401k scam or not? Taking the plunge..

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401k scam or not? Taking the plunge..

Andrey Y.
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.

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Brian EastmanPro Member
Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
9y

@Andrey Y.

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.

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  • Account Closed
    Investor · West Los Angeles, CA · Member since 2014 · 230 posts · 239 votes
    9y

    @Andrey Y.

    I highly suggest you read the millionaire fast lane by MJ Demarco.  It's around $14 and you can get the audio version to listen on your phone.  It will give you a different perspective.  It's considered a cult classic FYI.

    401ks are addressed extensively and offers a counter opinion to the masses.  I try to be an independent thinker.  

    I wish you continued success in your investing.

    0Reply
  • Mike Dymski
    Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
    9y

    The employer match is the best investment vehicle on the planet (if you have a match).  

    Contrary to many posts on BP, retirement funds are available for withdrawal prior to age 59.5 as @Paul G. described well with the SEPP or through the use of a Roth conversion ladder (or by simply paying the 10% penalty...which is better than missing the match).

    Also contrary to posts on BP, many 401k plans are very low cost...mine sits in an S&P 500 fund with a 0.11% expense ratio.

    Nice post Andrey...good candor and sharing of ideas.

    0Reply
  • Michael J Perez
    Investor · Phoenix, AZ · Member since 2017 · 7 posts · 3 votes
    9y

    @Andrey Y. 

    The reason why most people end up with $90k in their 401k is because they are too busy keeping up with the Jones. Buying German sport cars and maui jims sunglasses. People in this country live for the now, just like how you talked about and that's why their 401ks look like garbage. Those people pay the piper in their later years and that is coined by the phrase. I cannot afford that, I live on a fixed income. 

    Important to always do the max contribution that your employers will match. Also it rarely makes sense to contribute to both a roth and a trad. It's pretty cut and dry based on income which one you should be contributing to. If you are a doctor now, trad might make sense to help you with some deductions if you are a teacher or member of the military roth often makes more sense. People get hung up on getting back the biggest refund check they can they don't think about the implications down the line. Such as when you have 3 taxable forms income in retirement (pension, SS, trad ira distributions. All of this advice should be taken with a grain of salt as I am not a tax adviser.  Consult with one before making any moves. 

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  • Andrey Y.
    OP
    Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes
    9y
    Originally posted by @Michael J Perez:

    @Andrey Y. 

    The reason why most people end up with $90k in their 401k is because they are too busy keeping up with the Jones. Buying German sport cars and maui jims sunglasses. People in this country live for the now, just like how you talked about and that's why their 401ks look like garbage. Those people pay the piper in their later years and that is coined by the phrase. I cannot afford that, I live on a fixed income. 

    Important to always do the max contribution that your employers will match. Also it rarely makes sense to contribute to both a roth and a trad. It's pretty cut and dry based on income which one you should be contributing to. If you are a doctor now, trad might make sense to help you with some deductions if you are a teacher or member of the military roth often makes more sense. People get hung up on getting back the biggest refund check they can they don't think about the implications down the line. Such as when you have 3 taxable forms income in retirement (pension, SS, trad ira distributions. All of this advice should be taken with a grain of salt as I am not a tax adviser.  Consult with one before making any moves. 

     I have owned two pairs of $300-350 "Italian" sunglasses. One I bought and one was a gift. Both got lost. Then I decided, I will only purchase <$30 sunglasses until I have $5M in the bank. Maui is great for surfing though!

    You gave a different suggestion for a doctor and a military member. People in the military and their families do get sick you know. They get pregnant. They get into car crashes, etc. I'm a military physician currently. Which is why I split it down the middle for traditional/Roth 401k. Is it really ""pretty cut and dry" - what would you recommend? My rationale was that if I take a job as a civilian my taxable income would double or triple, favoring a Roth now. If i decide to live of rental income and try something else while earning less, that favors traditional now.

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  • Andrey Y.
    OP
    Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes
    9y
    Originally posted by @Account Closed:

    @Andrey Y.

    I highly suggest you read the millionaire fast lane by MJ Demarco.  It's around $14 and you can get the audio version to listen on your phone.  It will give you a different perspective.  It's considered a cult classic FYI.

    401ks are addressed extensively and offers a counter opinion to the masses.  I try to be an independent thinker.  

    I wish you continued success in your investing.

     Gimmikiest title ever. But I'll check it out! :P

    I told you that my total 401k fees are and will be 38 basis points for the life of the investment. No additional fees. Is it really relevant that average 401k fees are 1%?

    People have explained on this thread the ability to convert existing 401k plans into self-directed plans which invest in real estate. Also, they have described ways to access your money early by Roth conversation ladders and SEPP plans. What do you think about that?

    I have had quite a bit of cash in a savings account for the last 5 years earning 0.10%. I did use it for investments, but I always had a surplus. This makes me think I could have been contributing to IRAs and TSP and growing it.

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  • Michelle Elsaid
    Real Estate Agent · Orlando, FL · Member since 2015 · 127 posts · 39 votes
    9y

    Here is an interesting article to check out: http://www.jamesaltucher.com/2015/08/401k-scam/

    But with all that said, I do have a 401K but don't plan to contribute later in my life after having more real estate. Only invest the minimum to receive the full company match. Any additional retirement deposits should be made in a roth IRA to maximize tax benefits.

    If real estate offers you better returns, you may not need a 401K if your RE income is enough to cover you at your planned retirement age.

    1Reply
  • Michael J Perez
    Investor · Phoenix, AZ · Member since 2017 · 7 posts · 3 votes
    9y

    Even though you are currently a physician getting paid relatively well. If you make less than $183k a year combined with your spouse I would say that ROTH probably makes more sense. However, when your income triples usually at that point you are looking to get a break now on taxes because it is assumed you will not be making 300-400k a year in a retirement. However, I have seen high earners who earn more than the $183k which prefer to do the backdoor contribution to the ROTH still because at all costs they want a tax free pot of money they can pull from in retirement. I would assume they plan having solid rental or business income and are simply planning ahead. There is no right or wrong answer here as everyone's situation is different. Also I know as military physician you probably do well in terms of allowances, special pay and what not but how much is taxed because that is what really matters if your AGI is 80 or 90 a year then roth definitely. The beauty of the roth is that at any time you can pull up to your contributions without any penalties or taxes. Obviously that is not the smartest thing but it beats paying 35-45% in taxes if you get into a jam.

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  • Michael J Perez
    Investor · Phoenix, AZ · Member since 2017 · 7 posts · 3 votes
    9y

    Also nothing wrong with having nice things, I will occasionally splurge. I have a nice home and nice toys. The key is finding a balance and it's a big AND earning a decent amount of money. You can't rub two nickels together and make a quarter. However, I see people all the time who spend well beyond their means. It was especially prevalent among military enlisted folks. I had a friend that was an e-5 and three kids, wife didn't work her and my wife would go to the mall she would rack up $500 bills on Michael Kors and other stuff on credit cards. I highly doubt he will have even $90k in his 401k by the time he reaches retirement. Working in the industry, I see the same thing every day; matter of fact greater than 90%. People are not diligent enough savers to get anywhere they want to be. My company matches 8% and yet employees there left 27 million on the book last year. So the problem is not the accounts themselves or market but its the folks who want to pretend like they are more well off then they actually are particularly through their spending and saving habits. People put money into investment accounts and expect it to be like the movies, wake up one day and have half a million. It doesn't work like that. People complain about 7 percent returns but what they don't understand is that 7% of a small number is a very small number. I consider 100 grand to be a small number in the grand scheme of things and even a 7% return there is only 7,000 but if you lucky, diligent and smart enough you get that balance up to $500k. Now that is $35k a year which is the average american salary for doing next to nothing.  So as others said before its not a means to get wealthy it is just another tool in the toolbox provided you can stomach the ups, downs and volatility. 

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  • Account Closed
    Investor · West Los Angeles, CA · Member since 2014 · 230 posts · 239 votes
    9y

    @Andrey Y.

    401k get the fees whether they make you money or not. Furthermore there are many other fees such as marketing fees, administrative fees etc. 1% may not seem like a lot but compounded over decades it adds up. As for self directed IRA I have one. I use it to private money lend. It's better than a 401k because you have control.

    Again all of this is my opinion and not fact.  However the fact that you're asking the question and not blindly jumping in because "everyone " says it's a good idea makes me think you're smarter than he average bear.  

    Watch "The Big Short" for a front row seat of what following "everyone " will get you.

    0Reply
  • Andrey Y.
    OP
    Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes
    9y
    Originally posted by @Account Closed:

    @Andrey Y.

    401k get the fees whether they make you money or not. Furthermore there are many other fees such as marketing fees, administrative fees etc. 1% may not seem like a lot but compounded over decades it adds up. As for self directed IRA I have one. I use it to private money lend. It's better than a 401k because you have control.

    Again all of this is my opinion and not fact.  However the fact that you're asking the question and not blindly jumping in because "everyone " says it's a good idea makes me think you're smarter than he average bear.  

    Watch "The Big Short" for a front row seat of what following "everyone " will get you.

     I hope you are actually reading my posts. I said that my 401k plan's total fees are 0.038%. If they were 1%, 0.5%, or even 0.25% I probably wouldn't contribute at all.

    I read the first part of "millionaire fast lane". So the secret to wealth is to develop a dot-com sensation web site or invent something? Come on! If my current 35-40 hour per week job pays >$200K, the opportunity cost of quitting that to pursue website design which probably has a 1/10,000 chance of earning a higher income, is insane.

    My rentals already cover most of my living expenses. I have never met a book I didn't like, but this dude cannot be serious?! Worse than an infomercial..

    0Reply
  • Jeff Filali
    Rental Property Investor · Broken Arrow, OK · Member since 2016 · 1k+ posts · 1k+ votes
    9y

    I just started my solo 401K last year, but for someone like yourself who doesn't need the investment income now, to me its a no brainer. It can lower your taxable income, lower your tax bracket, it gains compounding interest without taxation until taking withdrawals. My plan is continue flipping real estate through my LLC, and maximize my annual contributions to the 401K investing it 50/50 in buy&hold real estate and into the market.

    Of course I live a very frugal lifestyle compared to my income, have no debt other then primary residence, also drive a 12 year old SUV that I paid cash for 4 years ago, and don't really buy "stuff", and if I do its on sale, I use coupons, negotiate the price, take advantage of CC cashback, free shipping offers, etc.  I like to spend like I'm still broke!!

    0Reply
  • Andrey Y.
    OP
    Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes
    9y

    I was the biggest basher of 401k on this forum. I was just reading through this thread: https://www.biggerpockets.com/forums/109/topics/45...

    and there is no doubt I was as anti-401k as a human being could be. Here is one of my posts:

    "At the end of the day, you have no control of what you are investing in. A CEO of a company can make a major decision based on his wife having an affair with the pool boy, which affects YOUR hard earned money invested in that company.

    That's great that YOU can beat the market (~7% return)... but 93% of stock brokers who do it for a living cannot.

    After fees, taxes, inflation, and human emotion, the return on a mutual fund/S&P 500 index fund is 0%. Probably less. Stocks are mostly for those who have no creativity or skill, or would otherwise spend that money on bs. It's giving up in a sense. Why else would so many millions of people invest in something they absolutely don't understand NOR have any control over?

    Mark Twain once said "Once you find yourself on the side of the majority, it's time to pause and reflect". I am glad I got out if stocks when I had only $100K or less in them.

    My real estate investments return >30% annualized, are inflation protected (leverage), and have tax benefits that stocks cannot touch. Money you invest in the stock market is money thrown away that could have been used to improve your quality of life NOW, now when you are old. Too many people believe they will be energetic, mobile, healthy, or even alive when they are 64 1\2, and that's truly a pity."

    While a lot of what I said there does hold, I was mostly referring to investing in individual stocks or trading funds a lot. Sometimes, our data and plans change.. I need to be mature enough to accept that maybe there is some merit to be diversified across different asset classes. I cannot believe that I did virtually a 180 on this, but you live and you learn.

    2Reply
  • Account Closed
    Investor · West Los Angeles, CA · Member since 2014 · 230 posts · 239 votes
    9y

    @Andrey Y.

    Yes I've been reading your posts.  Once again I am stating my opinion and not fact.  I commend you for exploring different opinions versus just jumping in and investing.  If after your research you've come to the conclusion that a 401k is right for your than great.  As for the fees, like I said before a lot of them are hidden and higher than the stated amount.  Your fees may differ.   As for the book, it's one of my favorites.  Real estate is included in there and my interpretation is it's not an infomercial as he has nothing to sell.  But again interpretation is subjective (including mine).  What I will say is my path is right for me.  I'm an accredited investor and in 6 months I will be retiring at the ripe old age of 47.  Your mileage may vary.

    Good luck 

    0Reply
  • Brock Lile
    Castle Rock, WA · Member since 2016 · 58 posts · 23 votes
    9y

    What does your employer match? If nothing else, contribute up to the maximum they'll match. Otherwise it's free money left on the table. 

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  • Carol Bloom
    Scottsdale, AZ · Member since 2017 · 95 posts · 24 votes
    9y

    @Account Closed good for you to be retiring in 6 months under 50 that's fabulous! 

    1Reply
  • Andrey Y.
    OP
    Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes
    9y
    Originally posted by @Account Closed:

    @Andrey Y.

    Yes I've been reading your posts.  Once again I am stating my opinion and not fact.  I commend you for exploring different opinions versus just jumping in and investing.  If after your research you've come to the conclusion that a 401k is right for your than great.  As for the fees, like I said before a lot of them are hidden and higher than the stated amount.  Your fees may differ.   As for the book, it's one of my favorites.  Real estate is included in there and my interpretation is it's not an infomercial as he has nothing to sell.  But again interpretation is subjective (including mine).  What I will say is my path is right for me.  I'm an accredited investor and in 6 months I will be retiring at the ripe old age of 47.  Your mileage may vary.

    Good luck 

     That's really nice, and congrats!

    I'm in a similar boat (but I'm early 30s) and my real estate investments already cover my basic expenses. Plan is to work until 36-37 and then decide.

    I realized that the time I was spending on real estate I was highly underestimating. If my line of work pays $400-500 per hour, and talking to tenants and realtors and lenders for hours on end is probably a bad use of time.

    So I figure, diversifying into a different asset class that is totally passive can't hurt since it won't materially affect my financial independence and just provide more income down the line.

    Real estate as wealth preservation is nothing new. But the author of that book actually made his money via the dot-com tech route. Not realistic or a good choice for most.

    Good luck and keep me posted in the future! :)

    1Reply
  • Wil Reichard
    Rental Property Investor · Greenville, SC · Member since 2017 · 185 posts · 178 votes
    9y

    There are many hidden fees to a 401k plan. And yes it is pre taxed when you pull it out. But guess who sticks their hands back into your pockets when you're 59 1/2? Yep, uncle Sam. It is taxed when you pull it out. Either way when people say one if its "pros" is its not taxed, it actually is. Just later when you need it... Here's how I look at it. If you are not good with managing your money/have no other plan to save for retirement... Then this is a great way to built massive wealth in the future. If you are even fairly comfortable with managing the money yourself, there are 10 other ways to invest your money with a return greater than 3-4%. Any investor out there is better off without it. That is my opinion. You all make some sound points though.

    1Reply
  • Hau N.
    CA · Member since 2017 · 153 posts · 74 votes
    9y

    @Andrey Y.  You should consider putting your savings in a high yield saving accounts.  0.10% is so low compared to other online banks such Ally (1.20% at the moment).  

    0Reply
  • Tom Hertel
    Saint Paul, MN · Member since 2016 · 40 posts · 19 votes
    9y
    Originally posted by @Wil Reichard:

    There are many hidden fees to a 401k plan. And yes it is pre taxed when you pull it out. But guess who sticks their hands back into your pockets when you're 59 1/2? Yep, uncle Sam. It is taxed when you pull it out. Either way when people say one if its "pros" is its not taxed, it actually is. Just later when you need it... Here's how I look at it. If you are not good with managing your money/have no other plan to save for retirement... Then this is a great way to built massive wealth in the future. If you are even fairly comfortable with managing the money yourself, there are 10 other ways to invest your money with a return greater than 3-4%. Any investor out there is better off without it. That is my opinion. You all make some sound points though.

    Be careful there... Yes, there are plan fees, but those have nothing to do with taxes. First, 401k contributions is not both pre-taxed and taxed when it's taken out (tax-deferred): it's one or the other. Some employers offer retirement accounts where contributions are after-tax dollars (pre-taxed), at which point it is a Roth-401k and any earnings are tax free after that. Second, the tax benefits of tax-deferred 401k contributions increase for those in higher tax brackets (35% or 39.5% federal) because in retirement they will be in lower tax brackets and paying capital gains taxes (0-15%). It's hard to make the argument that paying taxes later is not advantageous since this is exactly how depreciation works in real estate. Finally, the S&P 500 has averaged about a 10% annual return since it's inception in 1928 (very similar to what hard money lenders make in today's market), providing a realistic passive investment for those not willing to put in the time that real estate requires. 

    1Reply
  • Wil Reichard
    Rental Property Investor · Greenville, SC · Member since 2017 · 185 posts · 178 votes
    9y

    @Tom Hertel Always enjoy hearing another point of view, thanks for that. I learn something new every day on here

    0Reply
  • Alex Lucille
    Investor · Seattle, WA · Member since 2017 · 19 posts · 8 votes
    9y
    +1 for the pro-401k column, $ in 401k can be accessed early it just requires some planning. It's actually possible to never pay taxes on 401k money if you are able to generate enough passive income, so if you are a buy-and-hold investor there is no doubt that you should be maximizing this option regardless of company match. Here is the full explanation: http://www.madfientist.com/how-to-access-retirement-funds-early/
    0Reply
  • Andrey Y.
    OP
    Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes
    9y
    Originally posted by @Alex Lucille:

    +1 for the pro-401k column, $ in 401k can be accessed early it just requires some planning. It's actually possible to never pay taxes on 401k money if you are able to generate enough passive income, so if you are a buy-and-hold investor there is no doubt that you should be maximizing this option regardless of company match. Here is the full explanation:

    http://www.madfientist.com/how-to-access-retirement-funds-early/

     I think I've read that article at least once, and it doesn't sink into my tiny brain. I guess that's why I invest in real estate. Hopefully by the time I'm 40 and will withdraw the funds, it will click then ;)

    0Reply
  • Dan ShelhamerPro Member
    Realtor · Mesa, AZ · Member since 2015 · 163 posts · 99 votes
    8y
    Originally posted by @Andrey Y.:
    Originally posted by @Dan Shelhamer:
    Originally posted by @Andrey Y.:
    Originally posted by @Anthony Gayden:

    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?

    Personally, I max out my 401K with the $18,000 limit and then my company matches another $3,000.  I constantly struggle with only wanting to put enough in to get the match from my company because my returns in Real Estate are 2-3x what I get on my stock/mutual fund returns.  However, I also don't want to have all of my money in 1 investment vehicle.  I consider my 401k as "icing on the cake" when I turn 60.

    0Reply
  • Charles H.Pro Member
    Rental Property Investor · Orlando, FL · Member since 2017 · 94 posts · 39 votes
    8y

    My company is giving a 6% match 401k. I used to do the 6% until I stopped a few months ago. Definitely something that most people would not do, but I chose to take the chance of using that extra 6% of my income for my endeavors. 

    Few reasons why:

    - I have done stocks and never felt confortable with them. My company pretty much offer some mutual funds. I don't like the fact that they just aim for an average RoR that I can't even control.

    - If sh*t hits the fan, I can't control anything.

    - If sh*t hits the fan, a real estate investment is a roof where you can live under. Stocks can just disappears. 

    - It's giving me a challenge and i am not following the mainstream. 

    - My manager told me he had 1 million $ on his 401k and he is a 56-year old engineer with still a lot of debts. It made me sad to see that kind of savings after 30 years of aerospace engineer work.

    So we will see where my strategy will go. Definitely I could have made money if I had not change my 401k investment this year, but I feel the stocks don't really make sense YTD.

    Happy success to all.

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