Author Topic: should I REALLY max my 401k?  (Read 7540 times)

robbyho

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should I REALLY max my 401k?
« on: March 17, 2015, 08:51:13 AM »
So I only got serious about FI 5 months ago. I turn 30 in 3 days.  I've been saving roughly 70% of my income between my 401K and post tax savings. I'm in the process of buying a three family house and will have very little money left over after repairs. Right now I am contributing enough in the  401K to get the max employer match: 8% from me and 2% from my employer. This translates to about $6000/year.

Most of my FI plan is based on purchasing rental properties. For instance, this one will cost me roughly $12,000 out of pocket and  will return $3300/year after expenses.

If I do that or better every year, combined with my regular savings I will be FI in 6 years.

Now if I max out my 401K it would look like this:

Income - $60,000
401k - $17,500
Taxable Income - $42,500
After Taxes,Insurance - $31,000

So even if I could live off $15,000 that doesn't leave me a lot of cushion left over in case I need more out of pocket on the next rental home.

Also, I will probably leave my current job and sell real estate full time, and I have only 60% vested.

Thank you for your advice.


Gin1984

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Re: should I REALLY max my 401k?
« Reply #1 on: March 17, 2015, 09:02:20 AM »
First, as someone who has a rental, slow down.  I had great ambitions of buying rental property for FI it was more work than I expected.  Don't assume you can buy a rental every year.  Also after four, it requires different lending standards.  But that said, I'm trying to figure out how you are paying $11,500 in insurance /tax.  Do you have a HSA or FSA that is in there?  Do you have an emergency fund?  Is this triplex your personal home as well or do you own/rent elsewhere?  That all said, I don't know why you'd want to quit and be a real estate agent full time before you vest.  Is there something that causes you to not want all your money?  You are throwing away money here.  Yes, max out your 401k and use the remains for rentals.

robbyho

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Re: should I REALLY max my 401k?
« Reply #2 on: March 17, 2015, 09:25:28 AM »
Thanks for the reply gin,

I guess I failed to mention that I only started the 401K in October and have just about $2000 in it, so I'm only giving up maybe $300 maximum by leaving my company. Real estate has the bigger upside than where I am now and I don't see it being difficult to make the same or more if I were doing it full time. Plus my father is my broker and he has an established business that he wants me to take over in the next two years.

I know buying one property a year is ambitious but i am confident in my management skills and have done a lot of research on the subject. Being a Realtor gives me a lot of experience as far as rentals go. 

TheOldestYoungMan

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Re: should I REALLY max my 401k?
« Reply #3 on: March 17, 2015, 09:38:52 AM »
Badass savings rate, good job.

You can stop contributions if something happens to a property and you need a little more cash in a given time.  It's rare that 1.  The roof blows off and 2. It isn't covered by insurance and 3. The tenant withholds rent and 4. The guy fixing it for you won't accept a payment plan and 5.  The bank you have a relationship with won't lend and 6. It happens again at your other property the same week and 7. all of this happens at once.  If it does happen, stopping your contribution entirely and dumping the next larger paycheck on the problem ought to go a long way.

Part of it depends on the investment vehicles allowed within the 401k.  My last job the 401k sucked, so the only "return" I could expect was the match + the tax savings.

Assuming they are worthwhile:

Break down your scenarios, more into the 401k vs, current vs. less. 

Figure out the actual taxable income for both scenarios using likely deductions and the best estimates/real data you can. 

You end up with a difference in taxes between the two scenarios, that difference is the relevant factor.  Compare that to what you think you could be earning investing the money outside the 401k (in your case, real estate).  You can also try to factor in returns on the value of the real estate+rent-expenses vs. the investment vehicle of choice in the 401k, but I don't know a great way to do that, as I can't predict any of those markets.

Also, I think if you go into real estate as an agent it changes the tax situation on rental property you own.  I don't know if that is advantageous, but it probably factors in to the long term strategy.  There's something fuzzy buzzing around the back of my head about this.

You also have a tIRA as an option in lieu of the 401k, if you would like more options in your pre-tax savings.

Take a look at your draw-down strategy as well.  How you intend to access the accounts will affect where you put your money.

If your version of FIRE is managing a bunch of properties and living off of that income, then you may not need to be saving money where you can't use it to reach the right number of properties for you.  Having income from those properties may be enough such that a tax-deferred savings doesn't make sense (your long-term income stream from sources-not-retirement-accounts will not be significantly different than what you've got now).

In the back of my mind has been this idea that I could take the savings I have now, buy 4 or 5 decent properties, rent them out, and quit my job.  But I'm suspicious that managing them would be similar to working, probably more satisfying, but ultimately less lucrative.  It isn't really an option though as most of my savings is in retirement accounts.  It takes me a loooong time to save up enough for a downpayment outside of maxing my RAs.

So I guess for me it was a choice between two scenarios, and I went with going the tIRA/403b/457b route, and once there's a huge pile of cash there I may go ahead and pick up a property.  I couldn't do both though.

Good luck!

boarder42

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Re: should I REALLY max my 401k?
« Reply #4 on: March 17, 2015, 09:57:23 AM »
401k max is 18k FYI

robbyho

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Re: should I REALLY max my 401k?
« Reply #5 on: March 17, 2015, 10:55:43 AM »
hey Old/young man check out biggerpockets.com if you haven't already. You can always get enough rentals to make hiring a property manager profitable. Get something turn key and minimize the headaches.

thx boarder for the heads up on the 401k limit. My company still sent me last years paperwork.



As I'm thinking about it, I can always if needed take out a loan against my 401K if I really needed to. Obviously I'd like to avoid that, but in a true emergency I could.


Gin, I'm sorry I didn't answer all your questions.

I have basically no emergency fund to fall back on. All of my savings is going into this home purchase. I've just gone hard at savings and I'm confident that can continue so I'm honestly not too worried about it. I'm saving roughly $2k/month. I have family that would help me if needed and long term disability insurance.

This home will be my personal residence. I will live in the small basement efficiency and rent the rest. Even with me living there it will cashflow after expenses. With the FHA loan I am getting I must live there for 1 year, at which time I can buy another and repeat.

I based the taxes/insurance off what percentage I paid last year, I know I'll be paying less as I contribute more to the 401k, but I want to base off the lowest amount for a safety margin.

Let's say I want to keep my same savings rate of 70% based on my income last year. The 401k would be 40% of it ($18,000/$45,000). 30% more in savings would end up after a year:

401K - $18,000
After Tax Income ~$30,000
Taxed Savings - $13,500
Expenses - $16,500

I think that is doable and leaves me with enough for a 2nd rental purchase. But does it allow me enough fudge factor if I need more that ~$12,000 out of pocket for the purchase?

Thanks for the advice. I actually expect my income to be closer to $75K this year, but I work commission both jobs so it is hard to predict.



That keeps me at the same savings rate as before






boarder42

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Re: should I REALLY max my 401k?
« Reply #6 on: March 17, 2015, 11:21:29 AM »
you're leaving out many taxed advantaged vehicles still including IRA and HSA

Gin1984

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Re: should I REALLY max my 401k?
« Reply #7 on: March 17, 2015, 11:21:45 AM »
I live my duplex as well.  I did find that the banks would not include my rental income, unless I had been there two year, nor would they include tip/commission income until after two years.  That is something to consider.  If you have no EF, and a rental, I would definitely avoid buying a year especially if you want to going into selling real estate for a living which is cyclable in nature.  But I am getting off topic.  Personally we cut back on our retirement savings to buy a duplex and then used that money to pay into retirement savings.  We run pretty tight on our after tax savings though.  I think my attitude would be to max it out and hustle for the remainder.  The tax savings can be very helpful but you are not looking at that.  I would start looking for the next property once you have enough cash, but continue to save while looking.  Looking can take a while.

robbyho

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Re: should I REALLY max my 401k?
« Reply #8 on: March 17, 2015, 11:41:07 AM »
you're leaving out many taxed advantaged vehicles still including IRA and HSA
thank you. would these make sense to maximize before, after, or concurrently with the 401K?

The tax savings can be very helpful but you are not looking at that.  I would start looking for the next property once you have enough cash, but continue to save while looking.  Looking can take a while.

Thanks, I need to do more research on the tax benefits.

The great part is where I live, the market for multifamilies is huge and the income potential is great. Yes, there are a lot of two families that are overpriced, but there are tons of three or four-plexes that have just been sitting on the market and even with 100% financing would cashflow. That's certainly one of the reasons I am planning my FI around rental properties. Plus as a Realtor I am looking at the MLS everyday and kicking myself for not being able to buy the great deals.


Gin1984

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Re: should I REALLY max my 401k?
« Reply #9 on: March 17, 2015, 11:49:29 AM »
Well tax benefits for the 401k are very easy.  Assuming just 15% bracket (though you may be in 25%) every dollar you put in your 401k only costs you .85.  So say instead of putting in $4800 (8% of $60K), you put in 18K.  You would only "lose" $11220 instead of $13200.  That does not even take into account state taxes. 

SpendyMcSpend

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Re: should I REALLY max my 401k?
« Reply #10 on: March 17, 2015, 03:18:33 PM »
Very very risky

boarder42

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Re: should I REALLY max my 401k?
« Reply #11 on: March 18, 2015, 06:10:05 AM »
RobbyHo

The HSA makes the most sense to max after you've met employer match for 401k.  IF you have an HSA thru work as it will avoid FICA taxes.  If you dont its really kind of a wash.

robbyho

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Re: should I REALLY max my 401k?
« Reply #12 on: March 18, 2015, 07:29:50 AM »
RobbyHo

The HSA makes the most sense to max after you've met employer match for 401k.  IF you have an HSA thru work as it will avoid FICA taxes.  If you dont its really kind of a wash.

thanks, so if I'm NOT maxing my 401K it makes the most sense to go up to the employer max and then put money into the HSA? What are the benefits of that?

Gin1984

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Re: should I REALLY max my 401k?
« Reply #13 on: March 18, 2015, 07:40:01 AM »
RobbyHo

The HSA makes the most sense to max after you've met employer match for 401k.  IF you have an HSA thru work as it will avoid FICA taxes.  If you dont its really kind of a wash.

thanks, so if I'm NOT maxing my 401K it makes the most sense to go up to the employer max and then put money into the HSA? What are the benefits of that?
First, HSA money is pre-tax AND pre-FICA so you save an additional 7.65% on the money you put in.  Then you can pay for medical expenses tax free.  This includes (in the future) medical expenses like Medicare part B.  But after 65 you can pull any money out, not just for medical but it is taxed like a 401k withdrawal.

robbyho

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Re: should I REALLY max my 401k?
« Reply #14 on: March 18, 2015, 09:41:39 AM »
RobbyHo

The HSA makes the most sense to max after you've met employer match for 401k.  IF you have an HSA thru work as it will avoid FICA taxes.  If you dont its really kind of a wash.

thanks, so if I'm NOT maxing my 401K it makes the most sense to go up to the employer max and then put money into the HSA? What are the benefits of that?
First, HSA money is pre-tax AND pre-FICA so you save an additional 7.65% on the money you put in.  Then you can pay for medical expenses tax free.  This includes (in the future) medical expenses like Medicare part B.  But after 65 you can pull any money out, not just for medical but it is taxed like a 401k withdrawal.

I see....can you convert an HSA into a Traditional or Roth IRA tax free in a roth ladder scenario similar to how you can convert a 401K->tIRA->rIRA?

Gin1984

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Re: should I REALLY max my 401k?
« Reply #15 on: March 18, 2015, 10:01:46 AM »
RobbyHo

The HSA makes the most sense to max after you've met employer match for 401k.  IF you have an HSA thru work as it will avoid FICA taxes.  If you dont its really kind of a wash.

thanks, so if I'm NOT maxing my 401K it makes the most sense to go up to the employer max and then put money into the HSA? What are the benefits of that?
First, HSA money is pre-tax AND pre-FICA so you save an additional 7.65% on the money you put in.  Then you can pay for medical expenses tax free.  This includes (in the future) medical expenses like Medicare part B.  But after 65 you can pull any money out, not just for medical but it is taxed like a 401k withdrawal.

I see....can you convert an HSA into a Traditional or Roth IRA tax free in a roth ladder scenario similar to how you can convert a 401K->tIRA->rIRA?
I don't think so.  I have never looked because frankly, I am sure I can use up the amount in there for medical and pay no taxes what so ever.  But then, I have medical issues.
« Last Edit: March 19, 2015, 01:25:08 PM by Gin1984 »

robbyho

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Re: should I REALLY max my 401k?
« Reply #16 on: March 19, 2015, 01:11:20 PM »
Thanks for the advice. I went ahead and changed my contribution to 20%. I can adjust it every quarter, so if I feel better about it I can increase it in again in July to make up for it if I want to go to the full $18,000.

Mrkineticz

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Re: should I REALLY max my 401k?
« Reply #17 on: March 19, 2015, 08:51:35 PM »
Real estate is not for everyone But for some it is.. I love real estate, being a landlord, fixing stuff,dealing with people and how to better accommodate tennants needs. I also have a plan to buy a rental property every year. I bought my first rental last year. I am buying my primary residence this year and converting my house now as another rental. I am also buying my 3rd rental this year so as long as you have the determination you can purchase a house each year. the hardest one to buy is the first and you will be busy from the time you buy the house until you rent it out. I am also having difficulties trying to balance my money because I feel that if I have more liquid cash I can do more as far as buying potential if i dont put as much in my 401k.  I decided to max my 401k and my tIRA this year after I have 2 properties. Without the liquid capital in the past it would of been difficult to have bought all this property. Best of luck to you. best advice is  if you plan on getting married or have kids be prepared to get your dreams of being a slum lord sidelined from time to time. Nothing ever goes as planned.

robbyho

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Re: should I REALLY max my 401k?
« Reply #18 on: March 25, 2015, 11:01:06 AM »
Real estate is not for everyone But for some it is.. I love real estate, being a landlord, fixing stuff,dealing with people and how to better accommodate tennants needs. I also have a plan to buy a rental property every year. I bought my first rental last year. I am buying my primary residence this year and converting my house now as another rental. I am also buying my 3rd rental this year so as long as you have the determination you can purchase a house each year. the hardest one to buy is the first and you will be busy from the time you buy the house until you rent it out. I am also having difficulties trying to balance my money because I feel that if I have more liquid cash I can do more as far as buying potential if i dont put as much in my 401k.  I decided to max my 401k and my tIRA this year after I have 2 properties. Without the liquid capital in the past it would of been difficult to have bought all this property. Best of luck to you. best advice is  if you plan on getting married or have kids be prepared to get your dreams of being a slum lord sidelined from time to time. Nothing ever goes as planned.

Thanks! Got the word I'm closing today. And it is about $2500 less closing costs than I had anticipated so double win!

Hopefully I can get the tenants looking while the work is being done so I can minimize vacancy. Who wouldn't want the chance to pick out the new paint colors in their new apartment?

Mrkineticz

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Re: should I REALLY max my 401k?
« Reply #19 on: April 20, 2015, 02:57:56 PM »
If you haven't picked out new colors Supposedly gray is the new thing in paint color

RexualChocolate

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Re: should I REALLY max my 401k?
« Reply #20 on: April 20, 2015, 04:45:27 PM »

Thanks, I need to do more research on the tax benefits.

The great part is where I live, the market for multifamilies is huge and the income potential is great. Yes, there are a lot of two families that are overpriced, but there are tons of three or four-plexes that have just been sitting on the market and even with 100% financing would cashflow. That's certainly one of the reasons I am planning my FI around rental properties. Plus as a Realtor I am looking at the MLS everyday and kicking myself for not being able to buy the great deals.

Someone smarter, richer, and more experienced than you is looking at the same deals and passing them up.

That said, the market is not perfectly efficient. There are definitely deals to be had, but your comments give off an aura of irrational exuberance. A reasonable ROA is 15% on such a risk. If you have to kick out one bad tenant you've lost money for the year.

99% of people are better off throwing their money in VTSAX and going on living their life.

Good luck.