401K at work or rental property?

Question

I was listening to the Lifestyles podcast and he said that people investing in real estate should not invest into their works 401K but invest in rental properties.

Lets just throw an example out there. If you were looking to buy your first or second rental house/duplex etc and you were at a $40,000 per year job where your company matched .50 on the $1 up to 6% (I use these numbers b/c talking to several friends this is about what is offered in my area)

Do you take the free .50 on the $1 and invest in your 401k or do you take that money (lets assume that you can be dedicated and actually put that money back) and use it to grow your real estate portfolio faster.

Brian Eastman · Answer

@Brandon Holtzinger

This is a good question and one we hear frequently here at BP and with clients contacting our firm regarding self directed IRA & 401k plans.

An employer 401(k) has its limitations, and most of us who invest in real estate know we can do better than what wall street investments provide.

However, Chris Soignier hit the nail on the head.  That 401(k) match is effectively a risk-free 50% ROI.  So, if you can participate in an employer 401(k) and get a match, that is one of the best things you can do for your future financial well being.

In addition to the employer match, you are also effectively getting a match from the state and federal government equal to your marginal tax rate, since contributions to the plan are tax deferred.  Likely for every $1000 you could put in your 401(k), you would see the equivalent of $350-400 of after tax funds you could use to invest with if you opted not to participate in the 401(k).

At some point, you will change jobs or retire.  At that time, you can then rollover the funds from that 401(k) into a self directed IRA or 401(k) that you can use to invest in real estate on a tax-deferred basis.

A good wealth planning strategy is to have multiple strategies or streams of income.  If you can invest in real estate personally, that is great, and one of the best ways to put yourself ahead.  You should also have a retirement plan and take advantage of a company match and the tax-deferral on contributions and the income the plan receives.  If at some point you have the ability to invest that tax sheltered retirement savings into real estate and get better returns than you can from the market today, great.  By aggressively contributing now, you'll have a nice big lump of cash in that 401(k) to invest with in the future.

Robert Leonard · Answer

@Brandon Holtzinger here's how I would calculate the two options to make my decision.

40k income with a $.50 per $1 match, up to 6%

Plan A.  Capitalize on the 401k

6% of 40k= 2,400 x 1.5= $3,600 (to invest in whatever options are in the 401k plan)

Plan B. Skip the 401k and invest outside of the tax shelter

2,400 gets taxed at 25% for a person with 40k income and that leaves $1,800 to invest in whatever you want.

Decisions, decisions ...

Walt Payne · Answer

And then there is the possibility of using the Roth option with either of the above mentioned strategies, which creates a whole other set of possibilities in reference to future tax laws.

Get out your crystal ball and decide what to do, lol.

Account Closed · Answer

These threads are great at identifying the members with tunnel vision.

Brandon Holtzinger · Answer

I have mine set up at the minimum just to get the match and then we are putting the rest back for RE. It seems like nobody is really arguing against that.

Chris Soignier · Answer

We also max out our annual contributions to our Roth IRAs'....doesn't seem to be any real downside to doing that, since we could always access the money for alternative investments if necessary.

Chris Soignier · Answer

I use the Roth option for 100% of my 401K funding nowadays.    The way I see it, I get a bigger match (on after-tax vs. pre-tax $), have more control of my money prior to age 59.5, and won't ever have to pay taxes on those funds again as long as they earn within the Roth.

Walt Payne · Answer

I get to have my cake and eat it too ;) My employer uses a Simple IRA plan, which includes 100% matching for up to 3% AND it gives me total control, including the ability to immediately transfer the money into my solo 401k.

But I agree that taking the match, and using the investment as a means of diversification is still a good idea. That is why I do not withdraw all of what I put into the IRA. It still allows me to easily funnel income into my solo 401k that I would not otherwise have available there, by replacing the "lost" income with investment income generated outside the 401k.

Chris Soignier · Answer

It's not quite that simple, b/c you need to factor the ordinary tax hit (regardless of whether the earnings were ordinary, LT cap gains, dividends, etc.) of the distributions you'll eventually take.    Where do you think tax rates will go from here?

OTOH, earnings on the $1800 could be highly tax advantaged and deferred indefinitely if you execute an effective tax strategy.

Regardless, I'd still opt to take advantage of the full match, but invest no more than that into a 401K.

Kyle Hipp · Answer

I still work my day job. I have a healthy match with my employer 401k plan and they also offer a ROTH 401k. I put 10% of my pay into my traditional 401k which more than qualifies for the full company match. I also put 3% into the ROTH 401k. I want to have a huge retirement account in the most effective way possible. The benefits of having a large retirement account is that it serves as reserves for my funding requirements. I also have options a couple years down the road when I retire. It would be great to leave as a pure retirement option. It is also possible to transfer to a SDIRA or in the worst case cash out if needed.

401K at work or rental property?

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