Why the 401(k) Robs You of Opportunity and Options
Is Tax-Deferred Really a Benefit?
In some cases a 401(k) for dentists or anyone, can be a good thing to get started with.
In many cases, however, going down that road leads to higher taxes and a much lower return on investment compared to what you could’ve done in your own business.
No one likes to pay taxes. We’d all like to mitigate the tax burden if at all possible.
Typically, this starts with asking for help from a financial advisor or CPA. The first thing they’ll tell you: “Start an office 401k. As you put money in, you get a tax deduction for that particular calendar year. Every year as you load up this retirement account, if you're a wise investor, it will build up and become your retirement nest egg”
All true. And if it’s the only thing you do with your money, it is better than nothing at all. What I mean is, it is far better than spending as much as you make and failing to save for the future. Saving into a 401(k) requires discipline and discipline is a good thing.
But the 401(k) is only the “smart” play if it’s the only play on the table. There are much better strategies and better opportunities for those that want to put in the time to learn how.
With a 401(k), you get that tax deduction, but it takes the money off the table, leaving you with limited options and locking it up until you’re already out of the game.
The Opportunities Lost with a 401(k) for Dentists
What if you have a better opportunity? What if you could take that money and invest more into your business? You could get a far better return in your own business than in whatever mutual fund or annuities or bonds your money managers are putting it in. You can get a much better return in your business than in most other Wall Street Investments.
In fact, when investing in a business with a good business model, you can often create significant returns – far more than you can make in any other asset class. It is also within your control – not at the whims of the market. That's the real rate of return on good business models. You can't do that in the stock market.
Investing in your business should outperform even real estate (unless you’re hitting a major home run). Overall, if we shoot for a 15% return in real estate, we feel like we've done very well.
In addition, I regularly speak to doctors who have worked hard for decades and accumulated enough net worth in their 40s or early 50s to be in a position to begin to buy back their time from running on the hamster wheel of their practice.
Unfortunately, those who have invested heavily into 401(k)s find that they are unable to access the wealth they have accumulated without incurring a significant penalty. Despite having enough to retire, they are forced to continue to work for years longer than necessary simply because they do not yet have access to their own money.
It is frustrating to feel stuck behind the chair for years longer than necessary despite having diligently saved and accumulated a significant nest egg.
Keeping your capital free and clear of retirement accounts gives you the flexibility to buy back time on your own terms – not waiting until a distant retirement “someday”. After all, what use is Freedom if you don’t attain it while you are still young enough to enjoy it?
Don't let the Tax Tail Wag the Dog
Don't let the fact that you're paying taxes today keep you from keeping that money free where you can get a better return. Sometimes I see practice professionals get caught up in schemes they wouldn’t otherwise have been caught up in if it wasn’t for the “tax deductions” it came with.
If you’re only investing in an opportunity or putting your money somewhere for the tax deductions or deferrals alone, is it actually worth the trouble and risk? In the case of a 401k where you lock your money up, I say it’s not worth it.
401(k)s can be a Stepping Stone
One reason a 401(k) might be helpful is that you can convert that money into a Roth IRA (used as a stepping stone to something better). You’ll have to pay the tax on the contributions, but it's a way to get a big chunk of money into a Roth IRA very quickly.
Otherwise, the contributions to a Roth IRA are very small per year and many of you, because of your high income, can't directly contribute to a Roth. Using a 401(k) as a stepping stone to a Roth is what we call the “backdoor Roth IRA.”
When you get distributions out of a Roth IRA at age 59 and a half or above, they’ll be tax-free. But money in your traditional 401k is going to come out with a tax liability. You're going to have to pay tax on those distributions and the problem is we don't have any idea how high tax rates will be then.
I’ll tell you one thing, they will never be lower than they are today. So think hard before you decide to kick the tax can down the road, because in this case, it’s not the best idea.
Everybody's individual situation will be different. So I'm giving you an overall construct. You still need to talk to your tax advisor, but don't always buy into what the mainstream media says about why 401(k)s are so “great”.
In some cases, they can be a good thing to get started with. In many cases, however, going down that road leads to higher taxes and a much lower return on investment compared to what you could’ve done in your own business.
To your freedom!
P.S. Whenever you’re ready, here are some other ways I can help fast track you to your Freedom goal (you’re closer than you think) :
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