Cash out 401k to invest in real estate??

Question

I'm new to the whole real estate world but I'm VERY motivated to learn the ways and make a full time career for myself. I purchased my first home 2 years ago (primary residence). I plan to buy my first investment property within the next 6-9 months. I was wondering your thoughts on possibly cashing out my 401k to put towards my first investment property?

Dmitriy Fomichenko · Answer

Thanks @Ned Carey for the shout-out!

@Andrew Ramirez, congrats on starting out your REI journey. BP is the right place to learn all about REI!

If you cash out your 401k early you would have to pay taxes and penalties, so at the end you may end up with just half of your 401k balance. Be sure to consult with your CPA so that you are fully aware of tax consequences for your particular scenario.

An alternative to that would be to transfer your 401k into self-directed IRA or truly self-directed Solo 401k plan as Ned mentioned, then you can invest in real estate and other alternative investments tax-deferred (or tax free with Roth). If you do so then it would not be "your" investment property, but your IRA's property. You have full control over it, but don't get to benefit from it until later on, all incomes and gains would belong to the IRA.

Ned Carey · Answer

Andrew,

Welcome to BP. I don't know much about 401ks.  But I do know that you can invest in real estate within a 401K, so the profits are tax free or tax deferred.

You may need to convert or roll over your current 401K but there are many strategies to use retirement accounts for investing. There are many experts here to guide you.

@Dmitriy Fomichenko does this kind of work. He regularly greets new members to the forum so he will likely chime in.

Ned Carey · Answer

@Andrew Ramirez think abut why you want to invest in real estate. Do you want cash flow you can spend now?  Or are you building wealth for your future? If you are building wealth for your future. If you are building for the future then doing it inside a retirement account makes sense.

If you want cash flow NOW, you may be fooling yourself.  If you take the cash flow from your properties now you aren't allowing that money to compound and grow.  We have rentals for cash flow but we reinvest all the money into more rentals. This allows our investments and cash flow to grow. The minute we stop deciding to grow we have a much higher rate of cash flow due to compounding of our investments.

Now that is our choice, it may not be yours. But here is why I say you  may be fooling yourself. The cash flow that comes from one rental is insignificant. Is a few thousand dollars a year going to be life changing? Will it really move the needle as far as your lifestyle goes?

You may be overestimating the amount of cash flow you will get. There are many hidden costs in holding rentals. Things like, management costs, licenses, repairs, evictions, vacancy and capital expenses for items that take years to wear out but cost a lot when they do.

Now all that said, let me contradict myself again. It is sometimes easier to grow your holdings outside of a retirement account instead of inside of one. There are restrictions like self dealing and borrowing restrictions that apply to retirement account holdings that sometimes limit the best deals.

lastly is the cost of taking a tax hit now for pulling the money out of your retirement account worth the benefit? This depends on two things. Your tax bracket now and the amount of tax you will pay vs how much return you can get with that money outside of your retirement account.

As you can see there are many choices and complexities. Keep reading here and learning from wherever you can and the right path for you starts to become more clear.

Andrew Ramirez · Answer

Greatly appreciate the help @Ned Carey , thank you very much!

@Dmitriy Fomichenko , very useful information. I was unaware of those alternative routes and ill make sure to consult with my CPA before I make a decision. If I may ask, how long is "later on". And at that point do all incomes and gains come to you at once? Also, is there any deductions or do you receive the full amount you gained? Thank you so much for your help!

@Cherie Gatling , thank you for the warm welcome! More than happy to be a part of the BP fam.

Cherie Gatling · Answer

@Andrew Ramirez Hi Andrew! Welcome to Bigger Pockets. It’s nice to see that people are joining everyday. Glad you’re here!

Steve Alexis · Answer

Hey Andrew,

Another approach would be to not cash out your 401K, if you have over 100k you should be able to withdraw 50K as a loan if less then 100k about 50% of the value of your 401k. You can usually decide between a 5 year or 10 year loan term, the interest will get paid back to you. The 5 year is usually less paper work. This would avoid taxes and any penalties.

This would be a great approach for BRRR as well, so you can pay off the loan at time of refi.

You should expect to be able to afford the monthly principal and interest payments, because they will be due monthly.

I would speak to your plan administrator for more details. Hope this helps.

Andrew Ramirez · Answer

@Ned Carey I'll take your advice and stick to BP for those questions. You guys have been very helpful. I'm really just looking for the best way to fund my first investment property and I wanted to explore the option of doing so through my 401k. I don't know if I like the idea now that I know you have to wait until retirement to benefit from it. If I don't decide to invest the 401k money into buying real estate, should I still transfer my 401k out to a different plan?

Also, selling my primary residence and using the equity from that is another option that was brought to me today. That seems more logical to me to start cash flowing right away.

Ned Carey · Answer

@Andrew Ramirez  You may be able to convert your retirement funds to ROTH IRA or Roth 401K. In that case you pay taxes on the money before you put it into the account or when you convert the money to a ROTH. The reason to do that is withdrawals at retirement time are not taxed. The saying goes "pay tax on the seeds not the crop"           "ill make sure to consult with my CPA before   .   .   ."

Also many CPAs may not be totally up to date on self directed retirement plans. It is a complex area. Someone who specializes in the area like @Dmitriy Fomichenko or others here on BP can be very helpful.

Andrew Ramirez · Answer

@Dmitriy Fomichenko , Oh okay that makes sense. Thanks again!

Dmitriy Fomichenko · Answer

Later on is at retirement, after 60, although there are some loopholes to tap into your retirement funds earlier, but it must be carefully planned.

Distributions from 401K or IRA are taxed. However you only pay tax on what you pull out, the rest is growing tax deferred.

Cash out 401k to invest in real estate??

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