Real Estate vs. Your 401(k): Which One Is Actually Better?

Today, we'll be discussing what's better, investing in real estate or your 401(k). Hello and welcome to Money Talks. My name is Ken Wink from Summit Financial Consulting here in Southeastern Michigan. If you'd like more info about what you hear during our show today, give us a call 586-226-2100 or you can always reach us on the web summitfc.net. I highly encourage you to check out the podcast page, look at our past shows and you can also subscribe on all the podcasting sites. So if you've got some money to invest, one of the first things you have to decide on is, well, where do I want to invest it? Do I want to buy stocks or mutual funds or ETFs? Do I want to buy real estate? And then which one's better when it comes to performance, but also taxes? Before we jump into the topic for today, I want to introduce my co-host, Tony Shore. Tony, I used to own a big car wash, and now I'm invested in stocks and mutual funds and ETFs now. I know you're taking care of your parents' farm right now. Which way do you prefer, real estate or stocks? Stocks. Stocks.

Stocks. And it's because I never want to be a landlord. I never wanted to be a landlord. And then I had to take over all those duties for my parents. You know, they leased the farmland. They rent the house. There's two houses on the property. They rent those out. My dad set all that up and not well. And I never wanted to be a landlord. I get investing in real estate, but I would much rather have stocks. I'll be honest. Maybe it's laziness. It's a lot of headache to deal with owning real estate property. I never wanted to be a landlord or have renters, and I find it's truly a nightmare. In fact, it's funny you should bring this up, Ken. Last night... Watching the... We're recording this on a Friday. Watching the Thursday night football game. Oh, boy. I get a call at like 9 o'clock or 8. It was more like 8 or 8.30, I guess. Closer to 8 p.m. from one of the renters. We have no water. And the other house doesn't have water either. And then I get a text from the other house. No water's coming out. We don't have any water. And I'm like, I'm three and a half hours away. I'm like... Good Lord, what am I going to do about this? And how much is does my dad even have enough in his account to cover, you know, what this is going to cost? So I called a good friend of my dad's who helps us out all the time. And he said, oh, I'll run over there. That's no problem. He lives close. Oh, good. He went over and it was a circuit breaker for the pump. Oh, that's easy. Yeah. But it's that call I don't want to get and that panic feeling. I hate that. And so that's my reasoning. What do you think? Do you still own that car wash? And if so, if not, why not? It was a giant pain.

There you go. Yeah. Yeah. Yeah. Owning a business, just people would like the amount of comments that we would get online from people that say, I left the car wash and there was some water that trickled down my windows after you towel dried. Your guys did a terrible job towel drying. And it's like, well, we can't. duplicate you driving down the expressway 70 miles an hour and turning right, and the wind hits it just right and gets a little spritz of water out from underneath the window, you know, like, yeah, it's just sort of a constant, uh, drag on time, uh, trying to maintain the the business's image. So, um, yeah, happy that it was gone now, you know, but there's You can't please all of the people all of the time.

And nowadays, that's a problem because everybody's looking at your number on Google like, oh, less than four. Oh, my goodness, or four. I want somebody with 4.8 stars. But one customer that has unreasonable expectations or two or three, you can't please everybody all of the time, Ken. That's the problem.

Well, my my client that asked me to do this show owns commercial real estate and he has businesses subleasing his properties. And he's been it's in a popular, very busy place. So he's never had a problem with renters. So for him, it's like the businesses that are renting from him have to worry about Google reviews and those sorts of things.

He doesn't have to.

He doesn't have to.

Commercial real estate is different, and things like flipping houses might be different. But if you have renters or customers, that is a whole other ballgame. Some people say, well, rich people, wealthy people invest in real estate all the time. They own the land and that's where it might end and they get regular income from it. And that's great because that's mailbox money. If I have mailbox money, I'll almost prefer that over investments.

Sometimes when you have land, too, you can get solar panels there or wind turbines or billboards. That's mailbox to me.

A cell tower. On our property, on the farm that my dad owns, there's a Verizon cell tower. The best thing my grandfather ever put on his farm. And he did that. It's over $700 a month. And it takes up hardly any space. It's not like they're losing a lot of crop land. You know what I mean? If you added up the bushels that it takes once a year, the bushels that they would get of corn or soybeans off that little tiny, plus it's at a driveway into the field. So it's not really taking up any farmland space or very little. That's just mailbox money. And that's in perpetuity, right? I mean, that's amazing.

Well, our experiences are varied, I guess, and there are a lot of different situations. But if you're watching the show and you're asking yourself, well, should I invest in this real estate or should I put money into an IRA or a 401(k)? I think the first question you have to ask is, are you investing for your children and your heirs? or just for yourself, because with these two types of investments, something very interesting happens when you die. So real estate, typically, if you own it or a business owns it, when you leave it to your children, there's what's called a step up in cost basis. So a 401(k), a traditional IRA, annuities, none of those have a step up in cost basis. So under the rules, you know, the tax laws as they are today. And of course, these could change because our national government has a ton of money in debt and the interest is crazy. Yeah. But as of today, for beneficiaries that inherit an IRA or a 401(k), spouses have different rules. They can put it under their own name and different rules. But if it's for a kid or a niece or nephew or something, the IRA and the 401(k) have to be emptied out within 10 years and they typically are gonna have to pay taxes on all that money. But with a piece of real estate, they just get the piece of real estate basically tax-free. So there's there's a real benefit there to owning real estate, and the same rules apply for, uh, for some other types of investments. But for today we're just going to talk about real estate versus IRA or 401(k), and it depends on if the real estate value is the is the value itself of what you could sell it for. It's not very liquid.

But if you're getting rent or some type of income from that property on a regular basis or mailbox money, that's a huge benefit, right? It depends, is what you're saying, on what type of real estate you own. Like my dad... He was kind, generous, not a good business guy. I mean, he's renting it for way too little. I mean, you know, and I get that. Hey, that's great. I love being generous. But I mean, crazy too little. Like, he's not making enough off the property to pay for all the things. I mean, he's just not. Yeah, he's not making enough to live off of the property. It's not enough to help him or take care of costs that come up. Because when you're in a firm, there's a lot of costs. I mean, you know. If that water pump had gone out and it had been the pump that needed replaced down inside the well, you know how much that costs? They have to come out.

Thousands.

Yes. Or if the well had run dry to get a couple of tanks of water shipped out there. It's outrageously expensive. Yeah.

Yeah. Well, if you got two investments and they're both worth a million dollars when you die, your children could inherit both, but the tax consequences could be dramatically different. So a little bit later in the show, we're going to talk about what happens if your kids are in the 12% tax bracket, 22% tax bracket, 32% tax bracket. And then we'll also talk about sort of a comparison of how the investments have performed historically when you look sort of like broad at the whole stock market or all real estate.

But you're right. I wasn't thinking taxes. The real estate could be very tax advantageous.

Yeah. Yeah. Especially farmland.

Yeah. Oh, for sure. Yeah. You know what? That's one thing they can't make more of. No, that's true. Good farmland. My grandfather always said that. The reason farmland is so valuable, they can't make more of it.

Yeah. Yeah. Well, looking at the rate of return. So I'm going to look at historical numbers here. Everyone knows past performance can't predict future performance. So we got to look at something. So we're looking at the past figures. You know, I would argue stocks have been an extraordinary wealth building machine. The New York University Stearns College of Business decided to dig in a little bit deeper at one point and just see what have stocks earned long term. So they did the analysis and they said that if you invested $100 back in 1928. From 1928 until 2025, $100 would have grown to $1.15 million. So that's averaging about 10% per year. So now- Realistic.

Say that again. So very realistic.

Yeah. Yeah, absolutely. So that's that's a lot of wealth created. Right. Yeah. So now if we compare that to real estate and with real estate, we're just looking at like all real estate. So commercial farmland, residential, you name it, just group it all together for the purposes of our show today. A hundred dollars would have grown to five thousand six hundred and twenty six dollars. So four point two percent. So a hundred growing to 5,600 versus a hundred dollars growing to 1.15 million.

So let's see, which one would I prefer?

So that's kind of a no brainer choice, isn't it? Yes. Yeah. So that's, that's something that like when we speak with clients, we sometimes have to dig in a little bit deeper because they demonstrate that real estate doesn't necessarily outperform stocks on an appreciation standpoint. Um, you know, since 1928, that's, that's a really long period of time, right? We're getting a really good long-term average, uh, you know, but wait, you know, if it's a rental property, I don't want any of our listeners or viewers to start yelling at their monitor or their phone here. Like I understand if it's a rental property, it could be generating additional cash flows, which could add to the rate of return. So I'm not saying your rental property is only going to make 4.2%. Um, Real estate can be very, very different. Another thing with real estate that you can do that we typically don't recommend doing with stocks is you could use leverage. Oh, sure. So, you know, you buy a house and you do a $200,000 down payment, but you buy a million dollar property. You've got a mortgage now, right? But if the property appreciates $50,000, you just made $50,000 on your $200,000 investment, right? So you can't just walk into it and assume that everybody's going to pay cash for real estate. You have to take the leverage into consideration of using a mortgage. But, you know, it works both ways. You know, you do have to pay a mortgage potentially to get that leverage. Oh, sure. You know, and then, you know, real estate has property taxes and insurance and potentially error and emissions insurance or liability coverage, etc. There's maintenance, there's vacancies if nobody's renting for a while. Management costs, you know, and potentially can eat up a lot of your time too. So comparing a rental house to the S&P 500 isn't always a perfect apples to apples comparison. But the broad historical data, I think, does, if you look at history, and again, past performance can't predict future performance, stocks have historically produced a much higher long-term compound rate of return than a broad real estate asset has.

Yeah, I see your point, and that is why, right there, why I prefer the stock market or a 401 or IRA over real estate, because look at how many variables there are and how costly real estate can be over the long haul. That's just not for me. But some people love it, and they've done quite well with it. What about taxes? You mentioned that early on, and that's one of the big key deciding factors here that you have to look at, right?

Yeah, absolutely. So if you own a piece of real estate, let's say you bought it. We'll use my last example. Let's say that you put $200,000 towards the property, and now 30 years later, it's grown to a million dollars. So that's an $800,000 gain. If you sell that during your lifetime, you're going to have to pay long-term capital gains tax on it. So again, we have to answer the question from the get go. Is this investment for you or is this investment for the next generation? Because if you die, generally speaking, that inherited property is going to get a step up in cost basis and the next generation is going to get the property. Basically, with a cost basis of a million dollars. So that means if they sell it for a million dollars, there's going to be zero tax on it. So that that would be pretty nice for the children to inherit it. Sure.

Yeah. Yeah. I mean, any tax free inheritance is great. That's fantastic. So there's what I hear you saying this. You said at the beginning, it sounds like when it comes to taxes, real estate wins out. hands down.

Yes. Compared to an IRA or 401(k), because with the IRA or the 401(k), the children still inherit the balance, but now we've got to mess around with the secure act.

Those are joint accounts with Uncle Sam. And they have $40 trillion in debt. They can't service the, even the interest on the debt is now going to be the highest expenditure of the US government out. It'll be a bigger chunk of what we spend than even military spending. or Social Security and Medicare. So they're going to have to do something to make that money back, and they can mess around with taxes. But I see your point there. You want to be as tax-advantaged as possible. But that's assuming... Now, most people, it's true, still do have the traditional 401(k)s and traditional IRAs. But Roth IRAs, if you do that comparison, you still have to pay tax on the money that goes into the Roth, but... That's a tax-free option. So people might be saying, but what about a Roth? I have a Roth. That's true. You don't pay taxes on that. And your loved ones who inherit it won't have to pay taxes on it.

Yeah, that's a great alternative, Tony, is you could do a Roth 401(k) or a Roth IRA. And then I would say it in most cases is going to beat the real estate hands down because of the potential appreciation in the stock market. And then you would inherit it 100 percent tax free. Yeah.

Yeah. Yeah. There you go. So what next? What do we need to figure out?

So nobody knows exactly what the next 30 years are going to look like. Right. But if we look at four point two percent for real estate, if you invested one million dollars, that would grow to three point five million. If you look at the stock market and invest a million dollars at 10 percent, that grows to seventeen point four million. So that's a gigantic difference. But then we have to look at the step up in cost basis. So let's assume we've got $3.5 million in the real estate, that gets a step up in the cost basis. If we theoretically had $3.5 million in a traditional IRA, you know, that's different. So now let's look at some examples. Let's assume that the children are in the 12% tax bracket. So if they're in a 12% tax bracket, that means they would pay $420,000 in tax. So that would leave them with $3.08 million. If the kids are in the 22% tax bracket, that's $770,000 of tax. So that would leave them with $2.73 million. And then let's say those kids were really high earners and they were in the 32% tax bracket, they'd have to pay $1.12 million in tax. So they'd end up with $2.38 million after. Yeah. So if we just looked at 3.5 million in an IRA versus 3.8, or I'm sorry, 3.5 million in real estate, 3.5 versus 3.5 in the two investments, with the real estate, you'd end up with 3.5. With the 12% tax bracket, you end up with a little over 3 million. With the 22%, you end up with 2.73 million. And then with the 32%, you end up with 2.38 million. So just for comparison sake, I wanted to say if you had the same dollar amount in the two investments, how would it play out? But that's assuming that the stock market and your investments perform at the same level. And when you look at the historical precedent, the stocks have done quite a bit better.

Yeah. Interesting. So the tax brackets make a difference of where you're at or where your beneficiaries are at when they inherit the money. There's so many factors that go into it. But you do have to look at these things. And it's a boy. Your your client asked a great question. And because a lot of people do own property or inherit property.

Yeah, well, I've got a wrinkle to throw in too, Tony. So one of the other things we have to consider is, and you mentioned this with the Roth, but what did it cost you to get the money into the investment in the first place? So I just got done comparing 3.5 versus 3.5, but like a Roth IRA, when you invest in real estate, you gotta put the money in after tax. You're gonna pay taxes on it first. So, you know, every time you put a dollar into a 401(k), typically you're gonna avoid income taxes on that dollar. The 401(k) and IRA has tax deferred growth. So, you know, we're comparing tax advantages today versus tax advantages at death. My biggest takeaway from this whole thing, like if you're asking yourself the question, should I invest in real estate or should I invest in stocks? I would argue, which account should I hold based upon the investment performance and my risk tolerance? And then how do I want things to be handled when I die? Because the taxes are different when you're alive versus when you die. The rate of return could be vastly different. Is it a rental property or not? if you're asking me which one is better overall, obviously I'm a financial advisor and we manage portfolios here on a daily basis and we feel strongly about our process. So I would say invest in stocks. And when we meet with people's beneficiaries, we will tell them, hey, this is what tax bracket you're in. You've got up to 10 years to take this money out of an IRA or a 401(k). We'll crunch the numbers with our tax team and actually tell you, well, if you take it out over five years, you're going to pay X amount of tax. If you take it out over 10 years, you're going to pay a little bit less. If you take it over one year, you're going to pay this big tax bill because it all goes through the tax system as a single year's earnings. So whatever the person's circumstances are, I think you just have to ask yourself, is this for me or is this for my kids? Because they're two completely different answers.

Ah, good point. And I love that you point to the fact that the real way to answer this is to sit down with you and your team there, Ken, professionals that can look at all the facts of your specific situation. You shouldn't say, bullet points, here's what you should do because of... this. You can make blanket statements. It sounds like you and I would both prefer to have that money in stocks and over the long term might be beneficial. But it depends on where somebody's at currently, what they have. Is the property already owned? Are they looking at buying property? I mean, there's so many. Do you have beneficiaries? Is this for your beneficiary? That's one of the key questions. you brought up throughout the show. And taxes obviously always come into play anytime you're dealing with money or investing. The tax implications are just huge. So for our listeners and viewers out there, they need to sit down with a professional. And I know you offer a no charge, no obligation consultation. How do our listeners and viewers get a hold of you to set that up?

Yeah, give us a call at 586-226-2100 or on the web at summitfc.net. We'll look at your situation. We'll look at your beneficiaries. You know, if your beneficiaries are a charity, I'd lean towards doing an IRA or a 401(k). If your beneficiaries are in a low tax bracket, probably recommend an IRA or a 401(k). If you're beneficiaries are very wealthy, then we'd look at either a Roth IRA for you or real estate. So every situation is different. We'd be happy to sit down with you and go over all your numbers and figure out what makes the most sense to help you accomplish your goals.

Yeah. There you go. Boom. Great show today, Ken. I love this topic. What a great question. Whoever that was that asked you, good question. And I know we appreciate that. So if you are listening out there or viewing this show, ask these questions. And there is no dumb question. No. Only dumb answers if I give them. Smart answers if Ken gives them. I will work into my answer, pizza or music. Ken will actually focus on the actual finances and true answers to your questions. Ken, great show. Listeners and viewers, thanks for tuning in. Again, call Ken and his team at 586-226-7000. 2100 or go to summitfc.net. And that does it for today's episode of Money Talks with our host, Ken Wink. Thank you for joining us for Money Talks. Don't head into retirement without a strategy that addresses both income and taxes. For more information, please contact Ken Wink at Summit Financial, working with people you trust. Call 586-226-2100 or visit SummitFC.net. Join us again soon for another episode of Money Talks.