401(k) – Yay or Nay

Should You Invest In Your 401(k) As A Doctor

In short, if you can do something more profitable with your 401(k) money then take the higher paycheck instead of maxing out your 401(k). But if you’re just going to put it in a savings account then definitely max out your 401(k). At $200k of gross income you would need your money to grow at 15% to make up for the 5-6% returns you generally get by investing in mutual funds in a traditional 401(k). 

I’ve talked about the basics of a 401(k) before and I realize that it’s a bit of a convoluted system. It’s simply a way for you to put money aside for retirement and not pay taxes on it while you’re still saving, which means that it can grow tax-free. It’s just another ‘vessel’ like an IRA or a 457 to keep your money in. Once you hit the IRS mandated ‘retirement age’ you can withdraw the money and at that time you will be taxed at that current income tax rate.

Quick example, Dr. Mo maxes out his 401(k) to a tune of $18,000 per year for 10 years. He chooses to invest in some index funds earning somewhere around 5% per year. After 10 years he will have around $234,000.

Because Dr. Mo is only 40 years old at that 10-year mark he can’t access that money unless he pays a 10% penalty. He instead decides to let it sit and keep growing at the same 5% for another 20 years without contributing another dime. So when he reaches 60 years of age, besides being incredibly handsome, he will have nearly $630,000 dollars in his 401(k).

If he wanted the money at age 40 then he could pay the 10% penalty and either take a little bit of it out every year or all of it. If he took all of it out then 10% of $234,000 is $23k. So he could deposit $211,000 into his account but remember he would owe ordinary income tax rates on this money. If Dr. Mo was already making $200k at his regular job and suddenly added another $211k to his income he would be fucked by Uncle Sam, prison style.

But let’s say Dr. Mo decided to stop working at age 40. If he only pulled out $30,000 to spend on his blow habit then he would owe the ordinary 10% penalty – so that would leave him with $27,000 gross. Let’s say another $6k for state and federal taxes – which means he will be left with $21,000. Not bad.

We haven’t talked about the tax savings of maxing out one’s 401(k). If you already know how that works then skip this section. In short, the 2 most important aspects of contributing to one’s 401(k) is decreasing taxes owed to the IRS and allowing the money to grow tax-free.  It grows tax-free because you can buy and sell stocks, bonds, index funds (whatever you hold in your 401-k) and not have to pay taxes on any profits you make.

The math behind the tax savings of maxing out your 401(k) is very basic. If you make $200k and owe taxes on that $200k then by contributing $18k to your 401(k) you won’t be taxed on $200k but instead taxed on $182k. You are essentially lowering your taxable. This is the same concept behind tax-deductible IRA’s and HSA’s.

Of course there are the deductions and personal exemptions that would lower your gross $200k a little too but there is no need to get into that here.

"OMG Dr. Mo! I don't wanna contribute to my 401(k) because my paycheck will be smaller. I have greedy baby mama's."

Alright, let’s see how much your paycheck would be affected. If you make $200k of gross income you would owe $75k in taxes. Your take-home would be $125k/yr or $10,417/mo. 

Now let’s say you decided to deduct the $18k from your paycheck and invest that money. By maxing out your 401(k) you lowered your taxable income from $200k to $182k like we mentioned before. So you would pay $68k in taxes. Your take-home would be $114k/yr and so your paycheck would be $9,535/mo. By not contributing to your taxes your paycheck would be higher by $882 per month.

By maxing out your 401(k) you are essentially stashing away $1,500 per month and your paycheck is only dropping by $882 per month. Is it worth it? That’s the question for you to answer. True, your pockets will be lighter by nearly $900 but if you’re just gonna spend that on a new gadget every month then fuck it, max out your 401(k) instead.

If you invest your 401(k) money aggressively in stocks and know what you’re doing then perhaps your could have 10-20% returns. If you play it safe then you are probably going to beat inflation by 1-2%. Playing it safe means investing in low-cost mutual funds. In an aggressive portfolio you are risking your money quite a bit more but if Dr. Mo decided to do that then instead of having $234k he could have $417k assuming a rate of return of 15%.

Now, let’s say you are a genius with your money. You trade stocks intelligently, you dabble in options and buy and sell businesses or invest in real estate. In that case an extra $882 per month could be turned into some fat cash.

Let’s go back to Dr. Mo, if he decided to not contribute to his 401(k) and invested the $882 a month at 15% of annual return he would have $245,000 either in a brokerage account or in several real estate properties. 

The advantage to the above scenario is that his $245,000 would not be subject to a 10% penalty upon withdrawal because he likely has that money invested in real estate or stocks … or a strip club. The disadvantage is that Dr. Mo is probably working his ass off to invest that money. Nothing in life is free. You can’t get a 15% return on your money just because you are pretty. So do your research and decide whether you want to be the passive investor or the active money manager. Dabbling in index funds isn’t sexy and you get shitty returns on your money – but it’s conservative. Investing in stocks, real estate or businesses can make you quite a bit of money if you are willing and capable of putting in the time.


Are you currently investing in your 401(k)?

What would you do with your money if you didn’t contribute to a 401(k)?

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