Author Topic: Should I open up a 401k?  (Read 3615 times)

Guizmo

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Should I open up a 401k?
« on: October 09, 2013, 10:14:25 PM »

Hi folks, new to mustachianism but not to being frugal. I am also fairly young at 24.

Income:

$2150 - Monthly Salary after tax, pension contribution and healthcare
$300 - Second job
$650 - Rental Income from Condo

Current expenses:

Living at home, so fairly low

Monthly:
$1000 - Condo Loan
$55 - Verizon PrePaid Unlimited Plan
$164 - Condo HOA
$9 - Public Radio donation
$40 - Miscellaneous auto expenses, oil changes, saving for auto stuff
$150 - Beer, going out

Yearly:
$180 - Condo Insurance
$200 - Yearly gym membership
$400 - Car Insurance
$100 - Donation to local school

Assets:

1 bdr/1bath Condo - Paid $35,000, probably worth around 45k
Bank Account - $7000
Cash on hand - $2000
Car (estimated value) - $5000
Owed $5,000 by my parents business

Liabilities:
Personal loan on condo - $11k left, i paid a flat 2k interest on a 15k personal loan from family friend
Family loan - 8k, will pay 5k once my folks pay me from their business,
No student loans or credit card loans

Specific Question(s):
A quick point of clarification, I pay $1000 towards the personal loan on the condo. I will finish paying it off with a lump sum this December due to the contract that I signed  with the family friend.

 Should I open a 401k at my job or should I save towards buying another condo next year in the range of 40 to 45k? More details. My employer takes 8% of my paycheck towards a pension that I don't think I will qualify for since I don't see myself working 5 years here until I vest into the plan. Therefore, they don't match anything into the optional 401k. I do believe I am able to take out the contribution and move it to a 401k if I leave the job before I vest. If I choose to buy another condo next year, I would likely save 20k and look towards borrowing another 20k as I did this year.

I am leaning towards buying another condo and renting it out because the passive income I'm earning through the first condo is way more of a return than i think I could get in the market. Since I am fairly young, I don't think I should really worry too much about the 401k, especially since the return on my first real estate investment has been amazing.They say it is better to be risky when you are young. What do you all think?

Guizmo

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Re: Should I open up a 401k?
« Reply #1 on: October 11, 2013, 09:32:08 AM »
Any advice folks?

Zamboni

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Re: Should I open up a 401k?
« Reply #2 on: October 11, 2013, 10:01:55 AM »
Quote
Since I am fairly young, I don't think I should really worry too much about the 401k

Actually, this is the BEST time for you to be putting money into a 401K or IRA.  You get an immediate tax savings that then gets to grow tax-free for many years.  There is no doubt that you should automate some level of monthly contribution to this and just consider it money that you don't have.  You don't have to put every penny you earn into it, but not putting in anything is an opportunity missed.  EVERY reputable financial advisor will give you the same advice on this.

willn

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Re: Should I open up a 401k?
« Reply #3 on: October 11, 2013, 10:35:49 AM »
Quote
Since I am fairly young, I don't think I should really worry too much about the 401k

Actually, this is the BEST time for you to be putting money into a 401K or IRA.  You get an immediate tax savings that then gets to grow tax-free for many years.  There is no doubt that you should automate some level of monthly contribution to this and just consider it money that you don't have.  You don't have to put every penny you earn into it, but not putting in anything is an opportunity missed.  EVERY reputable financial advisor will give you the same advice on this.

To be clear, 401k and conventional IRA do not "grow tax free".  The growth is tax deferred--tax will be due on withdrawal.  Contributions are not taxed and serve to reduce tax in the year of contribution.

Given that you have an apparent mandatory contribution to the pension, which may be returned and rolled to a qualified retirement account when you leave, I would not contribute, but would instead pay down all debts except your residential mortgage.  With your income and frugal nature that should be very quick.

I'm also wondering why there are loans to and from family and friends--this may be a sign that there are some unhealthy or risky boundary issues surrounding finance in your family and may be worth examining.  Family loans, when they go bad, have a way of wreaking havoc beyond the math of what is lost, so they introduce more risk than a comparable loan to or from a bank.  Given that, I would deplete the 7K savings to the point of paying down as much as possible, leaving you the 2K cash as a small emergency fund. 

Zamboni

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Re: Should I open up a 401k?
« Reply #4 on: October 12, 2013, 08:25:05 AM »
Quote
To be clear, 401k and conventional IRA do not "grow tax free".  The growth is tax deferred--tax will be due on withdrawal.  Contributions are not taxed and serve to reduce tax in the year of contribution.

Yes, this is stated more correctly than I stated it. 

But the facts remain that: 
1)  Your income will not go down by as much as you think it will due to the current year tax reduction.
2)  You will not be as tempted to be spendy with money that is in a 401k (I hope!)
3)  Since it is automated, you have paid yourself first and then will learn to work with an amount of take home money that includes an automated savings component already subtracted.
4)  You will be very happy that you contributed 10 years from now, and at retirement you will ecstatic that young you was so forward thinking.

I know that most people have trouble planning ahead, and many psychological studies have shown this.  I also know that most people function as you are now functioning, rationalizing why they can't contribute at this time with the idea that the money will be better used in another way.  It's the "I'll do it tomorrow" mentality that has put the majority of Americans nearing retirement in a pickle.

You probably won't get much, if anything, from that pension, especially if you are not planning to work there 5 years.  Also, people seem to be oblivious about this but PENSIONS CAN DISAPPEAR or be cut at ANY TIME!  I have a friend who was a major airline pilot, and they cut his pension in half right before it was time for him to retire. 

Be wise and save your own money.  You don't have to make it an either/or.  You can put a portion in the 401k, choosing Vanguard if they offer that vendor, and then save some for another condo if you want.  It's a basic tenet of investing called diversification.

And I'll second the suggestion stop borrowing from family and friends. 
Good luck!

Guizmo

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Re: Should I open up a 401k?
« Reply #5 on: October 12, 2013, 08:56:16 AM »
Zamboni, thank you for the insight. I guess I am afraid I'm going to miss out on the real estate boom. I already know that I cannot get another comparable rental condo for the same amount that I got earlier in the year. I am afraid that I might miss out on something that is within my price range if I wait longer than a year or two to get another one. Once I finish paying off my first condo by January of next year the monthly cash flow on it will be around $500, which is very good for the overall cost of the property.

I guess I will probably start a 401 k and maybe start putting $100 a month. That would still let me save the bulk of my money so that I can get another condo. After I have two under my belt, I think I will aggressively put my money in the 401k and a taxable mutual fund.

matchewed

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Re: Should I open up a 401k?
« Reply #6 on: October 12, 2013, 09:29:32 AM »
*Facepunch*

At 24 you should be saving as much money as possible, that means utilizing your 401k to its full potential. The language you are using such as "I'm afraid I'm going to miss out on the real estate boom" shows me you're letting your emotions dictate your decisions rather than putting in the time to do the math behind these options. Also that is market timing, just a different market.

If you're really interested in real estate you should probably wander over into the real estate section of the forums and start learning (if you don't already know) what makes a good unit to rent out rather than make the interest rates or housing prices dictate your decisions.

Zamboni

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Re: Should I open up a 401k?
« Reply #7 on: October 12, 2013, 10:00:25 AM »
I agree the language you are using about the real estate market is concerning.  When prices are rapidly rising it is often NOT a good time to buy as housing tends to overshoot a reasonable value and then correct.  It sounds like you got a decent deal on the first unit, but that the second one would not be such a good deal.  If you are serious about real estate investing, biggerpockets is another site with good info as well if you haven't already checked it out. 

On the other hand, at your age putting money in a 401k is almost always a good call just based upon the tax advantages.  You NEED to be contributing to that.

It's not too hard to buy the first unit, but keep in mind that you are going to have to have some diverse assets (other than rental units) in order to be able to acquire more property.  401k money can be used as collateral when getting a loan on rental property.  So, really you can also view saving in the 401k as another avenue for improving your ability to continue to get into real estate.

You also need to have a maintenance cushion for your current unit and it sounds like you have only a small one (I hesitate to even call it a cushion since it won't even cover your existing short term loans.)  Do you keep the rent money in a separate account until you reach the maintenance cushion for that specific unit?  Or are you spending the rent income?  I owned a condo and was responsible for thousands to replace the air conditioner when it went out after only a couple of years; could you cover the cost of something like that happening with your unit, or would you need to borrow?  We also had a "special assessment" of $2k to cover exterior building maintenance after our HOA had planned poorly.  Not having a dedicated maintenance coverage plan is facepunch worthy.

Guizmo

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Re: Should I open up a 401k?
« Reply #8 on: October 12, 2013, 10:08:11 AM »
Trust me Matchewed, my decisions are not based on emotion. My unit has gained approximately 18% in value since I bought it. While I may be young, I have been involved in my parent's real estate business since I was 10. I do repairs, I hire subcontractors. In fact, the income from my second job comes from doing the bookkeeping for my parent's rentals. They have approximately $2M in rental assets and over $200k revenue from their rentals. Moreover, my brother is a builder and a real estate agent.

I think I may be overconfident in real estate because of my background. I think I will end up putting at least $100 bucks a month into my 401k. When I leave my current job I will see if I can withdraw the pension contributions and roll it over to my 401k. Obviously after my next rental buy I will dedicate my savings in non-real estate investments.

matchewed

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Re: Should I open up a 401k?
« Reply #9 on: October 12, 2013, 12:06:48 PM »
Trust me Matchewed, my decisions are not based on emotion. My unit has gained approximately 18% in value since I bought it. While I may be young, I have been involved in my parent's real estate business since I was 10. I do repairs, I hire subcontractors. In fact, the income from my second job comes from doing the bookkeeping for my parent's rentals. They have approximately $2M in rental assets and over $200k revenue from their rentals. Moreover, my brother is a builder and a real estate agent.

I think I may be overconfident in real estate because of my background. I think I will end up putting at least $100 bucks a month into my 401k. When I leave my current job I will see if I can withdraw the pension contributions and roll it over to my 401k. Obviously after my next rental buy I will dedicate my savings in non-real estate investments.

Don't get me wrong there's nothing wrong with real estate in of itself as an investment choice. I currently don't pursue it but it is not because I think it's too risky, it is because I haven't done the research to feel comfortable with it. Your language choice just concerned me as to whether you were thinking with your head or your emotions.

That aside I guess my advice would then be much like I'd advise someone asking if they should invest in X or Y. What is the plan? How much is your lifestyle going to cost? How do you see yourself affording that life? Work your way backwards from there. If it is revenue streams from rentals then so be it. If it is having a 401k cushion for old man time then so be it. Answering these questions will give you the answers you need today to determine how you structure your life for the future. As always be flexible.