Input Please - Pay off our Rentals or Contribute to our 401K's ?

Question

We have six rentals. Both of us are W-2 employees within 10 years of retirement at 67. One employer matches 401K contributions for first 6% at 50% match. The other employer offers No Match at all.

We had each been contributing to our 401K's to the max to shield some of our income and grow the 401K's, so $24K x 2, or $48K per year combined was going in.

Recently have thoughts of dumping the contributions to Employer No Match, and putting those funds towards paying off rentals, one at a time. Contemplating doing the same with Employer who matches, but contributing just to what they will match.

Thoughts?

We had up to 14 rentals, and are comfortable with the 6 we have left, so are not looking to purchase more.

Keli A. · Answer

Thank you for the input/suggestions @JimBlackburn and @AllenFletcher. Your posts, together, are very intriguing. This investors strategy might be something to consider; we've used helocs/cash out refis in the past to purchase more rentals. They hadn't been available here for some time, since the crash in 2008. So good to gather info from such a diverse group here!

Allen Fletcher · Answer

@Keli A.I sat down with an investor and he shared this bit of wisdom with me. This investor holds hundreds of properties and has been in the RE industry for 30+ years. He pays of the mortgages on his rentals completely and then picks a certain number each year that get refinanced at half of their value. In other words a property worth $100k is refinanced or a HELOC is pulled for $50k. He then lives off of the cash pulled out of the property and throws 100% of rents at the loan until it is paid off. As he says the cash pulled out is tax-free and the rental income is used to pay-off the debt so he is able to live at a lower tax bracket while still "making" $100k per year. I have not looked into this strategy much as I am in the accumulation phase and he is well into the retirement phase of the RE game, but you may want to look into this type of strategy as it could be beneficial to you.Regards,Allen Fletcher

Jim Blackburn · Answer

Keli A. If you payoff your rental, your equity inside the house earns a net internal rate of return of exactly 0%. If you'd like to keep your equity making more than 0%, then you invest it. Your desired return determines your risk tolerance, and thus investment vehicle choice. Looks like you are Realtor and so you personal expertise in the field could make investing in real estate and lower risk (more informed) investment choice than investing in the stock market. With real estate, you have more leverage. With just 25k for example, you might control 100k of assets. If you make 10% on 100k asset, you just made 10k. With stocks / mutual funds (unless you are using a margin account, Complex, and not discussing here), your 25k investment only controls 25 of assets. So to make the same 10k profit, you would need to make a 40% return on 25k!!

George Blower · Answer

@Keli A.If you think your nest eggs are a good size and will keep up with inflation, then paying off rentals may be in order to also grow your capital gain assets.

Thomas S. · Answer

Where do you see any advantage in paying down a rental property mortgage. The only return on it is the present day extremely low mortgage rates. Might as well keep it under your mattress in case of an emergency.Realistically investing it anywhere other than in a rental mortgage will generate a higher return.As your equity in a rental property grows it turns your investment from a asset to a liability due to the opportunity value of cash. In most/all cases it causes negative cash flow on the investment property. At that point it is no longer worth holding the rental since the property itself is no longer generating any income. The property is simply a maintenance money pit.Rentals, in order to generate the highest returns, should be leveraged to the maximum and the cash put to work, like children in a Asian sweat shop, to work earning it's keep.

Keli A. · Answer

Thank you Brian, Tom and Austin. :)I have a feeling that in speaking with our CPA, he will bring up the same points you've all listed, and then of course tell us it's a personal preference.Definitely understand we'd be taxed at our current bracket of 25%, but am not sure it would push us into another bracket, would have to check.Austin, current rate of return on the 401K is 4.85% for the past year, so not great.Am not a fan of the stock market, too many moving parts in the current environment. Not sure where we're headed there; definitely more volatile/fussy than the rentals. Rentals will be income-producing during retirement, can we say that about a 401K? When the funds are gone, I believe they're gone.....Rent payments keep coming in.Will call our CPA for a sit-down.Thanks again!

Austin Fruechting · Answer

What are you making in the 401k and what interest are you paying on your investment loans?I would think dumping it into 401k and letting it grow, especially with the match, would put you further ahead than paying off a 5% loan.

Tom Spaeth · Answer

Really a personal decision. Possibly good to review with a CPA that is familiar with Real estate. I would probably keep contributing to the Matched 401K. You automatically get a 3% return the first year which is nice. I would be very tempted to take the other 401K and start dumping into the house with the lowest mortgage and pay them off one by one. Paid off houses end up being a great annuity. The down side is you will be paying taxes at your highest rate on that money. Unknown how Trump will affect that. Of course then you will lose access to the cash because it will be locked up in a house. There is no clear cut answer I see.

Brian Eastman · Answer

@Keli A.It would take a bit more analysis and a discussion with your CPA or financial planner would be a good idea.The advantage of the 401k contributions is tax reduction and essentially an initial return on investment in the amount of the employer match and your marginal tax rates at the state and federal level. Even if the performance of the investments is somewhat lackluster, that front end boost can be very worthwhile, especially if the reduction in income from the contributions keeps you in a lower overall tax bracket.When you are 59 1/2, you will have the option to transfer some of that 401(k) money to a plan of your choosing. At that time you could establish a self-directed IRA and invest that tax sheltered money into additional rental properties.