One of the tax questions that I get again and again at my CPA firm is some kind of variation of “Should I invest in a 401(k) plan?” My short and simple answer is always “It depends.” The longer answer actually has five questions you need to ask yourself first.
The first three questions are a little more for basic planning, and the last two are more advanced. Let’s start with the first three.
Is there any kind of company match?
If you work for a company (not your own) and the company is offering to match some of the 401(k) contribution, I can’t think of a single reason why you would NOT want to do that. Get the money! First rule in investing is always “Get the money!”
What would you do with the money if you didn’t put it in the 401(k)?
I recently was asked whether someone should continue to aggressively grow their business (for returns of 100% – 300% per year) or put money away in a company 401(k). In this case, my suggestion was that the money would be put to better purpose within their business. But, what if you don’t have real plans for the money? It might make sense to put the money in a 401(k) plan so you start a savings plan. It’s not necessarily the path to riches, but it’s a first step to creating good habits for the future.
The key is be honest with what you would do with the money if you didn’t put it in the 401(k) plan. If you don’t have a good answer, then maybe the 401 (k) is a good idea, at least for now.
Can you self-direct the funds?
Now we’re getting to the main complaint of most 401(k) plans. Your investment options are limited!
There is one big exception to that limitation. If you are eligible to set up a Solo 401(k) plan, you can self-direct the funds to invest in real estate and/or businesses. First some of the rules: (1) Only you and/or your spouse can own the company, and (2) Only you and/or your spouse can be qualifying employees of the company. There are further limitations on what you can invest in (but not many!) and the role your investments can play with disqualified persons. Make sure you fully understand the rules on pension investing before you start self-directing. Don’t let the rules scare you away from setting up and investing through a pension plan. You can buy, flip, rehab, and rent real estate and either pay taxes later or never by using a pension plan. By the way, pension investing is not limited to a Solo 401(k) or Solo Roth 401(k). You can also invest with your SEP, IRA, Keogh, Rollover SEP and other types of pension plans. Learn more with [The Insider’s Guide to Tax Free Real Estate Investments.
There is a danger to learning how to self-direct your pension. You are now fully responsible for your pension, your retirement and your future. All of this leads to the need for a basic understanding of Financial Fluency. I’ll post the final two more advanced questions tomorrow.