Many people put their noses to the grindstone for years and years, working hard, saving, and investing with the goal of ultimately having $1 million. While that might seem like a perfectly admirable goal, to me it seems a bit short-sighted; not knowing the kind of life you desire, or where your journey is headed, can cause misaligned expectations when you want to spend this money in the future, which can hurt. It’s like having a bunch of ingredients without knowing what you’re going to cook.
It’s important to realize that $1 million, in and of itself, doesn’t mean anything. And, it’s more likely that you want to spend a million, not simply just have it. That leads to the point of this blog: you need to understand the tax impacts, timing limitations, and tools for providing financial independence of the three most common asset classes — 401(k)s, company stock, and real estate — as well as their pros and cons, as you plan for your financial future.
The most common path for most people to save $1 million, 401(k)s have a number of pros. Your contribution is taken automatically from your paycheck and your company often matches it. You can also do a basic calculation using an expected rate of return to determine how long it will take before you reach $1 million. However, 401(k)s can be limiting, given their typically short list of investment options.
- Taxes — While you’ll have a tax deduction now, your tax pain will come later, as you’ll be paying ordinary income tax when you take distributions.
- Timing — It may take a long time to amass $1 million and until you’re 59½, those funds are not readily available.
- Tools — The most common scenario is using your 401(k) to help replace a portion of your salary at retirement, such as a few thousand dollars per month. If you take a larger distribution all at once for a property or large expense, taxes will take a big bite out of that withdrawal.
Often issued as part of your compensation package, stock options and RSUs offer a big pro in eliminating any heavy lifting on your part. The con, however, is you have a lot less control over when you get to $1 million, since what you amass depends on your title and how the company performs.
- Taxes — When you exercise your stock options and your RSUs vest, you’ll be paying ordinary income tax on those funds. However, if you maintain the investment, any growth that occurs long term will be considered capital gains, and taxed at a potentially lower rate.
- Timing — You have a lot more flexibility with these assets, as most vesting periods are three to five years.
- Tools — You can use this money for big-ticket items like a downpayment on a home, a college education, and a new car, or even buy a business. You also can reinvest it as part of your long-term savings strategy.
For the purposes of this blog, real estate doesn’t include your primary residence, since you can’t assume it will ever produce a big payday. However, if you have the skill and energy to dabble in real estate as an investment, you can accumulate $1 million in equity — using a financial calculator to determine when that will happen. On the flip side, some of the cons are that real estate takes time and there’s no guarantee the property will appreciate.
- Taxes — Real estate taxes can get complicated, but you may realize favorable benefits like deducting interest, writing off expenses and reporting long-term capital gains when you sell — although you’ll have to report any rent collected as ordinary income.
- Timing — You lose some flexibility when relying on real estate as an investment, since it’s generally considered a long-term investment, so you should consider it as potential future cash flow.
- Tools — You have options that include diversifying into other real estate investments, cashing in and adding to your nest egg, or continuing to own a rental and using the cash flow to supplement your income.
Whether you’re an intrapreneur or an entrepreneur, now is when you want to think about how you want to design your life. I’d be happy to meet with you to discuss how we can get to you to your first — or next — $1 million.
Nothing provided herein constitutes tax advice. Individuals should seek the advice of their own tax advisor for specific information regarding tax consequences of investments. Investments in securities entail risk and are not suitable for all investors. This is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.
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