To pull the 401k or not to pull the 401k

[Erik Carlson]

Has anyone pulled their 401k out (not borrowed) to purchase an investment property? After paying the taxes and penalty, we’re the returns still better or worse than leaving in a 401k? This seems to be dependent on an amount of time before one would retire. If you’ve done this, we’re you in your 20’s, 30’s, 40’s, or 50’s?

[Erik W.]

@Erik Carlson, keep in mind that any money lost to penalties and interest has to be made back PLUS the additional profit margin that beats what the 401K would have made if left intact.

For example.  Let's say you had $100K in a 401K and decided to borrow $50K, and with taxes and penalties that came out to 30% ($15,000).  All this happens during a year in which your 401K earns 7% return.  Since you're down half that balance, you would "lose out" on half that growth ($3500). 

So let's consider what happens if you left the money alone in the 401K.  After year 1, your account would be worth $107,000.

Let's consider if you pulled that money, took the hits, and lost half the earnings.  After year 1, your account would be worth $53,500 (50% + growth).  So whatever you did with the remaining $35,000 (after penalities and taxes) would have to be worth at least $53,500....or a net profit of $18,500 (52.8%) to yield the same return.

How confident are you that you could achieve that ROI?

Granted, this is only a one-year analysis, and over time leverage + value + other stuff would kick in.  Lots of factors play in here: stocks could tank, real estate could soar, but those are all speculation.  The point is you take such a butt-kicking up front in taxes and penalties you have to achieve abnormally high rates of return just to catch up, much less do better than having a boring old 401K earning you returns.

Food for thought.