Thoughts on 401(k) vs Real Estate for Retirement?

Question

I am currently saving up money for a down payment on my first investment property. I plan to use real estate investing as my primary retirement nest egg and as cash flow to sustain me after retirement. I just graduated college and started full-time as an engineer, which allows me to save a good amount of money for a down payment. I have the opportunity to start investing in my 401(k) through my employer. Should I even consider putting money into my 401(k) or use that money to save up for my down payment?

I'm currently leaning towards skipping the 401(k) all together. Any thoughts from people getting started and experienced investors would be appreciated!

I'm currently leaning towards skipping the 401(k) all together. Any thoughts from people getting started and experienced investors would be appreciated!

Brian Eastman · Answer

@Stacey Agustin

I would strongly recommend participating at least at some level in your employer 401(k) plan.  This is especially true if the company provides any kind of match.  While the investment options of many conventional retirement plans are not amazing, as savings vehicles they have several advantages that will pay off in the long term.

If you are in a 30% tax bracket, then when you make a tax-deferred contribution to your plan, you can put $10K in as compared to putting $7K in your personal control after paying taxes on income.  That is an instant return on investment equal to your tax rate, and allows for a greater amount of capital to invest.  If your company does a match, that is also an instant boost to your starting capitalization.

If your plan offers a Roth component, you should seriously look at that.  You will not get the tax break, but building a Roth portfolio early in your career can have a huge impact on the amount of after-tax money you will be able to draw from your retirement plan when you reach retirement age.

You will likely change jobs somewhere down the line.  When you do so, you can take the tax-sheltered savings you have accumulated in your employer 401(k) and move that to a retirement plan of your own choosing.  You could then establish a self-directed IRA or 401(k) that could be invested into real estate.  So, over the longer term - the best of both worlds.

A conversation with a fee only financial advisor (a consultant, not a stock salesperson) would probably be very well worth your time, especially at this early stage of your career.  A few good decisions now can pay off huge with an early start.

Account Closed · Answer

Do both.  Your income will support this.

Brit F. · Answer

@Stacey Agustin, good on you for asking the question.  To decide how much, if any, to contribute to a company sponsored 401k plan, you have to ask yourself a few q's:

• The premise of a 401k is that, in retirement, the account owner will be taxed at a lower rate than they are now.  Are you planning to be in a lower tax bracket after retirement?If so, then contributing to 401k probably makes sense.If not, then 401k may not make much sense for you (unless it's a Roth 401k, but you didn't mention it, so I'll assume we're talking about a traditional 401k)Sidebar: Assume that all of your retirement income will be fully taxable.  Don't plan on including Soc Sec Income and its preferential tax treatment.
• If so, then contributing to 401k probably makes sense.
• If not, then 401k may not make much sense for you (unless it's a Roth 401k, but you didn't mention it, so I'll assume we're talking about a traditional 401k)
• Sidebar: Assume that all of your retirement income will be fully taxable.  Don't plan on including Soc Sec Income and its preferential tax treatment.
• If you contribute to 401k, could you put in enough to get your company's matching amount?  Everyone loves Other People's Money (OPM), and getting a company match certainly counts.
• Are you happy with the investment choices available to you?  If you like control, does your company offer a self-directed 401k (expands your options beyond the typical mutual funds)?Considering realistic returns of the available investments, can you beat the returns outside of a traditional 401k with REI?  (hint: the answer should be 'yes')
• If you like control, does your company offer a self-directed 401k (expands your options beyond the typical mutual funds)?
• Considering realistic returns of the available investments, can you beat the returns outside of a traditional 401k with REI?  (hint: the answer should be 'yes')
• Are you comfortable with 401k volatility?You could contribute enough to get the match, let's say 4% from you and your employer (8% total contributions), but your 401k loses 6% one year, resulting in growth of only 2%.During a good year, maybe it grows by 16% (=8% investment gain on your 4% contribution and 4% match).Alternatively, you could keep the entire 401k account in cash (not invested in any securities) and let it grow at the matching rate, guaranteed like a CD.
• You could contribute enough to get the match, let's say 4% from you and your employer (8% total contributions), but your 401k loses 6% one year, resulting in growth of only 2%.
• During a good year, maybe it grows by 16% (=8% investment gain on your 4% contribution and 4% match).
• Alternatively, you could keep the entire 401k account in cash (not invested in any securities) and let it grow at the matching rate, guaranteed like a CD.
• If you forecast out to retirement, based on what you plan to contribute, do you anticipate that your 401k will be your primary source of retirement income?  Or, will your 401k be only a small portion of your retirement income?  

If it's a small portion in your retirement, are you happy with that?
• If it's a small portion in your retirement, are you happy with that?

• If so, then contributing to 401k probably makes sense.
• If not, then 401k may not make much sense for you (unless it's a Roth 401k, but you didn't mention it, so I'll assume we're talking about a traditional 401k)
• Sidebar: Assume that all of your retirement income will be fully taxable.  Don't plan on including Soc Sec Income and its preferential tax treatment.

• If you like control, does your company offer a self-directed 401k (expands your options beyond the typical mutual funds)?
• Considering realistic returns of the available investments, can you beat the returns outside of a traditional 401k with REI?  (hint: the answer should be 'yes')

• You could contribute enough to get the match, let's say 4% from you and your employer (8% total contributions), but your 401k loses 6% one year, resulting in growth of only 2%.
• During a good year, maybe it grows by 16% (=8% investment gain on your 4% contribution and 4% match).
• Alternatively, you could keep the entire 401k account in cash (not invested in any securities) and let it grow at the matching rate, guaranteed like a CD.

• If it's a small portion in your retirement, are you happy with that?

--

Personally, I find company-sponsored 401k's too restrictive, and returns don't justify the risk.  Looking back, I feel like 20-something me was dupped into it.

Stepping on my soapbox, I abhor the stock market and want nothing to do with it...started out as a good idea, but it jumped the shark some time ago.  (I like Solo 401k's and SDIRA's, but that's not what we're talking about here).  Deep regret is what I feel about listening to the gurus telling me to max out 401k contributions early in career.  Now, I expect to continually grow my income over time, even in retirement, and will be taxed higher than I am today, which ironically, creates a desire to leave my W2 so I can access the 401k balance sooner rather than later.  If I left my W2 today, I would take a lump sum 401k distribution, tax penalty and all.

Craig Jeppesen · Answer

At least do enough to get the full match in the 401k. Do Roth and only stocks, not bonds and money markets. Use the rest of your disposable income to save up for properties. Maintain your standard of living and each raise put entirely into the 401k until you max out. Keep saving for down payments using the rest of your disposable income and cashflow from properties.

Darius Ogloza · Answer

After 35 years of investing and living through three market and one real estate crash,  I have learned that the key is to stay sufficiently liquid (so you do not have to sell during inevitable downturns) and diversify your assets so that you have eggs in more than one basket.  By all means, put some money in the 401(k).  Pick a good diversified equity fund from among the choices presented to you.  Include some small cap exposure.   You will not regret it.

Justin Windham · Answer

@Stacey Agustin

I would also recommend contributing to a 401k if your income supports it. The tax advantages can be powerful. Once you leave the employer, you can transfer those assets to a self-directed IRA or (even better) a Solo 401k, if you have self-employment activity. Either way, you would no longer be locked into the stock market with that money. 401k participant loan features can sometimes be helpful to get your foot in the investing door as well. Congrats on graduating and using your degree to earn money. It seems fewer and fewer people are actually successful in doing so nowadays.

Brit F. · Answer

@Weston Couch, converting to Roth 401k might be a good option for someone who 1) expects to taxed higher at retirement and 2) is comfortable investing in traditional securities.  I'm out on #2.  The other option I might consider is, after leaving my W2, roll the company 401k into a new Solo 401k, but let's not derail the thread with my quirks.

Back to the OP's question :)

Gordon Starr · Answer

Or, you could do like I did.  Contribute to the employer 401k enough to get a full match. Then when enough is available, borrow the downpayment from the 401k to buy your first investment, A house hack multifamily is what I bought. Then when you leave the company, cash out the 401k and sink it all into rei. I signed up for the irs installment plan at that point. Good luck, Gordon

Stacey Agustin · Answer

@Brit F. I appreciate your thorough response! I probably should have mentioned that the company I work for doesn't provide any sort of match. The retirement plan they provide isn't traditional. The way it works is the Board decides each year how much money they want to contribute to the "Plan," as they call it. From there, I'm not completely vested in that money until 6 years of being with the company. On the side, I can contribute pretax dollars, of which I would be completely vested.

I would have to completely agree with you on the 401k's being too restrictive and returns not justifying the risk. I feel like 20-something y/o's are being dupped into it as well, and want to avoid that regret of throwing money in there just because every traditional W-2 employee thinks it's the holy grail for retirement.

The reason why I leaned towards not using their plan is:

- I plan on retiring by 40 and imagine there's a big penalty for taking money out before 60. Additionally, I want to continually grow my income after retirement, which would put me in a higher tax bracket.

- They don't match and the amount of money they contribute is completely out of my control.

- Whether I contribute or not, they contribute to the plan allowing that nest egg to grow.

- Most importantly, I've opened up and maxed out a Roth IRA every year since 18 y/o, which has been open for about 5 years now and plan on doing that till 65. I figured that could be my dip in the stock market and diversifying my assets.

Thank you everyone for your responses!

Weston Couch · Answer

@Brit F. Ah, I hadn't realized you were still with the W2, I was specifically thinking of a Roth Solo 401k or Roth SDIRA so you can invest in real estate though.

Thoughts on 401(k) vs Real Estate for Retirement?

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