Buying rental within Solo 401k vs. taking loan from Solo 401k

[Sheryl Gurvey]

I have been going over this in my head for weeks and I just need some feedback.

Which option is better, buying a rental property directly within my Solo 401k (with the intention of refinancing non-recourse down the road) OR take a loan from the Solo 401k to buy the property (with the intention of refinancing conventional)?

I am not thrilled with the non-recourse loans (poor LTV and higher cost and interest rates), BUT there are so many pros and cons for each choice. Can I hear some of your thoughts on what you would do?

[Brian Eastman]

@Sheryl Gurvey

This is a no-brainer.  Buy the property with the 401k.  A 401k loan sounds appealing, but carries two hidden costs.  

Firstly, when you borrow from the plan, you will repay the interest to the plan at a rate of about 5%.  You are giving up any potential returns > 5% over the life of the loan.  This is an opportunity cost.

More importantly, you are not just paying 5% interest to the plan.  The real cost is much higher.  When you put money into the plan, it was done on a pre-tax basis.  When you repay the loan, you are repaying with after tax dollars.  That means you likely need to earn about $70K or more pre-tax to replace the original $50K that was tax-sheltered within the plan.

Owing income producing property in a Solo 401k is a great way to diversify your retirement savings into an asset class that is solid and produces good results. You will want to retire some day, and taking advantage of the tax-sheltering benefits of a 401k or IRA to build a large nest egg is one of many strategies you should pursue.

Sure, non-recourse loans are a bit more expensive than a loan you can put a personal guarantee on, but it is still cheap money. You are able to leverage your retirement plan capital and receive a higher cash-on-cash return as a result. When was the last time you were able to do that on Wall St? (Not that I would ever trade on margin anyway, even if you could in an IRA).