Am I Missing Something? Maxing Out 401K

[MillenialMustache]

I am trying to figure out if I am missing something - I constantly see advice to max out your 401K after you no longer have any debt. I can, of course, see the general reasoning behind it (taxes and saving for regular retirement at 65 or whatever), but this is what confuses me - right now, I put in enough just for company match. The majority of my extra money goes to downpayments on rental properties. I have one now and almost have enough money for a second. We plan to have four total, and then once we have acquired them we are going to work to pay them off and at some point when we feel comfortable, retire. I am think this will be 5 years or less, by the age of 33. If we used the money to max out our 401K instead, I know there is a tax advantage, but we won't be able to use that money at the age of 34 without a huge penalty, will we???

Based on my readings of MMM, he did not max out his 401K, and did a mix of rentals and Vanguard. Why is the advice on here different - what am I missing??

Please help, and no facepunching - I am really trying to understand so I know if I am making the right choice for me.

[James]

Donations to 401k comes before taxes, so donations there reduce your taxable income. Because of that, it is usually the biggest bang for your buck investment wise.


If you taxable income is very small, the savings are less due to a lower tax rate and it may not matter that much.

[Gone Fishing]

401(k) funds can be withdrawn penalty free via an IRA ladder.  Read the ROTH vs Traditional link in my signature below:

[purplepear]

http://www.madfientist.com/retire-even-earlier/

You want to max your 401K to reduce your taxable income and have more investments that grow tax-free. Also, you can touch that money before you're old by setting up a Roth IRA Conversion Ladder. That's the basic idea.

[MillenialMustache]

Donations to 401k comes before taxes, so donations there reduce your taxable income. Because of that, it is usually the biggest bang for your buck investment wise.


If you taxable income is very small, the savings are less due to a lower tax rate and it may not matter that much.

That is helpful - maybe that is why I am not really understanding - my taxable income was $50,000 this year for married filing jointly. At what point would it make a difference - am I there or is it higher?

[catccc]

You max out a 401K because it is tax advantaged and there are multiple ways to tap into it before you are an oldster.  Someone here has already mentioned the roth conversion method.  there is also rule 72t, SEPP, or substantially equal periodic payments.  There are also advantages if you have kids and might apply for financial aid when they are college bound. 

[ohana]

I don't think it applies to your strategy.  Most people have no interest in having investment homes, though, so it's good advice for most people.

[rpr]

I am trying to figure out if I am missing something - I constantly see advice to max out your 401K after you no longer have any debt. I can, of course, see the general reasoning behind it (taxes and saving for regular retirement at 65 or whatever), but this is what confuses me - right now, I put in enough just for company match. The majority of my extra money goes to downpayments on rental properties. I have one now and almost have enough money for a second. We plan to have four total, and then once we have acquired them we are going to work to pay them off and at some point when we feel comfortable, retire. I am think this will be 5 years or less, by the age of 33. If we used the money to max out our 401K instead, I know there is a tax advantage, but we won't be able to use that money at the age of 34 without a huge penalty, will we???

Based on my readings of MMM, he did not max out his 401K, and did a mix of rentals and Vanguard. Why is the advice on here different - what am I missing??

Please help, and no facepunching - I am really trying to understand so I know if I am making the right choice for me.

The biggest thing about the 401k space is a use it or lose it proposition on a yearly basis. You cannot go back and fill previous years under contributions. Plus, there is a significant tax benefit depending on your marginal tax bracket. This may be quite significant. In my case in order to save $10k post tax, I need almost $15k in pre tax.

[rmendpara]

Not really.

You are maximizing most of your benefits by at least getting your employer's match. From there, it's a question of a few particular items. The biggest one is what your current marginal rate is. At 50k gross and married, not sure what your deduction picture looks like, but I'm assuming you're already in the 15% bracket federal/

Either way, you've got a good case to do your real estate thing. Given the leverage and local nature of real estate, you really can't compare that to investing in stocks/bonds (regardless of 401k or taxable account status).

Your plan doesn't seem too aggressive, although you haven't provided all the details. If anything, try and come up with a good split between your real estate investments and stocks/bonds, maybe half of each as a long term target? You may be real estate heavy in the next 5-10 years, but likely a good idea to consider diversifying once your cash flow starts to build, as opposed to tying up all your cash in home equity.

[FrugalShrew]

I believe MMM actually does advise maxing out your 401(k): http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/.

[JLee]

I believe MMM actually does advise maxing out your 401(k): http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/.

Yes, but--

So while I still advise maxing out any tax-deferred savings accounts like the 401k, you’ll also need to invest elsewhere simultaneously. My own strategy was in Vanguard index funds, a paid-off house, and some rental properties, but you will surely find other places depending on your own interests.

If I recall correctly, MMM was pulling six figures himself alone, plus whatever his wife made. That makes it a lot easier to max a 401k while also paying off a house and buying rental properties. :P

[TN_Steve]

I am trying to figure out if I am missing something - I constantly see advice to max out your 401K after you no longer have any debt. I can, of course, see the general reasoning behind it (taxes and saving for regular retirement at 65 or whatever), but this is what confuses me - right now, I put in enough just for company match. The majority of my extra money goes to downpayments on rental properties. ... what am I missing??

Please help, and no facepunching - I am really trying to understand so I know if I am making the right choice for me.

Max out is a general rule.  Doesn't necessarily apply to people with crappy plans, for example.  I think you also may be an exception to the rule.  As someone else noted, not everyone is interested/able, or has the time to do rentals.  If I were in a 40 hour a week job (and a different tax bracket), I'd give serious thought to doing what you describe and not be so concerned with maxing out each year.

[snshijuptr]

The thinking with tax-deffered plans goes something like this:

X = Your current highest tax bracket
Y = Your retirement highest tax bracket
X-Y = automatic return on your money

So let's say that right now you are in the 15% tax bracket, but when you retire, you will only pay 10% on your highest dollars. So that means that if you can put off paying taxes, you effectively get an automatic 5% return on your investment.

BUT this doesn't take into account the time value of money and opportunity cost.
A = rate of return on rental properties
B = rate of return on investments
I = Inflation
FV = Future Value
PV = Present Value
FV = PV(1+A-I)^t

So for $18000 invested in a 401k (8% return) for 6 years it would be
FV = 18000(1+.08-.03)^6 = $24121 or $964 per year (following the 4% rule)
FV*(1-Y) = $21709

For $18000 minus taxes would be $13770 invested in a rental property (15% return) for 6 years
FV = 13770*(1+.15-.03)^6 = $27179 or $2065 per year (from 15% ROI)

So substitute in your ROI on those rental properties and you'll get a better idea. This also assumes you are depreciating all of your income from your rental property or include taxes in your rental ROI calculation.