in any market.
Will do, thanks! What is your personal view on 401ks and for my situation? What do you think of the 50/50 trad./Roth TSP approach?
So starting next year, they will only match 5% of BASIC PAY. Incentive, special, bonus, etc. pays are looking like won't be matched.
The thing is, basic pay is only 35-40% of my total income currently. It would take me about 24% of BASIC PAY per month to contribute the $18K max. I am leaning towards just throwing 10% into traditional and 10% into Roth TSP of my basic pay.
I wanted to see your thoughts on this? This so called "5% match" isn't that good on paper as it may sound when you dig into it.
So starting next year, they will only match 5% of BASIC PAY. Incentive, special, bonus, etc. pays are looking like won't be matched.
The thing is, basic pay is only 35-40% of my total income currently. It would take me about 24% of BASIC PAY per month to contribute the $18K max. I am leaning towards just throwing 10% into traditional and 10% into Roth TSP of my basic pay.
I wanted to see your thoughts on this? This so called "5% match" isn't that good on paper as it may sound when you dig into it.
I'd do up to the match for sure, then if I am right at an income threshold for a lower marginal rate) I'd contribute to traditional to get just below that. Otherwise I would do roth tsp only. The match will have to be in traditional, but if you do the math roth will win after tax every time. For you at your age it will probably be a $3M decision. It will be like 80+% growth when you take it out. Want that taxed at whatever rate exists in 30 years or do you want it all tax free, with no minimum distribution requirements at 70.5 + the ability to pass it to your grandchildren. Potentially hundreds of millions. Do the ROTH if traditional doesn't bring you down a notch on Uncle Sam's ladder.
@Andrey Y. I'm not sure what your situation is but as a civilian working for the VA I get up to 5% of my ADJUSTED basic pay, which is the sum of basic pay and local market pay. VA matches dollar for dollar the first 3% and then 50 cents per dollar the next to 2%. Basically that equates to 4% of ADJUSTED basic pay. I know this for sure because I just looked at my pay stu.
Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes
9y
I don't have time to read all the comments but if you have a 401(k) your annual contribution limit is likely only $18,000 per year. It was mentioned that you should be contribution up to the match amount but some require you to be in the plan to receive any profit sharing contributions which may be worth looking into.
The traditional route for most doctors is that they received big pay checks, they try to defer taxes by putting as much into retirement as possible.
The fact that fellow physicians are telling you about making retirement contributions concerns me about your entire tax situation.... Your tax preparer should be talking to you about ways to defer taxes, whether it is a 401(k) plan or a defined benefit plan.
There is way to find a right answer on here because we don't know about your entire financial situation, if you don't have a tax person I would highly recommend a consultation to discuss what you may be missing out on.
@Andrey Y. I'm not sure what your situation is but as a civilian working for the VA I get up to 5% of my ADJUSTED basic pay, which is the sum of basic pay and local market pay. VA matches dollar for dollar the first 3% and then 50 cents per dollar the next to 2%. Basically that equates to 4% of ADJUSTED basic pay. I know this for sure because I just looked at my pay stu.
My situation is that I get basic pay, incentive pay, special pay, and bonus pay (for being an attending physician plus specific specialty bonus), and non-taxable housing pay. Like I said earlier, as a percentage basic pay is less than 40% of my salary. From what I've seen in documents re: TSP on google, only 5% of BASE pay (basic pay) is matched, Which is a bummer.
I've not sure that "adjusted pay" applies to us. I better get out soon and apply to the VA!
I don't have time to read all the comments but if you have a 401(k) your annual contribution limit is likely only $18,000 per year. It was mentioned that you should be contribution up to the match amount but some require you to be in the plan to receive any profit sharing contributions which may be worth looking into.
The traditional route for most doctors is that they received big pay checks, they try to defer taxes by putting as much into retirement as possible.
The fact that fellow physicians are telling you about making retirement contributions concerns me about your entire tax situation.... Your tax preparer should be talking to you about ways to defer taxes, whether it is a 401(k) plan or a defined benefit plan.
There is way to find a right answer on here because we don't know about your entire financial situation, if you don't have a tax person I would highly recommend a consultation to discuss what you may be missing out on.
You are right. I have been meaning to find a financial advisor that knows about the benefits of real estate, but is smart enough to see the big picture. I have seen "tax planning" consultations that charge $400-500, but they require a stack of documents. I am a pretty busy individual and not a fan of paperwork. So when I see that, I kind of pause. Isn't there a way I can just compensate someone for their time, and tell them what my situation is, # of mortgages, rental income, what I am doing for depreciation, AGI, etc. without digging up 15-20 documents including HUD-1s? I am not talking about having someone prepare my taxes, more a TAX STRATEGY and FINANCIAL PLANNING.