4 Retirement Account Horror Stories That’ll Keep Investors Up at Night

by | BiggerPockets.com

I have never been one to enjoy the scary aspects of Halloween. Trick or treating and carving jack-o’-lanterns are Halloween activities that are much more appealing to me, but I know there are some of you who can’t wait to visit haunted houses and watch scary movies.

What’s scarier to me than any zombie movie, though, are the frightening mistakes I sometimes see taxpayers make. Horror stories don’t always have to have ghosts and monsters. Sometimes they involve things as simple as your retirement account. Take a look at the terrifying examples below to make sure that you’re not slipping into the same nightmare as these investors.

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The New Business That Cost a Scary Amount of Taxes

I met with a new investor this year named Sean. He provided a 1099-R form showing a $50k distribution from his IRA. He was only in his 40s so I asked him why he received this, as it would be subject to both taxes and a 10% penalty if he didn’t meet one of the penalty exemptions. He responded that he used the distribution to start a new business. This is a mistake that I see several times a year. Many investors fail to realize that IRAs do not work like savings accounts. Money can be rolled from one retirement account to another, but once money is taken out of the account as distributions, it general becomes taxable. If it is not done for a valid reason, it may also be subject to a 10% penalty.

Related: How Retirement Contributions Are Saving One Real Estate Investor $53K in Taxes

Because Sean was in a 37% tax bracket overall, he owed over $18k in taxes on the $50k of income plus $5k of penalties for early distributions. A scary amount to pay for a mistake that may have been avoided with some proper planning.


The College Tuition Horror Story

Rebecca set up a Solo(k) account a few years ago for her fix and flip business, and she has diligently contributed the maximum that she could to this account ever since. However, this year it was shocking to see that she took a $30k distribution from the account she had worked so hard to build. She said that she thought she could take a distribution out penalty-free if it was for higher education expenses. As such, she decided to take a distribution to pay for her son’s first year of college.

While there are some exceptions to the 10% early withdrawal penalty, they do NOT apply to Solo(k)s and 401(k)s. These rules are only for IRAs, and even then, there are very specific rules that need to be met to take these early distributions penalty-free. Rebecca’s mistake ended up costing her almost $9k in tax due to her 29% tax rate plus another $3k in penalties, over a third of her son’s first year of college costs.

The Tale of the Terrifying Tax Bill

Several years ago, a client of mine, Elise, called us in an absolute panic. She saw her tax bill and just about had a heart attack. Her tax bill was so high because she had received a 1099-R for an early retirement distribution, so not only did she have to pick up the income, she also had to pay the 10% penalty. Her argument was that it was not a distribution. It was a loan from her 401(k) that she used for real estate investing.

After more investigating, she found out that although she had originally taken a $50k loan from her 401(k) and had made payments for a few months, she stopped making her loan payments when her rentals started to go south. Once the term of her loan had ended, her retirement custodian had issued her a 1099-R for the $40k balance that was unpaid. It was now an early distribution and not a loan. What Elise learned the hard way was that if loans are not paid back timely, they become taxable distributions. To add insult to injury, if you are under 59½, then the 10% penalty is added to that total.


The Vacation Home Nightmare

Recently, a client named Jared came to me with what he thought was a fantastic investment. He had just purchased this perfect home right on the beach in Orange County and he had used his IRA funds to do it.

I asked him if he planned on having a full year renter or if he was going to do vacation rentals with the property. Jared’s response was neither. He was going to use it as a vacation home for his family. I had to stop him right there. This is a huge no-no when it comes to IRAs. If you purchase a house with your IRA, you cannot benefit from the property personally. It must be used solely to generate income for retirement. It cannot be your primary home, it cannot be your vacation home, and it cannot be a second home where you let your kids or parents live rent-free.

Related: The 6 Basic Principles (& 3 Common Myths) of Investing For Retirement

Jared was extremely upset to find out that after finding his dream vacation home and going through all the work to purchase and furnish it with his IRA, he was not able to use it. His options now were to either attempt to rent it out — or sell it and find a different investment. Make sure that you don’t make the same mistake as Jared! Any investments purchased with your IRA must not currently benefit you or your immediately family in any way.


Retirement accounts were created for the purpose of saving for retirement, and they want to ensure that you do just that. If you want to put money in an investment that is prohibited by the retirement tax law, then an IRA is probably not the best place to deposit that money. Always consult with your tax advisor BEFORE you take a loan or distribution to make sure that you understand the potential taxes and penalties associated with the transactions or else you could find yourself in your own tax nightmare.

Do you have any retirement account horror stories to tell?

Share them below!

About Author

Amanda Han

Amanda is a CPA specializing in tax strategies for real estate, self-directed investing, and individual tax planning with over 18 years’ experience. She is also a real estate investor of over 10 years with a focus on long-term hold residential and multi-family assets across multiple states. Formerly a tax advisor at the prestigious accounting firm Deloitte in the Lead Tax Group, focusing on tax strategies for the real estate industry and high net worth individuals, and at an international Fortune 500 Company in the high-tech industry in the Corporate Tax department, Amanda’s goal is to help investors with strategies designed to supercharge their wealth building. Amanda’s highly rated book Tax Strategies for the Savvy Real Estate Investor is amongst Amazon’s best seller list. A frequent contributor, speaker, and educator to some of the nation’s top investment and self-directed IRA companies, Amanda has been featured in prominent publications including Money Magazine, Realtor.com, and AllBusiness.com. Amanda was a speaker at Talks at Google and is a 40 under 40 honoree by CPA Practice Advisor, showcased amongst the best and brightest talent in the accounting profession. Her firm Keystone CPA, Inc. was awarded a two-time winner of the Top CPA of Orange County Award by OC Metro Magazine. She is certified by the CA State Board of Accountancy and is a member of the prestigious American Institute of Certified Public Accountants (AICPA) with clients across the nation.


  1. Ronald Perich

    Great examples, Amanda! I was talking with someone the other day and she mentioned her and her husband had something like eight rentals. I hadn’t known this, so I was really interested in hearing about it.

    She mentioned that it really was her husband’s thing as he did all of the property management and stuff. She was pretty hands off. I asked how they were able to fund it (hoping to maybe find a private investor for my business).

    When she said they used their Self Directed IRA, I stopped in my tracks. I asked her, “Did you say your husband manages these himself?” “Yep” came the reply.

    “He doesn’t do a lot of the repair work himself, but he leases them and …”

    I told her to talk with her CPA and attorney to make sure he was on the up-and-up. But she isn’t the type to listen. She only hears what she wants to hear. So I think some day the IRS might come knocking on her door. It sounded to me like they were contributing too much in the way of services to the IRA from a disqualified person.

    • Nice article Amanda,

      Hi Ronald, I think we are solidly in a gray area when it comes to managing rentals that your IRA owns. I have a friend that moves stocks around in his IRA. He spends about 15 hours a month researching, tracking, buying, and selling stocks within his IRA and it all appears to be legal. If a guy spends 10 hours a month managing his rentals that somebody else does the physical labor on, why wouldn’t that be legal? If one has a 6, 7, or even 8 figure stock portfolio within their IRA, they are going to spend some time monitoring the returns, moving stocks and funds around, etc.

      The IRS allows purchases of stocks, bonds, mutual funds, commodities, currencies, futures contracts, etc within your IRA. There has to be some expectation that there will be administrative effort on the individual’s part to manage this. Particularly for those with accounts in the 7 or 8 figures ( 10 figures if your name is Mitt Romney!)

      I agree if you make a full time job of managing a 250 unit apartment building that is owned by your IRA, you will probably raise flags at the IRS.

      I have rentals inside and outside my IRA ( mostly outside). My CPA does as well. His full time job is being a CPA , but he will answer phone calls, pay bills, and deposit rents with the IRA custodian related to his IRA rentals.

      My IRA custodian ( Equity Trust Co) knows that I pay bills on behalf of my IRA ( property taxes, repairs, etc). They process the bill pay request and send out the checks. They deposit the rent checks that I send them on a monthly basis.

      So I feel pretty comfortable doing administrative and management work on behalf of the properties owned by my IRA.

      The real place most people get in trouble with real estate related IRAs is buying, selling, or renting properties from yourself or prohibited family members. That is easy to spot and easy to prove.

  2. Larry Letizia

    @Amanda Han I’ve read I thought extensively but not ventured into the Solo or Checkbook IRA. In NJ I’ve been met with the “deer in the headlights look” or given very negative responses in my attempt to find an accountant in NJ that understands them and can guide me, not me guide him! (BP people from NJ any suggestions for that source near Toms River ?) Amanda; A quick questions would be :

    Can I as a RE Broker act as my own Buyers Agent, Sellers Agent and or leasing agent for property held in these accounts ? Thank you in advance.

  3. Dmitriy Fomichenko

    Amanda, thanks for the article, I’m sure it will be very beneficial for many readers!

    Unfortunately I also come across people making similar mistakes. One thing in common those in your examples had is this: they took action before consulting with a professional. They were assuming or thinking they knew the answer. Big mistake! I always tell my clients: talk to me BEFORE you do something that you are unsure, not after or it will be too late.

    Here is a story involving one of my clients. Let’s call her Mary.
    Mary called me few months and left a voice message. The message came in early afternoon. In it she said that she is closing escrow on a property involving her Solo 401k and she wanted run it by me to make sure she is OK. The escrow was scheduled to close at 4PM on the day she called. When I called her back I learned that it was a “Prohibited Transaction” because of personal involvement. And it was too late to back out of that deal. I asked her why didn’t she call me a little earlier than the day of closing escrow. She couldn’t answer…

    Mary would have to pay dearly for her mistake. I hope the readers would learn from these examples and seek wise counsel before making decision like this.

  4. Peter Mckernan

    Hello Amanda,

    Thank you for writing up this article. This is a very enlightening article about how costly withdrawing money from a retirement account can be. I have listened to Dave Ramsey a lot and he suggests that there should not be any money taken from those accounts unless a person is facing foreclosure or bankruptcy. I can see why these are the only two options to take the money out of the account.

    Thank you! Good job!

  5. Jerome Kaidor

    This is very interesting. I did use my IRA once to purchase Real Estate – but put it back within 60 days. That
    made it a tax non-event
    I didn’t know about the self-directed IRAs. Need to consult with my tax guy.

    What if your self-directed IRA buys a property and it goes negative cash flow?

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