Five Reasons to Supplement Your Retirement Plan with a Multifamily Real Estate Investment

Real Estate Investing 101
Kristen Ray

Retirement plans such as the 401k and the 403b have long been considered as one of the safest ways to build up a nest egg for your golden years. Under these plans employees are allowed to contribute a percentage of their annual salary to a retirement account managed by their employer or its designated financial company. The money is deducted from the individual’s paycheck on a pretax basis and its disbursement is slated to begin once the person retires. While it all sounds great in theory, the reality is that most employers do not offer retirement plans and only a third of eligible workers participate in one when offered.

Furthermore, the employees who did join their employer’s 401k or 403b plans are often in for an unpleasant surprise once they retire and discover that the true value of their life-long savings is not what they expected. In the paragraphs below, we will highlight the five reasons why a 401k/403b plan is not adequate as a sole source of retirement income.

Retirement Plans Do Not Offer Hedge Against Inflation

One of the main pitfalls of retirement plans is that they are inevitably affected by inflation. Even though the cost of living increases constantly, it often goes unnoticed on a day-to-day basis as the annual inflation percentage in the United States is relatively low. The compounded effect of inflation over a 20 year period however can have a huge impact on the purchasing power of your retirement account. For example, $1,000 worth of goods in 1999 would cost you $1,537.17 in 2019 – that’s a 53.7% cumulative rate of inflation according to the US Inflation Calculator.

Income from Retirement Plans Is Subject to Taxation upon Retirement

A major misconception about 401k and 403b plans is that the money contributed to the plan is tax-free as it is deducted on a pretax basis. This is not true. The entire amount of cash you place in a retirement plan will eventually be taxed. Once you retire and you begin withdrawing money, you will be required to claim these distributions as earned income on your taxes and pay the current tax rate. While no one can predict the future, there is a pretty good chance that the tax rate will be higher than anticipated.

Plan Administration Fees Can Significantly Impact Your Savings

Another incorrect assumption about 401k and 403b plans is that investing in them is free. The truth is, the financial institution managing your retirement plan does not work free of charge. These plan administrators charge a variety of fees that cover everything from bookkeeping, customer service, postage, transaction processing, investing, etc. The fees are usually a percentage of your account balance and may vary depending on the size of the plan. Even a 1% fee, which is on the lower end, would cost you a $1,000 for every $100,000 annually. If you take into account the compounded return value of this money over the life of the 401k, you will realize the costly impact of administration fees.

Retirement Plans Usually Have Low Returns

While the rate of return on each retirement account can vary widely depending on factors such as the financial markets performance, the investment portfolio mix, and the projected retirement date of the plan owner, in general 401k and 403b plans produce low returns. According to a report released by the Employee Benefit Research Institute in November 2018, the average annual growth rate of retirement accounts between 2010 and 2016 was 14.2%.

Retirement Plans Do Not Generate Cash Flow

The lack of liquidity is one of the fundamental principles of retirement plans. After all, the idea is to save money for your retirement age, which is encouraged by limiting the access to your 401k or 403b plan funds until you reach 59½ years of age. If you need to take out your savings prior to that day, you will be charged an early withdrawal fee of 10%. While this may be viewed as a benefit by some, it essentially locks down your money and you are unable to use it as cash flow for an alternative investment.

While contributing to a retirement plan also has its benefits, it is wise to diversify your savings. One alternative investment that has a great wealth building potential is multifamily syndication. Also known as apartment syndication, this is a real estate investment opportunity where multiple passive investors pool their funds to purchase multifamily rental properties.

Benefits of Investing in Multifamily Syndication

* Cash flow throughout the life of the investment – Unlike a retirement plan, a multifamily real estate investment will provide you with a steady cash flow. This passive income is generated by the monthly rent payments and other fees incurred by tenants, and it is distributed to investors on a monthly, quarterly, or annual basis. You will be able to benefit from your investment almost immediately by using these cash distributions to supplement your income, or use towards other investment opportunities.

* Lower impact of inflation – Compared to many alternative investments, including retirement plans, multifamily syndication offers better hedge against the long-term effects of inflation. Real estate prices usually rise along with the prices of other goods, so your money is less likely to lose value once you decide to sell off your ownership in the syndication.

* Tax benefits of owning rental properties (Note: I am not a CPA, please consult your CPA before making any tax related decisions) – Owning real estate, including syndicated multifamily properties, has many tax benefits. Whereas any distributions you receive from a retirement plan are always taxed as earned income, the passive income generated by your rental properties is typically taxed differently and often times it can be offset by depreciation costs and recapture, mortgage interest expenses, capital improvement costs, etc.

* Better control over capital appreciation – With retirement plans often times you are at the mercy of the financial markets when it comes to capital appreciation. With multifamily housing investments on the other hand, the appreciation can be “forced” by renovating older properties, increasing rents, and adding fees for services and amenities such as parking, pets, laundry, garbage collection, etc. This can not only facilitate a greater rate of return, but also offset the effects of inflation over the lifetime of your investment.

* Lower risk through diversification – One of the fundamental principles of investment is diversification. Multifamily syndication is a great way to diversify by putting your money into various syndications across different types of properties and markets, while owning only a small percentage of each.

If you would like to learn more about multifamily syndication and what it can do for your investment portfolio, please visit our website and schedule a call with us for a detailed discussion.

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