32: Optimizing Your 401(k), 403(b), 457(b), or ESOP

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1:22Since quitting my full-time job in corporate finance a few years ago, I've built a seven-figure media business and actively advise some of the most well-known fintech companies around the world. As the show name might suggest, every episode we talk about rich habits as they relate to business, finance, and mindset. However, we try and bring you two unique perspectives. One from an industry veteran, which is Robert, and the other myself, someone who's still in the process of building wealth and figuring it all out. I'm pumped for this episode. We are now into season three. This is episode 32. We've got a lot of tailwinds behind us, and I'm really excited to dive in.

1:59So Robert, what are we going to be chatting about in today's episode? In today's episode of the Rich Habits podcast, we're going to be demystifying all of the different employer-sponsored retirement accounts that exist and really explain what these all mean, as well as sharing our thoughts on the best ways to participate in each one. We hear the 401k, the Roth 401k, the 403b, the 457b ESOPs. They're all so confusing. Trust me, I've been doing this for years and it's still confusing for me at times. But not anymore. We're going to simply explain how each of these common employer-sponsored retirement accounts work, their tax advantages, as well as how we think people should be using them to build wealth for a comfortable retirement.

2:47And this episode is especially important, Robert, because over 110 million Americans across the country have access to employer-sponsored retirement accounts, but less than half of them actually contribute toward them, unable to take advantage of their benefits. So if you're listening right now and you're investing toward your employer-sponsored retirement account, pat yourself on the back. And if you have a coworker or know someone who maybe hasn't yet begun, send them this podcast episode so that they now know the definitive truth as to what the account is and how to use it to build wealth. With that being said, Robert, start us off with the first account.

3:26Yes. Number one and the most common is the 401k in the Roth 401k. We talk about these every single day, so we're going to dig into it and break it down for you. I deal with clients, friends, family members every single month of the year that just don't understand the difference between all of these accounts. So our first account is the most popular, and that's the 401k. A 401k is simple. It's a retirement account you're able to open alongside your employer whose entire purpose is for you to contribute a small portion of your paycheck to the account that will be invested towards your retirement.

4:03As a company benefit, you might also receive a percentage of your paycheck as a company match to boost your monthly investing. For example, if you make$100 ,000 per year and your company matches 3 % of your salary and contributions and you contribute$3 ,000 per year towards the account, your employer will also contribute$3 ,000 to your account. A total of$6 ,000 is now in the account. That original$3 ,000 contribution you made is also tax-free, which means you're able to write off the$3 ,000 of your taxable income for the year, saving you hundreds and potentially over $1 ,000 in taxes just for the year.

4:44Now, the maximum amount of money you're able to contribute to the 401k per year is$22 ,500, which is a lot of money saved on taxes if you're actually able to contribute that much. However, we don't exactly recommend doing that, and here's why. So the potential downside risks that come with a 401k is the fact that it's not exactly flexible. Here's what I mean. When I worked at a publicly traded healthcare company out of college, I contributed to my 401k. However, I wasn't able to exactly choose what my money was being invested into. Instead, they parked my money inside of a few target date funds, depending on my age and risk tolerance, which in my opinion is not a good investment strategy, right?

5:26That is not a retirement strategy. I had no autonomy over my money and where it was being invested and my account often underperformed the S &P 500. This is why we believe everyone should be investing the money in this specific order. First, up to the match, right? You want that free money from your employer. Next, max out that Roth IRA. If you don't know what that is, listen to episode 31, where we domestified the alphabet soup of finance and we talked about what the IRA is. Then, once you've done both of those things and you still have money left over, now invest money back into the 401k only if you have autonomy.

6:03Only if you have autonomy. I wanna say that twice. It's very important. You don't wanna underperform. And if you don't have autonomy, then park money into some index funds on public.com. Love that. And that is a really important part of this section. so I hope everyone is listening and taking notes. Now let's move on to the Roth 401k. It's the exact same thing, except one little difference, taxes. Remember, when we mentioned you'd be able to write off those contributions against your taxable income, well, that comes with a catch. The money you withdraw in retirement to spend and live off of, you'll have to pay taxes on that income.

6:41Whereas with the Roth 401k, you're not writing the money off your taxable income now, which means, yes, you're paying taxes on the money, but when the money grows into potentially millions upon retirement because of compound interest, you'll be able to cash out and spend that Roth 401k money tax-free. If your employer offers this, we'd choose this version every single day of the week and twice on Sunday over the normal 401k. Pro tip, it's never a good idea to borrow against these funds or cash them out for any reason. This is your retirement. Never borrow from your future to pay for today. Say that again.

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8:01That's stitchfix.com slash Spotify. Now let's move on to number two, the 403B. So as we pivot slightly into the 403B, I want to remind everyone that this account is very identical to the 401K, except they're only offered to employees of public schools and other tax-exempt organizations like churches. Now, these accounts are also sometimes referred to as TSA accounts, so keep that in mind. Now, just like the 401k, these 403b accounts allow employees to contribute a portion of their paycheck every month to a retirement account. And also like the 401k, these 403b accounts are just as limited in what they're invested into, which is why, again, we want to reiterate up to the match, max out the Roth, and then back to the 403b only if you have autonomy over the investments.

8:53Yes, and also as a reminder, similar to the 401k, there are Roth 403b accounts with the same tax-free retirement benefits. And always keep in mind, without full autonomy over these accounts, likely they're going to underperform. And I want to make sure everyone understands this so they're optimizing on their wealth building journey by having the proper investments in place. And number three, the 457B. Now this next retirement account is another spinoff of the 401k, but instead of it being offered only to employees of public schools or other tax exempt organizations, this account is offered to government employees.

9:37The 457B, similar to the 401k, is a retirement account contributed towards through your paychecks every month with an annual contribution limit of$19 ,500. Now listen closely. This is very important. The 457B also has something called a double limit catch up that allows employees who are three years away from their retirement age to contribute twice the annual limit or$39 ,000. So if you're using the 457B, this is an amazing little add on a little pro tip that helps you out in the long run. And that is one of the benefits of the 457B that we like. That's probably also incredibly important for people who are nearing retirement and looking for some of these tax write-offs.

10:27Assuming it's not a Roth 457B and it's a traditional one through their employer, I mean, gosh, that's what,$10 ,000,$11 ,000 in tax savings on a$39 ,000 contribution? That could be huge. Just want to quickly reiterate though, there is a Roth version of the 457B, which means no taxes on your profits when it's time to retire. Now, our last employer-sponsored retirement account isn't exactly a retirement account, but it's worth mentioning because so many companies offer it as an employee benefit. And that's the ESOP, or Employee Stock Ownership Plan. Now, this is an employee benefit plan that gives workers ownership interest in the company they work for in the form of stock.

11:08For example, let's say you're an employee of a publicly traded company like Amazon. If the company you work for offers this plan and it's part of your compensation, you'll earn shares of company stock over a period of time. Now here's the pro tip. The important term to understand with this plan, and many people don't, is vested. Which essentially means how much time has to pass before you're able to actually own the stock. Once the allotted amount of time passes, sometimes one year, two years, or three years, maybe even four years, it totally depends on the company, you'll have possession of the stock and be able to do with it what you will.

11:48So make sure you understand and read up on the vesting schedule within this plan before you jump in head first. I also want to encourage people to think about this ESOP as part of your compensation, not your retirement. So here's what I mean. Companies, especially single stocks, sometimes they outperform the stock market. Think Apple or Microsoft or Amazon, while others sometimes drastically underperform. Think about Disney, for example, right now, right? Disney stock is at like 2016, 2015 lows, like 10 years ago lows, like that's terrible. As you receive the stock, don't be afraid to sell the stock and put that money into index funds on a public.com or maybe you diversify that into real estate on Fundrise or some sort of alternative investing strategy that you have.

12:34I think that was a mistake that I made when I was out of Metasys. I had an ESOP and this was the company I worked for out of college. And I think I had maybe$2 ,000 or$3 ,000 given to me in employee stock. And I was like, oh, this is great. It's just going to keep going up. We're going to have fun. And then the stock came tumbling down during the pandemic. And I lost half my money, right? All because it was so concentrated into this one stock. So when you receive the stock, don't be afraid to sell it. It's all good. It's part of your compensation anyway. Don't think about it as a long-term retirement plan.

13:05I love this point. and most people don't even understand when it comes to vesting and getting company stock, that it truly is part of your compensation. Everyone looks at it as a gift from the heavens that goes towards your retirement. And it really isn't because many times that stock is in lieu of maybe higher pay or a better overall package. So it doesn't come free of charge. So make Make sure you always understand once vested to do what's best for you with that stock. Don't feel guilty in selling it just because you work for the company. You want to make sure you're always optimizing all of your investment strategies, even if it was through stock that you feel you got for free.

13:49I couldn't have said it better myself, Robert. With that being said, let's hear from this episode's sponsor. This episode of the Rich Habits Podcast is brought to you by Neos Investments. NEOS offers ETFs that aim to offer monthly income while providing core portfolio exposure across equities, fixed income, and cash alternatives like T-bills. Their ETFs may be particularly interesting for folks looking to generate passive income inside of their investment portfolio. They even offer an ETF that provides exposure to the S &P 500 index while aiming to offer high monthly income beyond what investors would receive from plain exposure to the index.

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15:47Time for everyone's favorite segment of the podcast episode. And by the way, we have a surprise for you this Thursday. What we're doing is we're going to introduce a new weekly episode. That new weekly episode is going to be entirely dedicated to question and answer. We're going to sit down for 20, 30 minutes and introduce a bunch of questions to you all that we receive in our Instagram and Discord and share them and have a whole episode dedicated to Q &A. We're probably going to answer 7, 10, maybe 12 questions. Who knows? So tune in now every single Thursday. Be on the lookout for that one for an entire episode dedicated to Q &A.

16:26All the good, fun, juicy questions and juicy answers you guys are asking, so we're delivering. Love it. Let's go. With that being said, our first question comes from Lydia. Lydia says, I know you guys are all about diversifying. What do you think about the people who say diversification is the dumbest strategy I've ever heard? Go all in on a couple of things and do them really well. I've heard this financial advice from several people recently, but also knows so many that recommend diversification such as yourselves. Have you guys heard of this take? What's your immediate reaction? I love this question, Lydia, and I can't wait to dig in.

17:00I get the philosophy of going all in on one thing, but ask yourself this question. Let's say you go all in on one industry, one business, one sector of investing and living and building. What happens if that sector implodes? So you have to always be concerned. In the beginning, maybe, yes, you go all in on one thing. You're building a business. You're excited about it. It's starting to make money. That's great. But as soon as you can get that base built and diversify, in my opinion, I think it's a must. Because if you think back, even recently, let's go back to 2009. If you were all in on real estate, you got wiped out.

17:42You were starting over. You were losing all your properties, losing your primary house, probably even your cars, because you thought you could do no wrong in real estate. And guess what? If you would have been diversified back then, like I was, you would not have gotten wiped out. So why I love diversification is because that way I know that I'm hedged, that no matter what happens in any one given industry, I am covered and I'm never going to go broke and I'm never going to go backwards and lose everything. I want to take a different approach. I want to think about diversification now as diversification of time.

18:20A lot of people to be really good at something and go all in on one specific investment or strategy or industry, they have to educate themselves tremendously on that specific strategy, business, whatever it is, right? Think about it like this. Mark Zuckerberg, he was in college and so he went all in on Facebook. He spent every waking moment building this company. He wasn't spending time with his friends. He wasn't going on vacation. He wasn't making memories in college, he was building a company. And because he didn't diversify his time away into other more enjoyable things, he now is a multi-billionaire.

18:56Now, I'm not saying everyone listening right now is going to be able to do that, but some people will actually just laser focus, spend all the waking time, energy, and focus on a specific thing, and it might yield them a ton of money in the future. But at what cost, right? So I think when you also think about diversification, what's really important is to think about how you're diversifying your time, what makes you happy. And if investing into passive index funds, we all know it's a good way to build wealth. It's a very consistent way to build wealth. It has been for several decades now. And if building wealth slowly is something you're comfortable with, so you can have free time to go hang out with your friends and make memories and try hobbies, go do that too.

19:34Diversification is not just money, but it's also how you spend your time. And I want to follow up on that a little bit. And that's a great outlook different from mine, But also as me being the elder statesman here of the Rich Habits podcast, I've been through it all where I've personally spent five years, 10 years on one specific sector or business only to have it fail or maybe just fade away because times have changed and the offering may not have been good anymore for the public, especially when you're dealing with like a consumer product or a service. things change. So that's why for me, I would never recommend anyone being all in for long periods of time on one thing, because if you lose that and you don't have a backup plan, you're going to go broke.

20:21So that's the only reason I say, get your base from one thing, or maybe two things, then diversify. So you have that safety in knowing you're across, you're invested across a bunch of different sectors. That would be my takeaway. way. Our next question comes from Ujiro. Ujiro says, can you buy a rental property with less than 20 % down? What options are out there that I can explore? I already have a primary home and have a mortgage on it, but I'd like to own a rental property as well. Now I know Robert, he has way more experience than I do in real estate. So I'm going to let him answer this question.

20:56But before that, I just want to encourage you, I think scroll back to episode like 14, 16, 18, about, you know, call it 15 or 20 episodes ago, we made an episode that was called Becoming the First Real Estate Investor in Your Family. And we walked through a bunch of different ways for people to qualify for mortgages and lending and things like that to go buy their first piece of real estate. So that's a really good episode. Go listen to that one for sure. But Robert, take it away. Yes, I love this question. And Ujiro, I hope it's Ujiro. I didn't ruin that pronunciation. But yeah, I would say the key here is understanding what your options are.

21:33You might qualify for a VA loan. There are some options there. A self-employment loan, we don't know what you do, but say you own a company, you could do a self-employment loan, which is great because they go off of your bank deposits. And for a self-employment loan, it's only required that you put 10 % down. And there's also everyone's favorite, which is the FHA loan, which is 3.5 % down. So keep that in mind. There are several options out there. If you're trying to keep your money invested and keep more of your cash on hand for other investments, there are other options that are less than 20 % down.

22:11I guess my only take on this is just want to really encourage you to make sure that you're in the personal finance position to afford that second house. You know, as Robert and I have said a hundred times, it's not all sunshine and rainbows whenever you're able to finally get that rental property and attendance. And now you're hanging out, oh, passive income, like, you know, be careful. Maybe think about house hacking for sure. And at the end of the day, I just want to encourage you not to be house poor. Yeah. One way to look at the house hacking, you could literally take the house you currently have and rent that out, buy a multi-unit with an FHA, live in one of those units, and then you get around the 20 % and you get the best down payment percentage, which is 3.5 % through the FHA.

22:55And that way you'd be able to make those moves because you can do up to four units with the FHA low. Yajiro, you heard it here first. There you go. Our last question comes from Michaela M. Michaela says, I'm very interested in building wealth. However, I'm having trouble finding like-minded people that have similar goals as me. I live in a small town and it seems impossible. Should I keep trying to find these people or just get started and keep it all to myself? I love this question, Michaela. And honestly, it's all about getting entrenched. And that doesn't mean locally. I'm saying you're already here watching the Rich Habits podcast.

23:31You're probably joining Austin and my lives on TikTok. Maybe you belong to my private community, the Money Mindset community. There are so many ways to meet like-minded people virtually and then start going to those meetups, going to those masterminds where these groups of people you're getting to know that are like-minded are going. And I think that's just the best way because you're not always gonna find like-minded people that are in your neighborhood or go to your coffee shops. One of the reasons I moved away from Denver was because I just couldn't find like-minded entrepreneurs in my area.

24:07And it was very difficult because there wasn't a lot of that happening at local meetups or Facebook groups. So I think you can do it virtually, get to know people better and then really start to join those masterminds and those groups and those events to be able to have those people close to you. Just want to double click here on that virtual call out that you had, Robert, right? We have the Discord group. About 200 people are in there asking questions, communicating, helping each other out. So be sure to join that using the link in the show notes below. You know, Robert and I both have our respective newsletters.

24:41Mine's called Rate of Return. His is called Money Mindset. And, you know, the final point here I want to make is, and it's probably the most important one, as you start your wealth building journey, I want you to make sure that you're surrounding yourself with information. You're constantly flooding your inbox with new information about investing or the markets or real estate or whatever is important to you, right? A really good newsletter that I read every morning that I highly recommend everyone listening to the podcast take a look at is called Grit Capital. It's gritcap.io is their website to go check it out.

25:13And so it's a super fun, easy way to just spend five minutes making sure you're up to date on all things personal finance and investing. I don't post my own newsletter enough to do it every day. It's every week. So make sure you're checking that out. But like maybe go to Twitter and find some accounts that are always talking about it and turn on their notifications, right? There's just so many ways as someone starts their wealth building journey that they can begin to arm themselves with new information as it relates to personal finance and investing. that isn't sort of a chore, right? It sounds fun.

25:42It's exciting. Like there are so many people out there that are sharing information from their own unique perspectives that might resonate with something that you're going through. And you might just find that on Twitter or in a newsletter or in a podcast like us, right? So don't be afraid to diversify all the different types of ways that you're consuming content as well. This is amazing. And Michaela, I love the question. And don't get discouraged. I just want to make sure as the last takeaway for me on this question is that you understand there are tons and tons of people that are like-minded out there and you can find them virtually, become friends with them and that will just fill that gap for you of being able to have people to bounce ideas off of by joining these communities, joining the discords and really just getting involved with the right people because we've all heard the old adage, you are the five people you hang around and you don't want to drag your financial life down if you're hanging around a bunch of local people that just aren't going where you're going financially.