Investing in Real Estate vs. Saving With a 401K: A Comprehensive COmparison

Today, many employees have a 401k plan as a means of saving for retirement. It was first introduced in 1978 and has since become the most commonly used retirement plan in the country. When it first began, it wasn't used to save for retirement. However, companies quickly discovered that it was considerably more affordable for them to require their employees to fund their retirements themselves. Throughout the 1980's, 401k accounts were widely adopted by most companies. 

While 401k plans have become increasingly popular over the years and are now held by a large percentage of employees, this retirement plan has only been around for upwards of 45 years. If you use this plan, you can benefit from matching contributions that your employer makes and the ability to set aside some of your funds for retirement. However, a 401k account won't be enough to help you replace your income before you reach retirement age. In fact, the 401k was only used by companies to avoid paying their employees with pensions. 

Despite the few small advantages that come with a 401k account, a much more viable investment opportunity is real estate. With the right real estate investments, you can substantially grow your retirement savings while planning for the future. You aren't limited to a certain amount of savings ever year, which means that a well-performing rental property can net you a considerable sum of savings after just one year of ownership. In this comparison, you'll learn why real estate is a better option for your retirement than a 401k. 

How Does a 401k Plan Work?

A 401K plan is a type of retirement savings plan that your employer can sponsor. It allows you to save for retirement and gain certain tax advantages. When you place money into this account, you can let it accrue or use it to invest in everything from stocks and bonds to mutual funds. It's also possible to open self-directed retirement plans to invest in real estate and other alternative investments. 

Likely the most tangible benefit of investing in a 401k is that you'll gain certain tax advantages. For instance, these retirement plans allow you to effectively defer your income taxes until retirement. You also have a choice over whether your income taxes are paid now or later. If you'd like to pay these taxes now, you can do so with a Roth 401k. 

While you can save for retirement with a 401k plan, you may reach the annual contribution limit when you place money in the account. This limit varies from year to year and depends on how old you are. The main advantage of a 401k plan is that you can receive matching contributions from your employer as a way to increase your savings. However, not every company that offers 401k plans will make matching contributions. 

Issues with 401k Plans

The primary reason that 401k plans aren't a great way to save for retirement is because they are just savings plans. If you want to lead a comfortable lifestyle once you retire, you can't save enough funds to cover your retirement needs. The only way to use those savings to fund your retirement is by converting them into something that will allow you to build a steady cash flow. 

The majority of plans have very limited flexibility when it comes to possible investment options. It's also common for fees to be high if you work at a smaller company. In the event that you withdraw from this account before you reach 59.5 years old, withdrawal penalties of 10% could be assessed. Likely the main issue with this type of account is that you'll need to make investment decisions without much guidance from a plan provider. You must also manage your 401k plan yourself, which can prove difficult if you're unsure of how to use it to make strong financial decisions. 

Let's say that you choose to convert your 401k into fixed-income securities. In this scenario, your return would likely amount to around 4-5%. If your 401k account reaches $300,000 in savings, a 4% return would be just $12,000 per year for you to live on. If your annual earnings from your job are around $75,000, you should focus on reaching this level of income once you retire, which would allow you to maintain your current lifestyle. The only way to obtain annual earnings of $75,000 at a return of 4% is to have nearly $1.9 million in your 401k plan. 

Before you start building your retirement funds, you should first identify the age you'd like to retire at. While 59.5 years is the beginning of retirement age according to the government, most people work well past this age. If you want to have control over your retirement, a 401k isn't going to give you the funds you need to determine your financial future. 

Investing in Real Estate

Investing in real estate gives you the opportunity to generate income and build cash flows. These investments are meant to be used on properties that you won't live in. You can own many pieces of real estate and obtain rental income through them. It's also possible to increase your returns with price appreciation. 

With the right real estate investments, you can build wealth, diversify your portfolio, and increase your income. Real estate offers ample opportunities to make money as an investor. While there are many different types of properties you can choose to invest in, they can be broken down into residential properties and commercial properties. 

The real estate you invest in can include residential properties and land. These investments often involve townhouses, single-family homes, and condominiums. They can also include multifamily properties, which are usually apartment buildings. 

Commercial investments can involve anything from a retail store to an office building. This type of real estate is typically more expensive than residential real estate. However, leases are often longer and can last for years. Profitability and costs are measured with a per-square-foot calculation. 

Advantages of Real Estate Investing

There are numerous benefits of investing in real estate, which can vary depending on your current goals. The amount of money you choose to invest in real estate largely depends on your risk tolerance. These investments can be highly beneficial if you invest in properties that will provide you with consistent income. Even single-family homes can serve as rentals that will earn you a steady income every month from the rent you collect. 

There are many different reasons why investors choose to buy real estate. You may be someone who wants to make this type of investment to diversify your portfolio and reduce your dependence on a 401k plan. Other investors are looking to place their money into physical assets as opposed to bonds and other securities. 

There are two clear benefits of investing in real estate when you're attempting to increase your retirement funds. These benefits include capital appreciation and rental income. Investment properties are able to realize capital gains because of property value increases that occur over an extended period of time. These gains are profits that come from the difference between the property's sale price and initial purchase price. You can only realize this gain once it's been sold. 

However, property values have increased substantially in recent years because of the higher demand for housing. There's also a relatively low supply of homes on the market, which makes it impossible for demand to be met. Until supply can meet demand, prices will likely continue rising. 

Another advantage of investing in real estate is that you'll be able to build rental income. Whether you choose to invest in residential or commercial properties, your tenants will pay you a specific sum of money every month until their lease or rental agreement expires. You can use this stream of income to build up your retirement funds. Keep in mind that real estate income is able to be used as a hedge against inflation and stock market downturns. 

Take This Opportunity to Diversify

If you're looking to invest for retirement, doing so allows you to diversify. If you solely open a 401k account, you would be limited when it comes to the types of investments you could make. You would also be relying on the income that you place into the account, which is also capped based on annual contribution limits. Real estate investments provide you with the means of diversifying your portfolio and building long-term wealth that you'll be able to live on once you retire. 

These investments are considered tangible assets, which means that they're more stable in comparison to mutual funds and stocks. While you can earn a large sum of money when investing in stocks, you won't have as much control over the outcome of your investment. 

By taking an investment-focused approach with your retirement plan, you can start reaching your financial goals. With a 401k plan, you likely wouldn't be able to reach these goals without an unexpected windfall or a high annual income. Keep in mind that the value of a piece of real estate often increases or remains steady at worst, which means that a single investment could provide you with higher returns than the 4% return you would likely receive from your 401k plan. 

Real estate investments also allow you to earn sizable tax breaks that can be more favorable than the ones you receive from your 401k account. Whether you invest in real estate outside of your 401k plan or with a self-directed 401k, creating an investment portfolio is highly recommended if you want to maintain your current lifestyle even after you stop working.

Achieving Financial Freedom

Now that you understand why you should focus on real estate instead of a 401k plan when attempting to reach your retirement goals, it's time to identify the amount of money you'll need to retire. If you want to replace 100% of your annual income, that's the first thing you should consider. 

Let's say you earn $90,000 per year. Break this number down to $7,500 per month. If you have a rental property that provides you with $750 per month in cash flow, you will only need to invest in 10 properties to reach your goal. If you buy two properties every year, you'll likely gain financial independence in just five short years. Once you pay off the properties you've invested in, your annual income should increase substantially, which is impossible with a 401k. 

While there have been talks of a recession, real estate values have been steady for many years and will likely remain high regardless of what happens in the stock market. If property values drop temporarily, you have a better opportunity to make affordable investments before they rebound. Don't settle for a retirement lifestyle that's worse than the one you currently have. Start investing in real estate today to begin your path to financial freedom.