Should I withdrawal my 401K to expand real estate portfolio

[Saqib Raja]

Withdrawing 401K entails a 20% tax cut and 10% penalty fee but I want to use it to being my real estate journey and exit my 8-5 in the next 2 years. Any thoughts if this is a good plan?

[Charles LeMaire]

@Todd Goedeke - 

(#1) I don't think I implied there were taxes on distributions from a Roth Solo401K (or Roth IRA), you already paid income tax on that bucket of money. Getting funds into a Roth Solo 401K is somewhat limited, for instance Roth IRAs can not be transferred.

(#2) One should not ignore the "tax dog", I assure you the compromises between tax deferred qualified accounts, RMDs, Medicare IRMAA, SS, etc is confusing.  With respect to the declining bonus depreciation, that isn't change, it was set-up with a fixed sun-set.  

(#3) WRT the tax now, rather than taxes later, don't let that tax tail wag the tax dog. Paying the penalty is the pain and should be avoided. But on Trad IRA/401K account, the tax will be paid now (tax rate on a small amount, which will grow) or later (tax rate on the large amount after it grew). This is the same math as the choice between Trad & Roth, the result is the same at a fixed tax rate - time is not really a factor. Note the tax rate are low now and will increase in 2026. If you have a lower FMV now, consider converting or distributing. One can do a 1031 on personally owned property, but not on property in a retirement fund.

[Daniel Burke]

If your able to make some real good financial decisions in RE Investing than you could possibly do well. If your an average investor with limited time than you could set yourself back quite a bit. It all comes down to your picks in the marketplace and luck of the draw. If you bought a four plex right next to a tourist's hotspot and rented it out on AIRBNB you could do well. It could turn into a cash cow & you could make up your losses on the 401K hit really quickly. Then again you could be doing really well in that same situation and have the city restrict short term rentals and kill your business plan overnight. It's not just what you do with your money but the opportunity costs. If you let your 401K grow and stash up money for investments how long would it take for you to get to your goal? 

[Basit Siddiqi]

Quote from @Todd Goedeke:

@Charles LeMaire taxes do not have to be paid on income coming from the Roth portion of a Solo401k . 

Never let the tax tail wag the dog. Future tax law changes may change the depreciation rules. Look at bonus depreciation for example. It’s being phased out.

Numbers wise I can t think of any reason to pay taxes now and take a 30% hit to invest when those same investments,RE, are available in an IRA or Solo 401k account.

The only difference is 10% from the penalty, not 30%. Not even sure where you are pulling 30% from...
Taking money from a traditional retirement account(non-Roth) now or later is subject to income tax at your marginal income tax bracket.

Any 'planning' around distributions that you can do later can also be done now.
If you want to take money out in a year where you are in a lower tax bracket(result of going back to school, taking a year off from work to travel, a year where you have a lot of losses from real estate via Real Estate Professional Status, etc).
Also, hard to say what your income / tax rates will be when you retire. You can have a lot of social security, rental income, interest, dividends, etc

I am not to say your income will be higher when you retire or that tax rates will be much higher, I am just here to say the only difference is 10% and not 30%.

To add on all of this - 
If you keep your assets in a retirement account, your distribution will be taxed at marginal tax rates(Currently tax rates are between 10% and 37% + state taxes)
If you invest personally in your own name, you have the opportunity to escape tax on any appreciation if you have heirs that inherit the property.
Even if you decide to sell the property, you are paying taxes at the preferred capital gains tax rate(Currently at 0%, 15% or 20% + State taxes + Potentially NIIT)

That difference alone pays for the 10% penalty.

[Todd Goedeke]

@Basit Siddiqi you skip over fact that money in Roth IRA and Solo401k Roth portion , income and appreciation , is forever tax free . And no penalties will ever result. Tax free beats a 10% penalty and tax deferred any day.

[Carlos Ptriawan]

it's tax-free for something that you can't enjoy until someone is older enough to have a stroke,cancer and other diseases. If I put that money into STR obviously I will live longer and I still have cash flow and appreciation , not everything is about tax and tax.

What's funny is I took 2 loans from 401k in the span of 10 years, so after I move the money, in 10 years my $20k becomes $600k. Stock market is impossible to beat this number LOL I took the 401k loan again so I can enjoy the money *now* and makes me live longer.

[Charles LeMaire]

@Todd Goedeke - you are forgetting that you paid the tax to put it into the Roth.  YES, Tax Free is wonderful, but a Roth is just paying the tax on the seed and not the crop.  This is the same thing as that 30% pre-pay you are arguing against.  YES, avoid the penalty! But the tax will be paid one way or another.

Note: the Roth IRA is subject to UDFI, the Solo 401K is not. But one may not move Roth IRA money to a Solo 401K, so it is a bit of a dance.

Note: when RMD start (for the Trad 401K) they must come from that account, so one must plan to have funds available in that account - this is a bit easier in Wall St, than in RE.

[Jay Thomas]

To ensure the best return on your money, it's a good idea to consider investing in a syndication using a self-directed IRA. This allows you to keep the funds in the account and potentially earn more from them over time. Furthermore, if you have sufficient assets already, this could be an ideal way to further diversify your portfolio. Investing with a self-directed IRA also has other benefits such as tax advantages which may make it even more attractive for some people. Ultimately, it all depends on your personal situation and financial goals so be sure to speak with a financial professional before making any decisions. Good luck!

[Charles LeMaire]

This is such a confusing topic: IRA vs 401K and Trad vs Roth and your money.

All IRAs (Trad & Roth) are subject to UDFI. UDFI is triggered if the asset is sold with an outstanding mortgage (on previous year-end).  Buy a rent house and pay it off, UDFI is not a problem; there are other issues.  Invest in a syndication that holds for 5 years and sells with that mortgage, you have UDFI to deal with. There are disqualified persons with whom you can not do business. These do NOT get a step-up in basis.

Both Trad IRAs & Trad 401Ks were funded with pre-tax dollars but will ultimately be distributed (by you or your heirs) and those distributions will be taxed at income rates.  The timing of RMDs has changed, but they will happen! There are disqualified persons with whom you can not do business. These do NOT get a step-up in basis.

Both Roth IRAs and Roth 401Ks were funded with taxed dollars, but can be distributed tax free. The IRA is subject to UDFI, the 401K is not. Now neither have RMDs. Roth IRAs have two (maybe 3) 5 year rules to contend with. There are disqualified persons with whom you can not do business. One may not transfer Roth IRA funds to Solo-401K accounts.

Investing with Your Money is funded with taxed dollars, the gains are usually deferred and usually ultimately taxed at Cap Gain rates.  RE Pros get tremendous tax advantages.  Non RE Pros also get some advantages.  No disqualified persons. You have access to the funds/assets now. Assets in this group do get a step-up in basis.

In summary, it depends! A Roth Solo 401K might be the winner, but as I don't have a path to creating a large Roth 401K, my choice is Your Money. 

[Elisa Zhang]

Hey Saqib- I have a team dedicated to helping investors like yourself with trainings on complementary passive investing through retirement accounts. As a few BP members mentioned, a self-directed 401k may make sense in this case but there are other avenues. Ping me if this interests you and I can get you connected

[Todd Goedeke]

@Charles LeMaire Your response misses the point of using a Solo401k for tax free returns on cash flow and appreciation. First, you ignored the fact that IRAs( not Roth ITAs) can be rolled over into a Solo401k. Once in a Solo401k IRA money can be transferred and converted into the Roth portion of the Solo401k.

Your seed and crop analogy fails to grasp the fact that paying taxes upfront on a conversion to a Roth gives many multitudes greater returns than RE held in a taxable account or an IRA.

Using a STVR as an example. In a Solo401k Roth I can lock in 20% cash on cash ROI as long as I live. I have the freedom of tax free cash distributions forever. I can sell property whenever I choose not being pressured to buy another.

[Paul Moore]

Hi @Saqib Raja! You got a lot of advice above and it's been about a month. Have you decided what to do yet? Clearly there is not one right answer. But if you're going to take a 30% hit, you better be getting a phenomenal deal with lots of hidden intrinsic value when you make a purchase. I would not purchase at market values under any circumstance. Good luck and happy investing!

[Chris Davidson]

@Saqib Raja IMO it depends on how much you have in the 401k and if you have other options. If you can borrow against the 401k then no do that. If you don't have much in the 401k and won't be able to actually hit your goals, no don't do that. If you have enough you can withdrawl and still have a decent bit in there for your age why not.

I took half of mine out last year and for my age still have quite a bit in. Not being able to touch the money for 25 years, or having to set up self directed and deal with those rules wasn't ideal to me.

Yeah the tax bill sucks but the freedom was worth it to me. You timing might be awful though as we just finished one of the worst years so likely your account is down and then you would add another 30% reduction on what you pull out. 

At the end of the day it is personal finance. Do what works for you and just realize the impact. Part of my scenario was taking the taxes and penalties and figuring the FV of it based on some nice returns. This is really what the cost was to me. If you drawl 100k you get 70k and that 30k in taxes and penalties would be what when you can access the funds 120... 240...? Figure out your numbers and make your decision. 

Best of luck!

[Account Closed]

Quote from @Saqib Raja:

Withdrawing 401K entails a 20% tax cut and 10% penalty fee but I want to use it to being my real estate journey and exit my 8-5 in the next 2 years. Any thoughts if this is a good plan?

 You can roll your 401k into a SDIRA with Quest Trust and invest in real estate

[Todd Goedeke]

@Account Closedbetter to rollover 401k to Solo401k rather than an IRA. This avoids UBFI by using a Solo401k.

[Joseph Stockton]

I have done this several times and they have all been worth it. I’m more surprised by how many people are saying no to it. If you know what you’re doing it’s advantageous and can get you where you want to go. People will throw out XYZ percentages and say don’t do it, but what I’ve have realized is that it’s one thing to ask someone’s for advice vs being able to do a smart deal. What I will mention is that I also do deals where I’m gaining some good equity/value on each one so for me it’s definitely worth it.

Simple examples I have done. Take out $35K and keep $25K. That gives me enough for the down payment and bank funded work needed. My value typically goes up $30K to $75K range, and now I’m sitting on an appreciating asset where my renters pay down my debt and give me extra money each month. You also can’t rule out the tax advantages of growing a rental empire as well. Like I said everyone keeps going back to it will cost you XYZ in the end. Actually I end up increasing my net worth more than what I was taxed and get these nice little cash dividends each month that I can use now to my advantage. I’m also speaking from experience that I can do way more with my money now and grow it even more, and reap the benefits along the way vs investing money into something that I can’t touch until I retire. Converting to cash and using it to your advantage can make it worth it if you know what you’re doing with it. I will personally be much wealthier when I retire because of what I did before I got there compared to what it would have been had I just contributed towards average market returns.