Should You Invest In Retirement Accounts?

Filed in Investment Secrets by on October 9, 2018 0 Comments

By Travis Sperr:

I think of this frequently, “Where is money best invested for the future?” As a real estate investor, I often run the numbers to see how much cash-flow I need to live the way I deserve to in “retirement”. I use quotes around retirement, because I don’t plan to work into the age that retirement accounts are accessible, 59 ½ years old. Because of that, I focus on how to create enough semi passive income (very little real estate investing is completely passive) to live well with the option of continuing to work day to day. What is that number? It’s different for everyone, but I am working toward 25 properties owned free and clear.

So, are retirement accounts the answer to retirement income? There are pros; tax savings today, tax deferred income, tax free growth, potential employer matches and low-cost management. Saving through your employer is the easiest and most widely used retirement vehicle used for employees. The cons; access to the money and lack of cash-flow before retirement age.

I personally went through this exercise recently in deciding if I should continue to fund my own retirement account or use that money to buy more rental properties. Here is an example comparison between investing into a 401k and buying rental property. I use round numbers and use what I feel like are fair assumptions.

  • Married couple with a gross income of $120,000 annually.
  • Take home pay (After -Federal, State, SS, Medicare) $92,000.
  • Saving $20,000 per year toward retirement.

Investing in a 401k:  Putting that $20,000 into a 401k with a 3% employer match totals $23,600 per year. After 3 years using a 10% return, the combined account value is $82,227. If this account didn’t see another dollar in contribution and grew at that same 10% for 15 more years, the value would be $366,232, this is real money. If you made this investment at 45 years old, you would be able to use these funds at 60 years old.  With that same 10% return, the account delivers $36,000 before a year income (although the “experts” would say that you should expect to draw 4% of the account value, $14,650). However, if this investment was made at 30 years of age, the money would be tied up, but still growing for another 15 years before it can be used without penalty. The penalty is equal to the tax rate plus 10%, 40% in this case.

Investing in Real Estate:  Using the same $20,000 per year into savings after 3 years, they have $60,006 (in a money market account). Using that money to buy a typical rental property at a 7% cap rate.

$230,000 Purchase

$57,500 25% Down Payment

$2,500 Closing Costs

$1,850 Rent per Month

$5,158 Net cash-flow before taxes per year, all cash-flow stated will be net and before taxes.

See the math here, assuming 5% annual rent increase, 5% annual appreciation and 5% maintenance.

In 15 years, the net cash-flow before taxes $23,097 per year and the property is valued at $478,000 with $122,197 remaining on the loan. $356,000 in equity and $194,591 in cash-flow collected over 15 years, God Bless cash-flow! Another benefit is the tax advantage of depreciation.

One strategy that also works well with discipline and forward looking is to use the net cash-flow and put that money into principal reduction, the property is paid off in 13 years and provides $30,900 cash-flow annually and valued at $430,000. Just 4 deals like this and that married couple replaces their income, or continues working in careers they enjoy, with the freedom to live life on their terms long before the age of 59-1/2.

So, which is a better strategy for your long term goals?  Real estate? 401k/IRA? A blend of both? Each type of investments has its own sets of pros and cons, risk and reward, and barriers to entry. Consider your short and long term needs for income and access to money. Agree, disagree or have a better plan? I would enjoy hearing your feedback.

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