401k vs. RE Investment: Which one is best for you?

Question

I have been noticing interest rates continuing to drop and have seen them hit 2.5-2.75% recently. As a 26 year old, I have been aggressively putting money into my 401k for retirement and paying off student loan debt. I have no other short or long term debt. In total, I have roughly $29k in savings and $24k in student loan debt. However, these interest rates seem too good to pass up and I've heard about new policies being put into place that allow for increased forgiveness for drawing out of one's 401k.

My thought was that it might be worth it to draw my 401k to use as a down payment on a property to lock in one of these low interest rates to purchase my first property. The next move would either be to continue to pay relatively inexpensive rent and cash flow the property, creating additional income, or move into the property with almost certainty that the mortgage would be significantly cheaper than my current rent, which would increase my cash flow.

What advice is out there for making this decision, how should I look at this in a unique way, and what am I not considering when making this decision? Thanks!

Tanvir Sattar · Answer

@William Duncan as long as you think the early withdrawal penalty will be recouped why not? Also what do you think your ROI will be in the stock market vs. investing in real estate?

Whitney Hutten · Answer

@William Duncan I love that you are thinking this way!  I agree you need to have a plan in place before removing funds for a 401K.  For my financial strategy though (and this is me), deferring income in a 401K or IRA is the LAST move on my financial ladder (deductions, entities, other tax brackets, tax credits, deferral) whereas for most people it's their first move.

There are actually two ways to do this via a loan, which you have until September to do, and a withdrawal (or both!).  Talk to a CPA directly, but you may have some flexibility with timing based on how you structure this.

Now, what to do with the money.  That is a personal question.  For me, I like having control of my money in either direct cash or in a self-directed environment.  I personally opt for cash first since my goals are to build cashflow now (not leave it locked up until I retire).  Therefore, I'm completely fine with a financial model of a withdrawal (and have calculated that I will actually make more with it in my hand than locked up in an account).  The key here is I have a plan and a highest and best use for the money.

Another option is to withdraw the funds and roll them over to a self-directed environment so you can invest in real estate directly, use leverage (explore how to avoid UBIT taxes), and have greater control.

In either case, you can continue to contribute to your 401K, take advantage of the match and invest in the market if you desire.

Just a couple of ideas to entertain... Work to get a plan in place before making any moves.

William Duncan · Answer

@Cameron Tope,Did you borrow from your 401k on your first or second property? If second, how did you go about buying your first/would you have done that same strategy as the second on the first?

Cameron Tope · Answer

William,

I had a very similar situation when I started my real estate journey. I had just purchased a property and another deal fell into my lap.

I purchased the deal with private money but had to fund the rehab myself. I borrowed the 20k from my 401k paying 4.25% in interest (FYI you pay interest back into your 401k so it's like paying yourself interest).

It was one of the best decisions I made. That money has returned far more than 20k over the years.

Don't willy nilly remove money from your 401k, especially if that's your only retirement. But don't let a solid deal pass you by because you "didn't have cash available".

Hope that helps!

Corby Goade · Answer

I would definitely not pull money out of my 401K to jump in to real estate- diversification is good and you are young and time is absolutely on your side. Besides, you should be able to get aggressive loan terms for a house hack, which is the best way to start- you'll need very little cash. You don't have to go all in, hack a little rental. Then do it again. And again.

You'll end up with a nice 401k, a performing portfolio and a ton of equity by the time you are 40, that'll be a great position for you to be in.

Best of luck!

Will Fraser · Answer

HI @William Duncan; welcome to the BiggerPockets forums!

This is a big, dynamic bear of a question.  I'll try to give some sound guidance here and then point you to the "$30,000 ft view" things you really need to consider here.

If you plan to invest in real estate and keep investing in real estate, in my personal opinion I would NOT pull money for this out of my 401K, and especially if that money is invested in the 401k (as opposed to sitting as cash inside a 401K account).   This is because at scale diversification is your friend and it's easier to start now than later.

If you don't plan to invest in real estate in an ongoing and growing manner, then I still would NOT pull money out for this use.  You're going to want to look to other investment vehicles as your wealth generators and I wouldn't rob my 401K to dabble.

If you don't know yet that's completely fine!  Begin with the end in mind and work backwards from there.  If you'd like to have multiple income streams at age and have a great degree of stability through diversification then you'll likely find that having BOTH real estate investments and tax-advantaged retirement accounts is helpful.

Side tangents:

• Burn your 401k and roll with Roth! (Power of Zero)
• Roth IRA Conversions
• Rich Dad Radio Show podcast - why I love real estate investing even more than I already did
• Paula Pant's Afford Anything podcast and the ChooseFi podcasts for excellent personal finance thinking.

Terrell Garren · Answer

@William Duncan. You are one smart 26 year old. You are a much broader thinker than me at 26.  My focus was on good stable W2 employment, paid off mortgage and a 401K.  Student loans were hardly needed for my generation. 35 years of investing in a 401K has provided me with a great fall back plan should my 10 years of buy/hold REI hit a rough spot.  However, had I started smart REI at your age, I would have built wealth faster and retired earlier.  I am an advocate of long term employer matched 401K investing.  However, I think the factors and strategy you are considering are very savvy for someone your age.  Just be smart and go slowly with your REI.  I expect you will have the option to leave the W2 job at 45.

401k vs. RE Investment: Which one is best for you?

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