Recently, I have been doing interviews on radio stations around the country. With the downturn in the stock market, every radio show host asks me the same question – What should i do about my 401(k)? Should I continue putting money into my 401(k)? What if my employer matches my contributions? Does that make a difference?
I’m going to give you an answer that you may not like. But it’s the truth. Stop putting money into your 401(k), EVEN IF your employer matches you 100%! I say this for two reasons – tax savings and leverage.
Let’s start with tax savings. Unless you 401(k) is a Roth 401(k), you are merely postponing your taxes to a later year in a 401(k). Now, if your only choices were to pay now or pay later, you would certainly want to pay later. But these aren’t your only choices. Of the over 5,600 pages of law in the Internal Revenue Code, less than 400 relate to postponing or deferring income taxes such as with a 401(k) or regular IRA. The remaining 5,200+ pages explain how to permanently reduce your taxes.
So which do you prefer – temporarily postponing your taxes like most people do or permanently reducing your taxes like we teach our clients at ProVision? If you want to permanently reduce your taxes, don’t be putting your money into a regulard 401(k). Instead, invest in some good permanent tax planning and get those savings every year without having to pay it back.
I will blog another time about the other reasons I don’t like 401(k)’s.
I love your insights on tax strategies. I’ve heard you talk about this idea of not using a 401(k) which intrigues me. I own an online business which is passive and starting to grow. I also will start making money as a doctor soon. I want to primarily invest in real estate. As a high income employee my tax rate will be very high and so in the past I thought I would use a self-directed 401k to get a deduction and use that account to purchase real estate. From my understanding there are agencies out there that will lend on these so I could theoretically use leverage to purchase real estate. However, I’m unclear as to the exact tax savings with this strategy. For example, would I still be able to claim deductions from the rental income and still be able to do a cost segregation to accelerate my depreciation using this strategy? I’ve you heard you say that using these accounts nullifies any tax benefits from real estate but I don’t fully understand that concept. Could you help me understand if this is a good strategy? If not are there any alternatives to sheltering my high salary as a doctor? Thanks!