401k Max vs Real Estate

[cpadave]

Hello!

First post but long time reader and FI enthusiast.

Looking at planning for 2019 401k at my job and I’m struggling to know if I should max it out ($19k) vs put in the most to get my employer to fully match (6% they will give me 3%) and use the excess to invest in rental real estate.

I’m not new to real estate I have 6 units in my local city.

I’ve leaned towards less in the 401k because with real estate I’m getting non-retirement semi passive income, say in the range of 20% Roi. For me this would be the fastest route to FI but I hear so much about maxing the 401k, other than the current tax breaks (RE is tax friendly too) I’m not sure what the advantage would be. For what it is worth I could max the 401k but would slow the RE funds.

I’m 32 with $150k in retirement investments, paid off house, no debt other than rental mortgages.

Face punch away!

[Boofinator]

I'm not a real estate guy so don't know the ins or outs of the business, but 20% ROI will handily beat stocks long-term (even with tax breaks in a 401k (and maybe even with employer match!)). So you appear to be making the right decision for going real estate.

For those not into real estate or who don't feel they can get your projected returns, it is hard to beat a 401k for maximizing passive income.

[cpadave]

Thanks that was my mindset but wanted to run it past the forum to see if I was missing anything.

[FIREball567]

How did you get started? This is the next frontier for me to explore.


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[tralfamadorian]

What is your top tax bracket?

How confident are you with the 20% ROI? And that includes all expenses (vacancy, management, repairs, capex, PITIA)?

[Wolfpack Mustachian]

I'll start out by saying I know little of real estate. It's basically just a math problem. First of all, no offense, but the comment about it potentially being better than the employer match is silly. The worst employer match I've seen is fifty percent, which, of course, handily beats twenty percent. It seems from your comment thought that you aren't going below the match which is good. Other than that you'd just have to do the math. The stock market typically brings 10% over time. If your tax bracket is super high (30+%), it's more significant, but either way it's essentially increasing your investment in a more or less guaranteed fashion by reducing taxes. How reliable the real estate is at 20%, if that takes into account all costs and it's pure profit, and the tax status of real estate are items you would know better than me. Just my 2 cents.

[cpadave]

Yeah just a couple follow ups I never meant to make it sound like real estate is better returns than a match I was just wondering if I should do the minimum to get my full match (which I would always do) or go above and beyond and max out the 401k.

I do factor in all expenses in the re calc and I use leverage so real world examples would be somewhere around 35k to put down on 140k house that nets me 7k profit per year after everything. When I calculate a deal I’d factor in capex, vacancy, all of that. I’ve prpbably been slightly better than 20% due to no vacancy and no significant repairs in the 2+ years I’ve been a landlord. This is before tax breaks (depreciation) and loan pay down which are both in addition to the cash flow roi ive quoted.

Wife and I together will be around $175k plus being in NYS bracket would be around 30% taxes.

As for where to go to learn I’d be happy to chat with you. It depends on your goals l, real estate has so many options. Also BiggerPockets is a phenomenal resource where you can get all the info you’d ever need.

[tralfamadorian]

Okay; it just seemed like 20% is high but if you're getting that now and are confident you can continue to find those numbers.
However, depending on your goal FIRE tax bracket, maxing out your 401k first seems the way to go with that tax rate.

401k: 30% tax + 7% market returns - ?% expected FIRE tax bracket = 401k returns
RE: 20% returns + ?% depreciation reduces taxes on property income = RE returns

Personally, that's what I do. Max the 401k, IRA and HSA then contribute to the next down payment fund.

[Boofinator]

I'll start out by saying I know little of real estate. It's basically just a math problem. First of all, no offense, but the comment about it potentially being better than the employer match is silly. The worst employer match I've seen is fifty percent, which, of course, handily beats twenty percent.

No offense taken. 50% is a one-time deal, 20% ROI implies forever. If stocks return 10% on average, and assuming a 25% tax bracket, the real estate deal will come out ahead in about 12 years and diverge from there.

That being said, I wouldn't encourage the OP not to take the employer match, as 20% ROI is not guaranteed.

Edit to add: To be fair, I have been assuming the OP has implied a 20% annual ROI. This assumption could be incorrect, in which my numbers would be way off.

[Boofinator]

Okay; it just seemed like 20% is high but if you're getting that now and are confident you can continue to find those numbers.
However, depending on your goal FIRE tax bracket, maxing out your 401k first seems the way to go with that tax rate.

401k: 30% tax + 7% market returns - ?% expected FIRE tax bracket = 401k returns
RE: 20% returns + ?% depreciation reduces taxes on property income = RE returns

Personally, that's what I do. Max the 401k, IRA and HSA then contribute to the next down payment fund.

Though the tax break with the 401k is great, it is a one-time savings (as compared to compound returns that come with stock appreciation or rental income). You really need an investment timeframe to compare the two.

[Wolfpack Mustachian]

I'll start out by saying I know little of real estate. It's basically just a math problem. First of all, no offense, but the comment about it potentially being better than the employer match is silly. The worst employer match I've seen is fifty percent, which, of course, handily beats twenty percent.

No offense taken. 50% is a one-time deal, 20% ROI implies forever. If stocks return 10% on average, and assuming a 25% tax bracket, the real estate deal will come out ahead in about 12 years and diverge from there.

That being said, I wouldn't encourage the OP not to take the employer match, as 20% ROI is not guaranteed.

Edit to add: To be fair, I have been assuming the OP has implied a 20% annual ROI. This assumption could be incorrect, in which my numbers would be way off.

That is a good point that I hadn't considered. I guess I'm just being thrown by 20% annual gains. It's so insanely high (not doubting OP, just wow) that it makes my normal perspective on the finances of the situation a little wonky. As you said, I would have a hard time ever encouraging the OP or anyone to not get an employer match because it's totally risk free, but beyond that, it's hard to defend much else if OP's confidence is super high that 20% ROI is sustainable.

[Boofinator]

I'll start out by saying I know little of real estate. It's basically just a math problem. First of all, no offense, but the comment about it potentially being better than the employer match is silly. The worst employer match I've seen is fifty percent, which, of course, handily beats twenty percent.

No offense taken. 50% is a one-time deal, 20% ROI implies forever. If stocks return 10% on average, and assuming a 25% tax bracket, the real estate deal will come out ahead in about 12 years and diverge from there.

That being said, I wouldn't encourage the OP not to take the employer match, as 20% ROI is not guaranteed.

Edit to add: To be fair, I have been assuming the OP has implied a 20% annual ROI. This assumption could be incorrect, in which my numbers would be way off.

That is a good point that I hadn't considered. I guess I'm just being thrown by 20% annual gains. It's so insanely high (not doubting OP, just wow) that it makes my normal perspective on the finances of the situation a little wonky. As you said, I would have a hard time ever encouraging the OP or anyone to not get an employer match because it's totally risk free, but beyond that, it's hard to defend much else if OP's confidence is super high that 20% ROI is sustainable.

Actually, one slight correction. I would peg the immediate return of the 401k with match not at 50%, but at something like 167% assuming a 25% combined marginal tax bracket (=2*1/(1-marginal tax bracket)-1). Still loses over a long enough time period to 20% annual returns.