401K - Did I make the wrong choice? Looking to retire in 10 years.

[TJBeFree]

Hi All! I've lurked the forums for a bit, and I'm excited to write my first post!

I've been aware of Financial Independence for about four years, and have been working to achieve it via real estate (as a side hustle). I have done fairly well in real estate thus far, and have worked out a road map that should generate a decent income over the next 10 years. Currently I live n' flip single family homes (using IRS Section 121: capital gains tax exclusion up to $250K of gain, on the sale of a primary residence), but will transition to buy and hold rentals next year, when I turn 30. The goal is then to acquire one 2-4 unit property each year, for the next 10 years. That said, I cannot provide a dollar figure for the income I will generate at this time, but I am confident in my ability to execute this plan, as I have built the cash reserves to do so.

In addition to my live n' flip side hustle, I work a full time job as a fleet manager/supervisor. This, is where my dilemma begins to take place, and why I have been heavily lurking the Mr. Money Mustache forums to develop a plan. Hoping the community can point me in the right direction and help select the appropriate strategy for my 401K! Please see figures and explanations below. Any advice or information is greatly appreciated. Thanks a million in advance!


Age: 29
Retirement Goal: 39 (10 years from today)
Current Salary: 75K
Occupation: Fleet Manager/Government
Projected Salary in 3 years: $85K - $105K
*Almost guaranteed 5% salary increase for merit each year, for the next three years (would be the $85K minimum). As a government employee, the bargaining unit that represents my unit is currently negotiating cost of living increases. They have asked for 21% cost of living increase over 3 years, in addition to 5% merit salary raises above. So, best case scenario is $105K.

Savings Rate: Percentage not calculated, but I have a very low cost of living. My housing expenses are minimal, and I am a saver by nature. You can say $1000-$1500 goes into my savings account each month after all expenses. I will work on calculating this, and tightening it down.

Debt: Debt free, with the exception of my current mortgage.

Monthly Pension Contributions - $432/month (pre-tax - roughly 7.5%)
Monthly Roth 401K Contributions -     $500/ Month

Current Pension Balance - $20K, will be vested next month.
Current 401K Roth Balance - $10,900

I have only been contributing to my Roth 401K for about 2.5 years. I was saving as much as possible for a down payment on my first property out of college, and did not feel contributing to my 401K was feasible at the time (kicking myself now). And although I feel real estate will be the major driver of my financial freedom, I do not want to neglect the power of compound interest and additional revenue stream my 401K (or some other retirement account) can provide.

Here's where I'm at personally with my 401K; I feel like I'm extremely far behind in contributions, and that I should not have selected a Roth 401K. 

After reviewing some Mr. Money Mustache forum posts, and blog posts by the Mad Fientist, it seems like I should have selected a t401K or 457b and planned to use the Roth Conversion Ladder when I retire.

My major questions:
Should I switch over to a traditional 401K or 457b? What benefit would the traditional 401k/457b have over the other (I believe I could play catch up on the 457b???)?
Did I waste the last 2 years putting $10K in my Roth 401K? What should I do with those funds?
If I can roll my Roth 401K into a Roth IRA now, should I do so?
Is there still any hope for me in contributing to a 401K/457B over the next 10 years from scratch ($0 as of today)?

All of this is sparked in my recent promotion/raise, and knowing that I am behind in traditional retirement savings. I considered increasing my Roth 401K contribution to $1000/month, and could do so comfortably, but that brought me to think I could probably put $1250/$1300 each month into a traditional.

My initial reasoning for starting a Roth was that I feel I'll make more money in "retirement" than I do now, as my rental property will likely be generating more gross revenue when I hit traditional retirement age. Now, I am not sure if that was the right move. Regardless, I feel like I am on the right path, but just need to be steered in a different direction with my 401k contributions.

If at all possible, can someone please share your thoughts on my situation?

Again, thank you in advance for reading and any information/thoughts/resources/advice provided.

Best,
TJ

[tamuaggie2011]

My major questions:
Should I switch over to a traditional 401K or 457b? What benefit would the traditional 401k/457b have over the other (I believe I could play catch up on the 457b???)?
Did I waste the last 2 years putting $10K in my Roth 401K? What should I do with those funds?
If I can roll my Roth 401K into a Roth IRA now, should I do so?
Is there still any hope for me in contributing to a 401K/457B over the next 10 years from scratch ($0 as of today)?

1. The question of a Traditional vs. ROTH is largely a personal decision. If you expect your annual income to be higher as you have said from all the rental properties then it is better to continue putting money into ROTH option.  A 457b is essentially the same as a 401k with one significant difference: that you can take the money out before age 59.5 without paying the 10% penalty.
2.  Saving money is a never a "waste". Leave those funds in your 401k and continue to let them grow.
3. The answer to this really depends on the investment options but also your plans. If the funds in your 401k are decent then definitely leave them. Even if they are not the greatest remember that the contribution limits are much lower on an IRA (6,000) than a 401k (19,000)
4. There is definitely plenty of hope. You didn't provide specific numbers but if the goal is as you stated to have your income replaced by rental property in 10 years than any amount you have set aside in these accounts is pure gravy. You are putting money in these for 10 years but then don't forget it has another 20 years after that as well to grow while you live off the rental income.

Hope that helps and best of luck!

[Another Reader]

Do you have rental properties now?  If not, when do you expect to buy them and with what money?  How much do you know about rental real estate?

Some people have a vague idea from reading Bigger Pockets or some blogs that real estate is a great way to make steady, high returns.  If that is where you are, you need to learn a lot more before you decide you can rely on rental income and/or appreciation.

If you already have rentals, those impact how much you should save and invest and where your paper assets should be located.  If you post information about the rentals, you will get more detailed and relevant suggestions.

[BrightFIRE]

A 457b is essentially the same as a 401k with one significant difference: that you can take the money out before age 59.5 without paying the 10% penalty.

This is the only thing you need to know, right here. If you have a 457b, then you don't have to deal with IRA ladders at all. The 457b lets you withdraw at any time, with no penalty. Even better, legally you can contribute the max to both a 457b and a 401k! So you can squirrel away $38,000/year tax-free. https://en.wikipedia.org/wiki/457_plan

So max the 457b, then work on maxing the 401k if you can. (You can't "catch up" unless you're over 50.)

[Boofinator]

Do you have access to a 457b?

As far a 401k (and IRA), I'm a large fan of going Traditional (and squirreling away as much as you can at that), especially if you're in a tax bracket greater than 10% (of course a 0% tax bracket should go Roth). The Mad Fientist shows the mathematical optimization, but a couple of aspects I don't think he touches on are the game theory aspect and the utility value aspect, both of which also favor traditional.

From the game theory perspective, there are two choices (Roth or Traditional), and two outcomes (rich or scraping by). If you're scraping by, you'll have considerably more money had you gone Traditional and used the Roth conversion ladder or 72t, whereas if you're rich you'll probably break out even between the two methods (or slightly ahead with Roth), but at that point wgaf, right?

The utility value of money is closely related, in that a dollar is worth a lot more to somebody who has less than to somebody who has more (a dollar is worth more to a bum than to Bill Gates). So it takes the solution from the game theory perspective, and then amplifies it considering every dollar is worth more to you should you have less of them to work with.

So my recommendation to you would be to max out traditional 401k ($1600/month) and, if you can deduct it, traditional IRA.

Good luck!

[TJBeFree]

Do you have rental properties now?  If not, when do you expect to buy them and with what money?  How much do you know about rental real estate?

Some people have a vague idea from reading Bigger Pockets or some blogs that real estate is a great way to make steady, high returns.  If that is where you are, you need to learn a lot more before you decide you can rely on rental income and/or appreciation.

If you already have rentals, those impact how much you should save and invest and where your paper assets should be located.  If you post information about the rentals, you will get more detailed and relevant suggestions.

Thanks for the reply. As I mentioned above, I currently live and flip property (with the majority of my cash tied up in the current asset). I also have some "dry powder" sitting in an account, that I keep readily available in case I find a deal. After completing this live n' flip, I'll have a low six figure sum to leverage and acquire as much rental property as I can over the next 10 years. I have house hacked in the past, played in-house landlord, and my family has rental property which I've watched them manage over the years.

My goal is 20 units (10 duplexes, or a combination of 2-4 unit), by buying 1 property per year, and putting down a large down payment on each. Looking to house hack each for a year, and when I move out, the goal is $500 cash per property (after all PITI and cap ex.). I've ran the numbers a few times, and it is a fully executable plan in my area (holding interest rates and property prices constant). Obviously the price of real estate and interest rates will fluctuate. This plan is subject to change, but as of now, that is my current game plan.

Any advice on going 401k vs 457b (traditional)? Thanks again.

[TJBeFree]

A 457b is essentially the same as a 401k with one significant difference: that you can take the money out before age 59.5 without paying the 10% penalty.

This is the only thing you need to know, right here. If you have a 457b, then you don't have to deal with IRA ladders at all. The 457b lets you withdraw at any time, with no penalty. Even better, legally you can contribute the max to both a 457b and a 401k! So you can squirrel away $38,000/year tax-free. https://en.wikipedia.org/wiki/457_plan

So max the 457b, then work on maxing the 401k if you can. (You can't "catch up" unless you're over 50.)

Thanks for the reply! I am really leaning towards the 457b (traditional) right now. I don't think I could pull off both just yet.

As a hypothetical, let's say my gross pay is 65K this year. If I was able to "squirrel" away 19K in both a 457b and 401k (pre tax), would that bring my taxable income down to 27K  and put me in the 12% tax bracket???

[TJBeFree]

Do you have access to a 457b?

As far a 401k (and IRA), I'm a large fan of going Traditional (and squirreling away as much as you can at that), especially if you're in a tax bracket greater than 10% (of course a 0% tax bracket should go Roth). The Mad Fientist shows the mathematical optimization, but a couple of aspects I don't think he touches on are the game theory aspect and the utility value aspect, both of which also favor traditional.

From the game theory perspective, there are two choices (Roth or Traditional), and two outcomes (rich or scraping by). If you're scraping by, you'll have considerably more money had you gone Traditional and used the Roth conversion ladder or 72t, whereas if you're rich you'll probably break out even between the two methods (or slightly ahead with Roth), but at that point wgaf, right?

The utility value of money is closely related, in that a dollar is worth a lot more to somebody who has less than to somebody who has more (a dollar is worth more to a bum than to Bill Gates). So it takes the solution from the game theory perspective, and then amplifies it considering every dollar is worth more to you should you have less of them to work with.

So my recommendation to you would be to max out traditional 401k ($1600/month) and, if you can deduct it, traditional IRA.

Good luck!

Awesome info and appreciate you sharing those theories. I particularly agree with the utility of money, and looking at dollars from a game theory perspective.

To answer your question though, I do have access to a 457b! Does that change your recommendation from the t401k at all?

Also, any thoughts on opening a brand new 401k in the current stock market environment? With all the volatility as of late, and things being at all time highs, the thought of maxing out my 401k monthly makes me quite nervous....

[Boofinator]

To answer your question though, I do have access to a 457b! Does that change your recommendation from the t401k at all?

Also, any thoughts on opening a brand new 401k in the current stock market environment? With all the volatility as of late, and things being at all time highs, the thought of maxing out my 401k monthly makes me quite nervous....

I am not personally familiar with the 457b, so am not aware if there are any structural differences from a 401k beyond being able to take out the funds penalty-free (what BrightFIRE mentioned). Assuming that is the only structural difference between the two plan types, there appear to be four considerations: 1) contribution matching, 2) funds options, 3) fund expenses, and 4) potential penalties. Needless to say, you should try your best to obtain all employer contribution matching for any of your plans. Fund options and expenses are usually closely related, as the best fund plans (index plans) also tend to be the cheapest (win-win), though you may see significant differences in the fund offerings and expenses between 401k and 457b. Only after these other considerations are considered would I then split any tiebreak toward the 457b to avoid having to do a Roth conversion ladder or 72t.

I wouldn't worry about the current market conditions if I were you, especially when purchasing tax-deferred assets, and here's why (other than that it is extremely difficult to predict what the market will be doing): when you purchase tax-deferred stocks, and assuming you will be able to avoid all taxes for the entirety of owning those stocks, you are basically getting those stocks at a discounted price that is equal to your combined federal and state tax brackets. If those are a combined 25%, then stocks would have to be overvalued by 33% (1/(1-25%)-1) for your purchase to be a poor one (relative to an investor who waits for the impossible-to-predict 25% drop and then purchases using post-tax money).