401k 10% Penalty waived du to Covid. Should we take it out?

Question

I just finished talking with y broker and he has informed me that due to covid 19 the 10% penalty for taking your 401k before age 59 has been waived. My question to BP is...

As investors, we are all looking to achieve financial freedom as early as possible. A 401k would not to begin taking money out until age 59, so wouldn't it be better to just take it out and invest it in rental properties so we can begin enjoying the rental income at any age we wish? It almost seems like a no brainer to me, but here is the catch. If you withdraw your 401k you would pay income taxes which is a HUGE amount. It could be upwards of 25% depending on your bracket.

What would you guys do? I know if I pull it out I can buy 1 property cash in my area or 3 to 4 with loans and achieve a 10% coc return with the rents, but I also like the security of knowing that the money is there for when I'm old even if my rental business falls apart for some reason (like the gov't deciding rents are canceled for a year).

Your opinions area apreciated and if anyone else is doing this I surely would like to know.

Kevin S. · Answer

@Leopoldo Vazquez first off, you'll need to check and see if your 401k plan has adopted the new CARES-Act 401k options, they are not automatic. Each plan may choose to adopt some/all/none of them and last article I saw (its been a few weeks) they were projecting only about 50% of all plans would end up adopting the CARES-Act 401k options.

Second, just because you can doesn't mean you should. You'd be taking a distribution on a retirement account that has probably lost somewhere between 10-40% of it's value (depending on your investment spread). Unless you have a negative long-term view of the market, which I personally don't, to me it doesn't make a lot of sense to take a distribution when you're down unless you absolutely have to. If you want to use the money to buy properties, why not consider a 401k loan (assuming your plan allows them)? With a loan you have to make payments that include interest, but the interest you are paying is being paid to your retirement account - i.e. you are paying yourself interest.

Finally, if your company provides a match you may not be fully vested in it all currently (it depends on how your plan is written) and if you aren't fully vested and take a distribution on employer contributions then you will lose some portion of that money.

Overall my personal opinion is no, it's not a great idea to take a taxable distribution from your 401k.

Will Fraser · Answer

HI @Leopoldo Vazquez! This is a fun question to consider.  I'm going to try to establish this conclusion and then support it:  a 401k is not safer than real estate investing for the same reason you point out, and ultimately the answer to your question completely depends on YOU :)

1. The government could decide to pause rents for a year.  For sure, they could.  They could also decide to modify the tax bracket so that instead of you being in a 25% marginal tax rate you are at . . . . say . .  . 87%?  50%?  40%  Who knows what it will be, but the point I want to illustrate is that because 401k and traditional IRA accounts are taxed on the backend, the security of the $1 in the account is really determined by the same entity that can decide to pause rents for a year.

Bonus question: Yeah, they could raise taxes, but will they?  The Power of Zero and . . . .anything from Robert Kiosaki make very clear points that the government is running up an increasing tab . . . one that is paid ONLY through taxes . . . unless we change to a very different modus operandi (namely empire building) then taxation is the way to reduce the deficit.  In light of the facts about our national debt, our recently introduction of $1 trillion + new dollars into an economy (which oh BTW does NOT increase our GDP at all?), is the possible threat of the government stopping rents for a year (and not pausing all mortgages, too) seem more or less likely than the government adjusting the tax rate so that more of every $1 you earn in a 401k goes towards that nice shiny National Debt?

2.  Whether some strategy is good or bad or neutral is going to depend on what you want to be true of it.  If you want to grow a large real estate portfolio and you believe there are some quality deals to be had right now, then perhaps cashing out of your 401k, paying the taxes on it, and begin 3-4 single family homes is the right play!  If you think you'll be at higher tax levels in the future, then there could be a good play with taking the 401k funds out, living on those, and then stuffing as much into Roth IRA accounts as you possibly can.  Otherwise, if you plan to dabble in real estate but really value having a well diversified investment approach, then you might want to keep those funds in your 401K and deploy them into something other than real estate.

So, the net answer goes back to the original point: a 401k is not safer than real estate investing for the same reason you point out, and ultimately the answer to your question completely depends on YOU :)

Cameron Tope · Answer

Leopoldo,

I've successfully borrowed against my 401k many times to buy or rehab BRRRR properties, but I have never withdrawn my 401k money.

I disagree with @Will Fraser and would keep my 401k. If you read Chad Carsons book Retire Early with Real Estate he interviews almost 1000 early retirees. Most of them have a solid balance of stocks and real estate - and these are people who have actually retired!

Stocks are a fantastic compliment to real estate and you don't want all your eggs in one basket.

That is why I keep my 401k AND rental property.

Randy Rodenhouse · Answer

Why have a 401k if you are going to take out of the 401k?  I would not take out money from my 401k since the 401k has a separate purpose which is to allow me to benefit from stock appreciation.  When I take the money out I miss out since you just don't know when and how the fast the market will make a favorable move.  I have very little in this bucket compared to my real estate holdings but some diversification into long term companies in the stock market is probably good.

George Blower · Answer

@Leopoldo Vazquez

Keep in mind that in order to take a distribution under the CARES Act you must have been impacted by the virus in one of the enumerated ways.

If so, you can take a penalty-free distribution (as well as waive the 20% withholding requirement) from your 401k (assuming that the employer allows it) anytime between 1/1/2020 and 12/31/2020. You may avoid the taxes if you deposit the funds in an eligible retirement plan (which includes anIRA) within "3 years and a day" of the date of the COVID-19 distribution (note: compare to a 60-day rollover). Please note that the account into which the funds are deposited must be the same type of account from which the funds were first withdrawn (e.g. withdrawal of pre-tax funds from a 401k could be deposited in a pre-tax IRA but not a Roth IRA - "like to like").

401k 10% Penalty waived du to Covid. Should we take it out?

Most Popular Reply