Should I take a hardship withdrawal from my 401(k) for a down payment?

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Should I take a hardship withdrawal from my 401(k) for a down payment?

Edward Stephens
Realtor and Investor · Leawood, KS · Member since 2015 · 166 posts · 78 votes

Dear BP Community,

I am actively looking to purchase both units of a duplex, live in one unit and lease one unit (house hack). I found a property that I'm considering making an offer on, and I'm analyzing different ways to pay for the down payment and closing costs. The property is listed at $180k and I'll be applying for an FHA loan (@ 3.5% down + closing costs = $10k).

I have the money in my bank savings account now to make the down payment, or I could use my traditional 401k to fund the purchase. I’m not allowed to take out a loan on my 401k per my plan’s rules, but I can take a hardship withdrawal to cover closing costs and a down payment. Once I take this hardship withdrawal, it is my understanding I cannot ever take another one for any reason (is this true?). The penalty for a hardship withdrawal is 10%. I also have to pay taxes on the funds, although I’ll defer the payment of all these taxes until tax season next year. I can use the money in my bank savings to help me purchase my next investment property in December (I won’t live there), which I anticipate will require a 20% down payment. Also, I won’t be eligible to use a hardship withdrawal to fund my December purchase.

My questions are: (1) Have you ever taken a hardship withdrawal from your 401k to fund a down payment and closing costs? (2) Do you foresee any problems using the 401k hardship withdrawal to purchase both units of a duplex? (3) Is there anything you think is significant that I haven't considered on this deal? (4) Will the use of my 401k funds inhibit me from holding the entire property in an LLC?

One thing I didn’t mention above- I won’t be eligible to contribute to my 401k plan for 6 months after my hardship withdrawal, but I’ve stopped contributing to it anyhow after reading a half dozen Rich Dad Advisor Series books.

Thanks in advance

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Brandon Hall
CPA · Raleigh, NC · Member since 2013 · 1k+ posts · 2k+ votes
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@Stephen D.

Many plans do not allow you to take out loans, which the OP mentioned, as the cost to add that feature is not worth it to smaller businesses. 

@Edward Stephens

I can tell you from my experience in dealing with clients with various financial positions that a 401(k) early withdrawal is generally not a good idea. It's simply too costly, and if you are a first time investor, you need to focus on building your wealth, not cutting it. 

I typically ask someone in this situation what their income vs. spending looks like and whether or not they adhere to a budget. It's generally better to tighten the reigns on the spending and delay your real estate investing goals while you build up various savings and reserves. 

The problem is that your 401(k) withdrawal is going to be very expensive. You are going to pay your marginal tax on the money, the 10% penalty, and you will have foregone earnings. Easily enough, the withdrawal could cost you over 40%. That's insane.

I'd recommend trying to find another source of money to utilize or figuring out how to earn and save more. Don't touch the 401(k). That should be an absolute last resort option if life knocks you down and generally should not be used to purchase a rental. 

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  • Ronald PerichPro Member
    Investor · Granite City, IL · Member since 2014 · 658 posts · 301 votes
    11y

    @Judy Parkerand @Xavier Morales,

    Self-directed IRAs are for retirement, and they can invest in real estate (just not actively). I've decided that I don't want to wait until I am 67 to retire. Here's why.

    People using a 401(k) typically invest in a limited selection of mutual funds and company stock. Here are some problems with that:

    • You have zero control over those funds. You don't even get voting rights.
    • Most people take their match (or are forced into taking a match) in company stock. Anybody remember Enron?
    • The hidden fees in many 401(k) plans are going to eat away at your savings and many won't even know it. (http://money.cnn.com/2013/03/27/retirement/401k-fe...)
    • Most never look at their investments or rebalance. Less than 15% of participants rebalanced in any way back in 2015.

    Do I think 401(k) plans should be used to help supplement retirement? Absolutely! Especially by those who prefer, don't have the time, don't really care, or are have chosen to not be really actively in their retirement planning. I would much rather my niece use her 401(k) plan as opposed to taking the money immediately from her paycheck. At this point, she's not disciplined enough to invest that money wisely.

    But if you look at RE as an investment - something that is going to fund your retirement and perhaps be your source of retirement income - then I think it is a better alternative than a 401(k).

    I've run the numbers multiple times. Using a $10K investment in an S&P 500 index versus $10K into an income producing property? The income property wins every time, even if you include a company match. Why? Because of leverage, using OPM to pay down debt, and because RE provides a number of tax benefits that helps defer the payment of taxes.

    Again, I like the 401(k) as a vehicle for many people, because it is better than them taking the money. They won't or can't spend the effort putting that money to use in better ways. But when you hear that the median 401(k) plan has less than $35K in it and that the average 401(k) has less than $130K, it should make you think about how well those vehicles really do work in preparing you for retirement.

    One last thought. According to the Federal Reserve, the median level of retirement savings for those 55-64 is $103,200. How long will $103K keep you going in retirement?

    1Reply
  • Judy Parker
    Rental Property Investor · Closter, NJ · Member since 2015 · 884 posts · 722 votes
    11y

    If an amateur Real Estate Investor doesn't have enough cash to purchase a property, and instead chooses to tap into their 401k for the down payment, what are they going to do when the big-ticket repairs unexpectedly appear, I.e. new roof, new heat system, going a few months with vacancies while the mortgage, taxes and utilities still need to be paid? IMHO the 401k should not be touched.

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  • Ciprian L.
    Real Estate Agent · Burbank, CA · Member since 2012 · 271 posts · 79 votes
    11y

    I agree with @Xavier Morales and @Judy Parker. If you can not get 3.5% (10k for a down payment) any other way, you are not ready to invest yet.

    Keep the 401k money for a real hardship. 

    Keep reading in the forums and get educated, read the success stories and also the horror ones, while you find a way to save the money for a down payment and also have some reserves before you start investing in rental properties.

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  • Mark McInnis
    Investor · Fort Lauderdale, FL · Member since 2015 · 10 posts · 3 votes
    11y

    so OP if you have the money then why not use that towards the 3.5% down and closing costs. Since you have the cash you will save money in fees and taxes, that gives your 401k time for those funds to continue growing and will be another income stream later in life throughout the remaining of your retirement.

    But what about those who do not have the savings to cover 3.5% down and closing costs on an income producing RE property? (Like myself)

    It looks like there's a few options you can choose from

    1. (if your 401k plan offers it) loan money from your 401k then pay back with interest along with your original direct deposit amount.

    2. (If your 401k plan offers it) do a hardship withdrawal and pay the combined taxes on those funds which is up to 40% depending on your tax bracket.

    3. Wait until you have the required savings to purchase the property, but don't forget that the longer it takes to save, the longer it will take to find a deal, start an income stream, build equity, retire.

    After gaining some insight on this thread, I think #2 or #3 would be the more unfavorable options. which one being the worse decision depends on what your 401k offers and/or how good of a realestate investment deal you have.

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  • Edward Stephens
    OP
    Realtor and Investor · Leawood, KS · Member since 2015 · 166 posts · 78 votes
    11y

    Thank you.  I have come to a decision now.  I appreciate the quick replies from all those who were considerate enough to read the entire discussion before posting.  I look forward to asking and answering more questions on this forum in the future. -Edward

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