Lousy 403(b) Options Led Me To FI Via Real Estate

https://www.choosefi.com/091r-real-estate-inside-an-ira/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.

The sale

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.

Three flaws

  1. 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.
  2. 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?
  3. There are restrictions as to when you can access the money.

Withdrawals

When you withdraw your mone, 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.

Getting Smart

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.

Real Estate

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.)

Bottom Lines

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.

Your Turn

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.

Want to read more from Earlier FI? Check out: The Failing 403b Was My Wakeup Call

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7 Replies to “Lousy 403(b) Options Led Me To FI Via Real Estate”

  1. Interesting take! Do keep in mind this addendum though; not all 403(b) plans are created equal(ly bad), and many can be contributed to in tandem with a 457, with one or either having Roth options. In my case, I can contribute up to $18.5K towards each account, with whatever amount in Roth and/or traditional. While there is an 80 basis point fee tacked on, I do have access to Vanguard Admiral Shares of my choice. Since I plan to FIRE, 7 years of 80 basis points is annoying, but not the end of the world, especially considering the value of reducing taxes, making our family available for various tax credits.

    1. I’m glad you found this post interesting. Many can and do contribute to both a 457 and a 403b at the same time. $37,000 total plus $6000 more in each if you’re over 50 years and that does not include the catch-up which could mean a max of $36,500 in each plan for up to three years. Millionaire Educator did a Choose FI podcast on that topic.
      However, that does not explain or give credence to the excessive fees. Given a choice, the 457 is most often the lower cost option (no salespeople involved). While 80 basis points isn’t the end of the world to buy Vanguard Admiral Shares, it only highlights the inequality between a 403b and a 401k and 457. And it’s possible there is a wrap or annual fee attached to that which is often masked.
      You are correct about the Roth option – some plans don’t offer that option until someone asks for it. And many people wouldn’t know to ask for it.
      Congratulations on saving so much and most importantly, for being aware of how many bases points you are paying.

  2. You state, “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.”

    However, just because you have to take the RMDs doesn’t mean you need to spend the money. You can always pay the taxes and invest it into a brokerage (i.e. after tax) account, no?

    1. Hi Danny,
      Thanks for your comment. Yes, you are correct. Once withdrawn, you can let it grow again in a taxable account. If you don’t spend it, it will become your legacy.

  3. By the way, I am also sensitive to the high fees in 403b accounts. I’ve been contributing the max to my organization’s 403b. However, I’m hoping to FIRE in approximately two years. As soon as I do, I’ll be rolling over my 403b to a Vanguard IRA. Thar said, while I don’t like it, I can suck up the high fees for a short period of time.

    If I was dealing with, say, a 10-year window, I might have to reconsider contributing into the 403b.

    1. Danny,
      It’s understandable to tolerate the high fees for two more years. Better yet would be to ask (politely of course) for a better option. I successfully got our business department to add a low-cost provider. It saved other participants and me tens of thousands of dollars, in just a couple of years.
      Congratulations on being on FIRE! If you have a 457 plan, I bet you’re maxing that too.

  4. WOW, This was an excellent article. I’m a late bloomer to the FI party, but I’m learning so much from all of these blogs. Although I have a good 401k plan, now that I know more about FI I have been thinking the exact same thing about the restrictions and limitations of of the 401k’s and ira’s and thought real estate was a good income revenue. The only problem is that in NYC there are no homes under $50k, not even in the bad neighborhoods. I would love to read more about your real estate ventures and how you began and would love to know where you made your purchases (was it through roofstock.com? I just discovered this a few weeks ago).

    Thank you again

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