401k vs Real Estate – Which Is Best For Retirement?

401k vs Real Estate - Which Is Best - F

401k vs Real Estate – Which Should You Invest In?

For the first part of my career, I invested the traditional way that most of us do in the stock market with a retirement plan.

I did this because it was all I knew to do and also how most of the millionaires in the books, The Millionaire Next Door, The Automatic Millionaire, The Latte Factor and Everyday Millionaires gained a seven figure net worth.

Now I realize there’s multiple different investing options but I feel that we can boil them down into one of three categories:

  1. Traditional investments – 401k & IRAs (SIMPLE IRA, SEP IRA, etc.) using stocks, bonds and mutual funds. With this method, you invest over the course of your career (mainly with a financial advisor) and don’t start accessing funds until retirement with hopes of never running out of money. You mainly rely on compound interest to make your money grow over a long time period.; usually 40+ years. Again, this is how I used to invest until I learned about investing for cashflow.
  2. Non-Traditional investing – With this method, you don’t have to wait 30-40 years to begin using your money. An example would be investing in cash flowing real estate such as multifamily syndications. Once you purchase enough to cover your monthly expenses then congratulations, you’ve reached financial freedom!
  3. Combination investing – This would be a combination of #1 and #2 above. This is what I’ve currently shifted towards.

Pros & Cons – 401k vs Real Estate

When researching information for this article, there were many pros and cons to both investing in a 401k vs real estate. It’s ultimately going to come down to…YOU.

Most people invest in what they’re most comfortable and knowledgeable about. Also, you should have a list of financial goals to help navigate the road to success.

When I talk about success, it’s what your definition of it means to you and not anyone else.

For some, they may have a goal of working until they can’t work anymore and are content investing in a 401k their entire career. That’s OK if it works for them. 

For others, they may want to experience retirement earlier and work on their own terms when they become financially free using investments such as real estate for cash flow.

Neither of these options are wrong, it’s all about you, your risk tolerance and goals.

Let’s take a look at the pros and cons of 401k vs real estate investing so you can make the best decision for yourself.

401k Pros

Tax Breaks When You Contribute

Similar to investing in a Health Savings Account (HSA), annual 401k contributions are tax-deductible unless you’re investing in a Roth 401k (see below).

What this means is that you’re allowed to deduct the amount you invest from your taxable income. This is especially helpful as being a high income earner, your tax rate will be sky high and your tax bill is going to be one of your largest annual expenses.

Roth Conversion

Some companies allow the option of investing in either a Roth 401k or IRA. If your self-employed and own a practice, this can be set up for you.

When contributing to these types of accounts, the money is taxed BEFORE going in and you’re not allowed to take a deduction. The good news is that when the money is taken out, you pay NO taxes at that time.

You can also perform a Backdoor Roth Conversion.

A backdoor Roth is simply a conversion of money in a traditional IRA to a Roth IRA. Currently, anyone can convert money that they have put into a Traditional IRA to a Roth IRA, no matter how much income they earn.

All of this works because, in 2010, the federal government removed the income limits for IRA conversions, creating a Roth IRA loophole. Of course, you’ll need to get the mechanics right. Consult your accountant and/or tax attorney if you have any questions before doing so.

High Contribution Limit

For 2021, the annual contribution limit for a 401k, 403b, and Thrift Savings Plans is $19,500. If you’re reading this article, more than likely you’re a high-income earner and a good idea would be investing at least 20% of your income each year.

For instance, someone making $200,000 should aim to invest $40,000 a year or more.

Investing in one of these retirement accounts can get you halfway there in this example.

Matching Contributions

I had a conversation recently with a new teacher regarding her 401k. Her employer, along with many others, offer some type of match which is basically free money. In essence, when she puts up money, they do too.

There are two main types of matching contributions: Partial and Dollar for Dollar Matching

Partial Matching

If your employer offers partial matching, typically they’ll match part of the money you invest, but not all of it. Usually it’s up to a certain amount.

One of the most common matches is 50% of what you put in, up to 6% of your salary.

In other words, your employer matches half of whatever you contribute, but no more than 3% of your total salary .

This is what my teacher friend’s employer offers. So in order for her to maximize the match, she’d have to put in 6%. If she wants to put in more, say 9%, her employer is only going to put in 3% because that’s their match.

Dollar-for-Dollar Matching

This type of matching is self-explanatory. When someone puts in a certain amount into their 401k, their employer matches it. Similar to the partial matching, but up to a certain amount.

Here’s what Dave Ramsey tells a caller that has debt but wants to know if he should contribute to a 401k in which his employer offers a match:

Now let’s move on to the downside on 401k investing.

401k Cons

Higher Taxes on Profits From Your 401k Investment

As mentioned earlier, your taxes are deferred when you invest in a traditional 401k. As nobody can predict the future, you will not know the tax bracket you’ll be in when you do decide to retire.

If you end up in a high tax bracket, the taxes on your profits could be higher than expected.

Less Flexibility

Typically, when investing in a 401k, your choices are limited. Most employer-sponsored plans are short on options especially if you’re looking for choices that are outside of the basic asset classes of stocks, bonds and cash.

Early Withdrawals

A major disadvantage of locking up your money in a retirement account, such as a 401k, is that you’ll be penalized for taking it out early.  This especially affects those that want to retire early and will need the money sooner than later.

Even if you’re experiencing a financial hardship and have to take money out early, you’ll still be penalized.

rich-dad-poor-dad-robert-t-kiyosaki

Here’s what Rich Dad Poor Dad author Robert Kiyosaki has to say about investing in a 401k:

The 401k is a Horrible Retirement Plan

There’s isn’t anyone that I know of that’s more anti-401(k ) than Robert Kiyosaki. One of his main concerns is regarding the lack of control.

He states, “You literally hand it over to a manager and hope that it will grow. Want to access your money? You can’t, at least not without a hefty fine.  And if the market crashes? You’re out of luck because there’s no insurance for a 401(k).”

Another problem he routinely discusses is regarding the fee structure. He’s big on educating others about how the manager’s fees will cut significantly into your earnings. 

Once you add up all these fees, they can come close to almost 2% off the top. 

The last reason he states that this type of investing is not good for most has to do with taxes. There are significant tax disadvantages to investing in 401(k)s.

Rather than taxed at the lower capital gains rate of around 15%, they are taxed at earned income rates, which can be twice as much.

Pros Of Real Estate Investing

Ability to Leverage

Successful real estate investors know that leveraging property is one of the major advantages of why they invest in the first place.

As equity grows in rental property, you’re able to leverage it to continue buying more.  This would be difficult to do within a retirement account.

Depreciation and Tax Advantages

One of the main reasons I started investing in real estate was to take advantage of the tax benefits. They’re awesome!

The government encourages us to invest in real estate as they offer tax breaks for things such as property:

Also, rental income is not subject to self-employment tax.

Appreciation

One of the most important aspects of real estate investing is location, location, location. If property is bought in the right location, then you can expect the value to increase.

Once you’re ready to sell, this appreciation allows you to make even more profit beyond your rental income.

Build Equity

One of the top reasons investors buy real estate in the first place is they know their tenants are going to pay down the mortgage and expenses.

What this does is allow them to take care of the mortgage payments with OPM (other people’s money) and also build equity at the same time.

Take Advantage Of 1031 Exchange

Section 1031 of the Internal Revenue Code allows you and me, the taxpayers, a way to defer taxes by exchanging one property and replace it with a like-kind property.

Basically you’re able to take all of the proceeds from the sale of one property and buy another and the taxes on the transaction are deferred.

Passive Income

Without a doubt, one of the greatest benefits of real estate investing is the passive income generated. Whether you’re an active or passive investor (like me), you’ll still be able to enjoy this stream of income.

Also, if you’re currently working and don’t need to use the income now, you can save it for future investing.

Cons Of Real Estate Investing

Real Estate Can Be Time Consuming

One of the main reasons passive investors avoid actively owning real estate is the time commitment being a landlord requires.

I have several friends that own single family homes, apartments and even storage units. They’re constantly complaining about the amount of time it takes to maintain them such as keeping them  occupied and performing regular maintenance.

Long-term Investment

Whether active or passively investing, real estate investing should be approached as a longer-term strategy. If you need money quickly for an emergency, you’re not able to liquidate your investment for cash. It takes time to sell a property if you’re actively investing.

For those investing passively such as in syndications, there’s typically a 5-7 year hold time on your investment.

Active Investing Can Be Problematic

The #1 reason I chose to not actively own property at this stage of my life was to avoid dealing with tenants. If you’re an active investor, you know what I’m talking about.

Tenants are humans (at least I hope they are) and humans can cause problems. For instance, one of the biggest problems you can run into are those that decide to not pay their rent.

The cash flow on the property can take a major hit especially if they move out leaving the property in a poor condition which require more money to repair.

Recently the anesthesia nurse I work with each week (who’s also an active investor) told me she recently received a call from one of her tenants at 1:30 AM.  Not good. Her tenant informed her that the hot water heater burst and water was going everywhere.

The worst part was that my nurse’s husband (who could have fixed the problem) was out of town. So she had to handle the problem her self and still get up to work the next morning.

Doesn’t sound like too much fun does it?

Risks Are Involved

Whether you realize it or not, any type of investment comes with its share of risks. Real estate is no different. There’s always a risk of losing money.

When I first started passively investing, I didn’t know what I was doing. I was putting my trust in a website that was supposed to only advertise the best properties available to passively invest in.

Now, after losing money during one of those deals, I’ve come to realize the risk involved if you don’t understand the investing process.

Which Investment Strategy Wins?

Now that we’ve discussed the pros and cons of both real estate and traditional investing, which is best?

According to Sam over at Financial Samurai, he likes investing in real estate over saving in a 401k.

The best strategy for you is…well it depends on YOU.

What’s your long-term vision or goals?

Do you have an Investor Policy Statement? The Physician On Fire claims you should, and he’s right.

If not, consider creating one. It’ll help you define your goals and the strategies you intend to implement based on your preferences.

Again, it’s all about what’s best for you. Not your buddy you eat lunch with on Tuesdays.

Bottom Line – The Hybrid Approach

For me personally, I take a hybrid approach. We max out our retirement accounts in index funds to take full advantage of the tax deductions they offer.

It’s also an easy method to become an “Automatic Millionaire” with a “set it and forget it” approach.

After we max out these accounts along with the kids’ 529 plans, any left over money goes toward investing in syndications.

Most of the deals I invest in are for accredited investors requiring a minimum of $50,000- $75,000. I save extra money on a monthly basis in a Vanguard money market account until I’m able to invest in these types of deals.

This is why I call it a hybrid approach:

  • some in traditional retirement funds
  • some in real estate

If you’re considering taking advantage of more income producing investments other than stocks and bonds, you may want to consider real estate as you’ll be able to potentially retire much earlier than expected.

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jeff@debtfreedr.com
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4 responses to “401k vs Real Estate – Which Is Best For Retirement?

Satish R Iyer

I agree with the hybrid approach of investing in real estate as well as stock market products at the same time. It really pays to be opportunistic and move the money from one to the other.

Currently, my money is flowing mainly from the stock market into real estate because the stock market is too over-bought and toppy, while the real estate market is getting ready to bounce back from COVID. So I’m taking my profits and ploughing them into real estate.

jeff@debtfreedr.com

I think that is a GREAT strategy to have now.

Brad

Jeff,

How does the 1031 exchange work for multifamily syndication? My understanding is that it’s much, much harder to take advantage of vs. a SFR property. How are you minimizing your capital gains tax within your syndication investing once the property sells in 5-7 years? Thanks.

jeff@debtfreedr.com

Here’s a couple of articles regarding 1031 exchanges:
How to use a DST for a 1031 exchange
What is a 1031 exchange?

And yes you’re correct, it’s more difficult when dealing with syndications. I do think it will get easier over time though.

Minimizing capital gains with continuing to regularly invest in syndications. Then carrying the losses forward and using those to help offset the gains.

I have a GREAT Real Estate CPA that handles that though.

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