When something is bad, you have two choices: Try to make it better or go somewhere else.
That was the case with my 403(b). I got wind of how bad it was here. When the moment came to make a change, I decided to opt for a completely different investment vehicle.
While selling their tax-deferred 403(b)’s, all financial advisors will tell you the premise is simple: Pay fewer taxes today when you’re in the highest tax bracket you’ll ever be in. When you retire and take the money out, you’ll have to pay taxes on it, but presumably, you’ll be in a lower tax bracket, resulting in fewer taxes paid. That sounds logical enough.
- The only option in a 403(b) is to invest in the stock market. The downsides of that are you have at best, one lower-cost option, no control over how the market performs, you’re at the mercy of the market, and you pay sales charges plus higher than necessary expense ratios for lackluster service, at best.
- It assumes, almost screams out at you, that you will be making less money in retirement. It seems then, that the goal is to earn less money so you can win a spot in the lower tax bracket. Why strive for that? Why work your whole career to one day bring you down into a reduced tax bracket?
- There are restrictions as to when you can access the money.
When you withdraw your money, you will pay taxes on it. Additionally, there will be forced withdrawals in dictated increments–no matter the need for it–and taxes due on it starting at age 70 1/2. This is called Required Minimum Distributions, RMD’s for short. The IRS wants its money eventually, and they think this is a fine age to start. Furthermore, the goal of the RMD’s is to deplete your money upon your death. Money won’t be able to be passed on to heirs unless you die sooner than the IRS expects and in that case, your heirs will be forced to pay the taxes on it. It doesn’t simply pass through your estate, tax-free like other monies.
I didn’t recognize those flaws right away. But I learned. The more I learned, the smarter I became. The smarter I became, the more action I took. The more action I took, the better my returns. It was a win-win. It worked for me because I put forth the effort to learn, to mitigate risk, to take action, and to be in control.
Conversely, I thought it would better serve me and my heirs if I built streams of income during my career that would allow my investment and income to grow throughout my life and my heirs. Clearly, the 403(b) wasn’t it.
That is what brought us to Real Estate. We bought a house with savings and filled it with a tenant. Tenants represent about 37 % of the U.S. adult population, by the way. Never in my life did I know that you could buy a house in a nice neighborhood for under $50,000. In the neighborhood we reside, about 80% of the houses are owner-occupied. I never gave it a second thought that more people own than pay rent.
The point is this: I paid taxes on the $45,000 as it was earned and I collect rent from it all day long, year after year and I don’t have to pay taxes on that, thanks to paper losses and depreciation rules. I will pass it on to my kids to either sell tax-free or to collect rent from. I will not be forced to sell it or take RMD’s from it when I turn age 70 1/2 like I will with my 403(b) or IRA.
The goal of this house, and the others like it, is to develop an income stream that increases as rents rise whereas the goal of a 403(b) or an IRA is to be depleted at death. (Learn more about real estate and income streams with Chad Carson, guest of Choose FI podcast episode #16.)
Their Way: Work hard, save money, stop working, deplete your money.
My Way: Work hard, invest money, collect income stream, stop working, collect streams of income.
And this came about because my 403(b) plan is rotten.
Not everyone wants to be a real estate investor or knows how to invest and manage properties wisely. There is a certain risk profile attached to every kind of investment and real estate is no different. Schools are not educating students about personal finance much at all, and if they are, they are NOT including real estate investing, expense ratios, 403(b)’s and wrap fees in the curriculum. It is ultimately up to you to examine each facet of your economic profile and question every line item. After that, look holistically at the big picture and not just those important details.
It was the pesky non-essential expenses and asset management fees, that caused me to evaluate not only the 403(b) vendor but alternative investment classes as well. After all, there’s no such thing as a Real Estate Advisor selling their wares in a faculty lounge. Yet real estate is remarkable FI vehicle with beneficial tax treatment.
Continue with an annual family finance review, Choose FI podcast #58R, but don’t get lost in the details while missing other suitable FI vehicles.