To 401k... Or Not??

Question

Dmitriy Fomichenko · Answer

@Tony Hoffer

Since you already have individual 401k plan established you can easily convert that into self-directed Solo 401k and use that for alternative investments. Yes you could pull those funds out of the 401k now to invest in your own name, but you will have to pay taxes and penalties on the amount you distribute prematurely which would not be wise thing to do. So it only makes sense to move those funds into self-directed account which will enable you to have virtually limitless investment choices.

You say that by "using 50% leverage in self-directed 401k diminishes returns"... Comparing to what? If you compare it with buying investment property using 100% cash - you are actually improving your returns because of the use of leverage. But if you are trying to compare this with buying an investment property in your own name using 20% down conventional financing you are comparing apples and oranges. The money is in your 401k not in your own name and conventional financing is now available there so this is a mute point. Funds are in your 401k and you need to look at ways you can put it to best use THERE (in your 401k).

Also keep in mind that buying investment property in your 401k is only ONE of the available options. You can do many other investments.  For example: you can become a private lender and be the bank for other investors or flippers and get double digit returns on your money without doing any work while your investment is secured by real property. And all incomes and gains that you generate as a result of this will be sheltered from taxes (not so if you did private lending outside of the 401k - all income would be taxes in the year you receive it).

In addition to this Solo 401k gives you the ability to invest via Roth. If you are OK with paying taxes now you can invest in a tax-free environment for the rest of your life! You probably have 20 years before retirement, think about how much your investments can grow over this period of time, tax-free! I think it would make sense to put some of your funds in the Roth bucket of your 401k.

And the loan feature of the 401k will give you the ability to access some of your funds should you have a need before retiring tax and penalties free.

I think you should work on building your personal investment portfolio which will provide you with immediate benefits, along with using self-directed Solo 401k which will be very powerful tool enabling you to build massive wealth over time.

Hope this helps.

Bryan O. · Answer

@Tony Hoffer if you want to own RE, then I wouldn't spend time doing it with a 401k. RE is the most tax sheltered investment in the US. Owning a tax-sheltered asset in a tax-modified vehicle seems a little silly.

I am a big fan of owning RE with "real money" rather than retirement funds. The 401k is great for private lending: funding flippers, other businesses, etc. Use the 401k money for investments that don't provide built-in tax mitigation.

Best of luck and happy investing!

Shawn Coverdell · Answer

I have this thought regularly. I toy with the idea of paying the early withdrawal penalty and taxes (huge). I can get some amazing deals with that money that cash flows NOW, not when I am pruned up sitting in a lift chair.

I can even see how the properties would surpass my 401K balance in a decade pretty easily.

But for now I am just dreaming. I continue to pay up to max matching which for me is 5%.  I suppose it is all that public education I got drilled with that keeps me holding onto a partial slave mentality.

But one of these days, gonna tap that sucker!

Justin Windham · Answer

@Tom Smith Although I agree, REI is a great suggestion for the potential returns and tax benefits, the hidden fees you mention aren't necessarily a 401k problem, but the a downside of certain 401k administrators and custodians that unnecessarily limit participants in their plans. A self-directed 401k can provide access to real estate and do so without the hidden fees. It all depends on the plan document and the fee schedule of the provider.

@Tony Hoffer I agree with recommendations to max out any employer match into a plan, if possible. The flexibility of those assets can increase greatly if you leave your job. You also want to check on the possibility that the plan allows for in-service distributions. It's not too likely, but if it does, you may be able to access some of the funds before you leave that employer.

Brian Eastman · Answer

@Tony Hoffer

Most of the responses to this thread touch on the key benefit of 401k contributions, which are the tax-deferral on the funds and the potential of an employer match.  Between the two, that is an instant ROI for your contributed dollars that is not insignificant, and probably better than the actual ROI produced by most real estate investments.

The investment options and management fees associated with most company 401k plans are a negative.  Yes, your own investments in real estate can probably do better, but if you stop putting money in the 401k, the additional after-tax cash you will have in your paycheck to redirect towards real estate will be a small fraction of what you are putting into the 401k.

In this economy, very few of us work for one employer for our whole career.  My recommendation is that you pump as much money into that 401k as your employer will match and build the capital in the account.  When you change jobs, you will then have a nice sum of cash in a tax-sheltered retirement plan that you can move to a self-directed IRA or Solo 401k.  Then you can control how the funds are invested and put them to work in real estate, private mortgages, etc.

Mark Nolan · Answer

@Tony Hoffer

Good question. You could always have your cake and eat it too. One option is to invest in real estate alongside your IRA or solo 401k (if you qualify for a solo 401k). For example, if the property costs $100,000 and you have $50,000 of personal funds, you could invest in the property under a tenants in common whereby your retirement account puts up $50,000 and you personally put up the other $50,000. All profits and expenses are then divided 50/50, so the 50% owned by you would be subject to capital gains and the other 50% owned by the retirement account would grow on a tax deferred basis.

Christos Philippou · Answer

I randomly have thoughts about stopping my 401k with my employer and saving that money to put towards buying another deal, then I realize that would be stupid (for me).

Every employer is different, but if I put in 6%, they put in 7.5. It's so much free money I am missing out on if I don't do it. I am super into real estate now, but who knows if I will be in 5-10 years. What if I hate real estate, sell everything, and don't look back. But the whole time, I wasn't putting any money into my 401k. I don't like the uncertainty, so I am going to continue to contribute until I retire.

Bryan O. · Answer

@Tony Hoffer For what already exists I leave it in the retirement account. Traditional contributions can be converted to Roth on years that you  are okay with the taxes and then it grows tax-free for the rest of the  time. One of my favorite things about getting my 401k converted and self-directed is for legacy wealth. One day when my wife decides I am not worth it anymore and has me die (by sheer accident) she will find my daughter now has a completely tax free business empire (granted, a small one) that she can leverage to do amazing things for the rest of her life.

For continuing contributions, in your scenario where you have no matching it is really up to you. If you prefer to lower your taxable income in that year,  put it in the retirement account and use it there. I do it because of the matching. I like to invest to change today (cash flow) and replace my W-2 income, so if I had no matching I would probably stop putting into the 401k and just dedicate that 6% to more investing.

It's really about long term personal strategy on this one.

Rick Pozos · Answer

Why not do both?? You can put money in a retirement account and invest in some real estate at the same time. The whole reason for investing is INVESTING. Nothing says that you can only do one or the other. It keeps life interesting when you do several things at the same time. Of course, you dont want to do too many things at once, but a few is always fun.

To 401k... Or Not??

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