Do You Have a 401K Balance That You Wish You Could Use Now?

So you have a 401K you’ve been contributing to, and hopefully earning a return on it in addition to company matches, you are far from 59.5, and/or are having doubts about the 401K for yourself, or rather, you are looking for ideas to put that money to work right now. Here are a few to think about, I’ve done a combination of them all.

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401K Options

Like I’ve said before, the 401K is yours, it’s your money, but there are rules for how you can use/access it before 59 ½ years old. I think particularly if you’re young, far from retirement, have some set away in your 401K from contributions, earnings, and matches, and are eager to put it to good use now, you have some options to think about. 

Here are some ways I’ve seen it used along with the benefits and drawbacks as far as I see them and or the rules go. It’s up to you to take the rules and find your own strategy. 

How many times have you looked at your 401K balance and thought, “I could do so much with that money right now?” Your CPA might be hesitant or tell you to absolutely NOT touch this, but even if they are the timid type, you should talk to yours about your situation. 

The general rules for borrowing are you can borrow up to 50% of your balance, up to $50,000. The loan must be paid back to yourself with interest. If you default on the loan, it will be considered income, and taxed, and the 10% penalty will apply. 

There are different options for 401K loans that range from few year terms to much longer. Generally, the loans can be paid off early, but larger payments can’t be made within the term. It’s payoff of in one sum at any time or pay the scheduled payment until it’s paid. 

Liquidate

You will pay tax now, and 10% penalties, and receive the remainder in one sum. 

You will pay tax anyways, later, at your tax bracket when you retire and start taking distributions. I know everyone plans to be in a higher tax bracket when they retire, also I think there is a better chance that taxes will rise, not fall.

 If you have a house and kids, chances are the house will be paid and the kids will no longer be dependent, you will lose those deductions and you could end up paying even more in tax on that money later. 

The draw back here is that the money is now out of the 401K and no longer earning – when times are good. Have a plan for this money. 

Most Americans who retire poor, retire poor not because they chose the wrong vehicle, but because they didn’t plan at all. 

You might not want to liquidate yet or at all, so here are some other ideas…

Borrow for a down payment

I advise my clients in most cases, and most usually when we are at the top of a cycle, to put down 20%, or in some cases 10% if they can avoid Mortgage Insurance, for their primary home purchase. 

401K money is usually never considered or even a thought, but it can be a great way to make a strong offer, reduce principal, interest - your mortgage payment, when compared to putting down less. Also, I have worked with clients with an existing FHA loan who would need to refinance out of it and get an FHA loan yet again, for that next property. When only one FHA loan is allowed at a time is allowed, the 401K loan saved the day by making up the difference for 20% down.

I have also worked with clients who were able to avoid FHA altogether by taking a 401K loan. You can either pay higher principal, interest, and probably MI, or you can use that money to pay back the 401K, with interest to yourself! 

There are certain rules around this, but interest on 401K loans used to purchase or improve primary or secondary homes can be tax deductible. What could become an issue here is that the loan payment will be considered into your Debt to Income (DTI) and that has the potential to affect your approval amount. 

You could also use this method now to pay down the principal of your home to allow you to refinance out of an FHA loan. With he new SALT Caps as part of the 2017 tax reform, refinancing and having a lower principal and interest payment might help offset the loss of deductions on property and state income taxes, and extend your interest deduction over time - spread them out. 

Leave as is - a portion of the balance will be used to satisfy reserve requirements 

Leave as is and use as part of an investment strategy where a percentage can be counted to satisfy reserve requirements when buying additional properties. 

Whether you continue to contribute or leave the balance alone, it will be counted as reserves, leaving you to focus on the 20% or 25% down. I think this could be used when there isn’t a need to borrow from the 401K but you're not ready to liquidate. 

I don’t believe that 401K balances will ever go to zero, however, when the housing market is down and the stock market is down, it’s likely you’ll have less available balance to show for. This also goes for the amount available for a loan to yourself.

Borrow to pay down your primary home principal

Borrow any amount allowable and apply it to the principal of your owner-occupied home. You will pay with interest in either case, to the mortgage or the 401K so factor each rate. 

You might be wondering to yourself about missing out on the deduction on the interest for the portion paid by the loan (reduced principal) and it would be a great question. Two things to consider here. Will the money you pay yourself in interest exceed the amount you earn through the mortgage interest deduction? How much Interest off the principal will this save you over the life of the 401K loan? Does it beat not taking a loan and instead making extra payments in the amount equal to a loan payment? 

You would compare making small extra payments over time to one large payment – immediate change in principal /interest ratio. Think of it this way, your payment will remain the same unless you refinance, otherwise it’s early payoff play…!

Could even be used in conjunction with a 15 year mortgage

Borrow to pay down investment principal

Pay down principal on your investment property. Pay the loaned portion back to yourself with interest, enjoy the equity and reduced interest payment to the bank. Roll 100% of the rents back into the PITI, which could really accelerate the equity you build. Or Refinance for more cash flow. Cash flow is money made also money counted from a lenders point of view, as well as the DTI, when looking at your next purchase! 

Borrow to buy Bitcoin

BTC has been the most awesomely performing asset of 2019, look at the charts from the beginning. 

If you bought in at the right time, or almost any time, and didn’t develop FOMO when it was heading to $20K in 2017, you might have made the investment of a lifetime. I know dudes who are pro’s, have a talent for reading charts, psychology, and have had either the foresight or luck, to believe in the issues BTC solves and have made good decisions. There are no guarantees, anything can happen, but if you believe in it, get educated, and dive in. 

If you bought at the end of 2017, hang on, just hang on. 

If you had bought this past January at what appeared to be the most recent bottom, and looks to have turned out to be the bottom, you’d be up over 120% since January 2019. 

Since January 2019 it has outperformed the Dow, NASDAQ, and S&P 500’s top performers. 

Borrow to loan out

Become a hard money lender. Using the max amount, if you have $100K in your 401K, you can take a loan for the max 50% and max loan limit of $50K, and loan to investors. Whatever the amount you have available to loan, learn everything you can, get the right contracts in place, and set your competitive interest rates and risk profile. Remember you are paying interest yourself, although to yourself, so make sure the gains are worth your time and effort and risk. 

You could also use your 401K loan to help fund your own fix and flips until you have cash reserves built to fund your business independent of any loan. 

There are a lot of ways to use this money now. It’s yours, you have the learn the rules and make a strategy that works for you. What I’ve written are some way to do it and to get you to think.