I NEED YOUR CRITICISM ABOUT MY 401K

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I NEED YOUR CRITICISM ABOUT MY 401K

Justin O'Malley
Lakewood, CO · Member since 2017 · 66 posts · 21 votes

Hey BPers,

So I've been brainstorming about how to start stacking up my finances to come up with a down payment and I came across something. I'm freshly out of school and I have a good paying job but it still takes some serious time to save up for a down payment on a home in the Denver area. I was think about everything I own down to the shirt on my back to see if anything to get me into a new property. I have a nice truck but I can't sell it because I use it for work and it's nice having a car nice enough that I don't have to worry about it starting up everyday.

I came to this realization....the only considerable amount of money to my name is what I have been putting in my 401k. I've set contributions to the max because A) I want a nice back up retirement plan in case I don't hit it big in RE and B) who doesn't hate watching all their money go to uncle sam.

I came across an option to take a loan out of my 401k. I did some research and found that my 401k provider allows loans up to 50% of your account value at a 7.5% rate. This intrigues me because for a 10k loan my payments would only be about $90 per month. To get a 3% down payment on a $300k house this could work perfectly and I would mind the $100/mo payment because it wouldn't hurt my numbers too much.

My question to you is this...accounting for all the negative effects ($100/mo loan payment, missed opportunity cost of taking my money out of the 401k, and the banks knowing I have an additional loan in my name) is this idea remotely feasible to speed up the clock on my savings account and get my name on a house hack title.

Feel free to tell me I'm dumb for even considering it or if I shouldn't be contributing to my 401k at all at my age but keep in mind that my company has a very competitive match program.

Thanks for reading!

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Account Closed
Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes
7y

How about not funding the 401K for a while and saving the money for down payment instead? Its a lot simpler solution. If the company matches you could still put that minimum into the 401K

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  • Nik Moushon
    Architect · Wenatchee, WA · Member since 2018 · 843 posts · 907 votes
    7y
    Originally posted by @Frank Wong:
    Originally posted by @John Nachtigall:
    Originally posted by @Frank Wong:

    @Account Closed

    I am with Anish and Nick here.  Don't fund the 401k.  Unless your company matches, I think its a complete waste.  That's just my personal view.   I don't want my money trapped in the system.  You are not going to get rich funding your 401k.  Run the numbers.

     I agree.  Run the numbers.  30-40 years of compound growth, tax free, with a free match for a portion of the contribution.   If that is a trap then lock me up.   If you look above I calculated the 10k he wants to remove would earn him 300k in 35 years, just that 10k.   

    With the free money match and the tax free growth the numbers are almost impossible to beat.   Add in that you can contribute small amounts at a time and the investments are 100% liquid it becomes unbeatable for the vast majority of people

     Hi John,

    Yes, those numbers are correct.  You gave an accurate growth rate based on $10k.  The problem is that you have to wait for 35yrs for $300k.  Wheres the fun in that?  All the miss opportunities you could have invested and times you need the money for other things. 

    Let's use my real life situation.  I bought my first property a 4 unit in Ft Worth in 2002 for $172k.  I used the $10k I saved for the down and closing costs.   The building is worth $370k today.  It's been 17yrs and I have an equity gain of $198k + all the rents I have collected during this period + depreciation.  

    I am able to use the cash flow from this building to fund other purchases and make a direct impact on my life every day.  You cannot do that with a 401k.  Like I mentioned its a trap.  I want to enjoy the fruits of my labor now and don't want to wait for 35yrs.  $300k in 35yrs is nothing.  Cost of goods and living will be through the roof.  My point is run the numbers you don't get rich investing in a 401k.  At least what I think rich really is. 

     While I dont disagree that you can make money faster if you invest it the right way outside of a 401k. But a 401k is NOT an investment. Its a nest egg for retirement. It was never designed to make you rich. It was designed to give you something to retire on. Comparing the short term gains of an investment to the long term stability of a 401k is not a fair comparison. They really do serve two different purposes. 

    There are enough details to argue for weeks on this I'm sure but thats not my intent. I'm not trying to argue for that one is better than the other, since I view them as two different things, just that I dont think its fair to compare them as apples to apples. 

    2Reply
  • Zach LemasterBusiness Member
    Rental Property Investor · Denver, CO · Member since 2015 · 1k+ posts · 3k+ votes
    7y

    Lots of info to sort through here. When investing with any sort of retirement vehicle, you will need to use non-recourse lending (non-conventional loans that are not personally guaranteed by you as the borrower). Much easier to qualify for, but usually more expensive! There are a huge variety of non-recourse loans out there! I've typically seen 25% to 50% down with a 7% to 10% rate, 20-25yr am. Let me know if you want some recommendations on these or about investing in markets that would allow you to scale up easier based on your resources. 1st step would be having a discussion with a 401(k) custodian to make sure this would be a good option for you to establish this account.

    Hope this helps!

    Zach

    [email protected]800-311-6781Podcast Guest on Show How to Get 10%+ Off Your Next Real Estate Deal Right Now
    Rent To Retirement5334 Reviews
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    2Reply
  • Michael Craig
    Rental Property Investor · Saratoga Springs, NY · Member since 2017 · 238 posts · 200 votes
    7y

    @Justin O'Malley if the numbers make sense and you have enough savings for closing costs and roughly $5,000-$7,000 in reserves, you should go for it. You're young and it's your first property - this is how you will learn. Just be sure to buy based on numbers and not emotion.

    @Bill S. brings up a good point about 401(k) loan terms, just be sure to abide by them so you do not pay fees/penalties.

    1Reply
  • Andrew B.
    Specialist · Denver, CO · Member since 2018 · 83 posts · 42 votes
    7y

    @Justin O'Malley I'd suggest if you are just getting started reading "Set For Life". Pretty much everything you need to know starts there. Then move on to "How to Invest In Real Estate". Both are in the BP bookstore or on Amazon.

    Wish I would have started with those 10 years ago. 

    1Reply
  • Lizzie Carver
    Rental Property Investor · Denver, CO · Member since 2017 · 51 posts · 39 votes
    7y

    @Justin O'Malley I was in your shoes 3 years ago. I was long overdue for a promotion and made only half the salary I am now making, and I lived in DC (even more expensive than Denver). I consider myself to be financially conservative, but I also was eager to buy. I was living in a no-frills studio for $1600/month and had a salary in the low $50s. I didn't have a car (could walk to work and everywhere else), which is likely not an option here in Denver, but that helped and I found it extremely difficult to save money at more than a snail's pace. I knew if I could figure it out and buy a place, I'd have a lower mortgage than my rent and be in a bigger/nicer place.

    I felt guilty about it, but I did end up borrowing $5k from my IRA (and then replacing what I borrowed). This was to purchase a 1 bedroom condo for myself to live in. One big thing I will say is that I would not have bought a single family house when I didn't have a lot of savings--as others have pointed out you will have lots of expensive surprises in a house and if you are house hacking/renting to others, you need to make those repairs immediately and it will be extremely stressful doing so without $5k or $10k on reserve. Condos aren't ideal since nobody likes the HOA dues and other people having a vote on your ownership rights, but as you save up I'd consider what the most basic type of property would accomplish your goals--maybe a 2 bedroom/1 bath house in a nice enough neighborhood where you rent out the other room and it covers more than half your mortgage and you essentially get really cheap rent for your room and that allows you to keep saving for the next best thing.

    Other than cutting expenses by bringing pb&j for lunch, can you also find ways to bring in more money? Not sure what your schedule is like, but if you can't pick up a part time job, maybe something that is just a few hours a week? I've done some work through Upwork in the past (freelance jobs of all types).

    2Reply
  • David M.
    Rental Property Investor · Scottsdale, AZ · Member since 2018 · 49 posts · 44 votes
    7y

    I live in Phoenix, where it is hot.  Like over 100 degrees for six plus months straight.  Not saying this is right, but this is what I did when I wanted a 2nd home / vacation rental in Northern Arizona to get out of the heat.  I cashed out a 401(k).  I had two at the time.  An active one with my employer, and a legacy account from a previous.

    I don't remember the numbers, but I paid 39% tax, plus 10% early withdrawal penalty, for the ability to put 15% down on a townhouse in Flagstaff. With only 15%, I still had to pay PMI for several years on top of all of the taxes and fees to get the money. We began to short term rent the townhouse most of the year, except for several summer weeks and one winter week when we would enjoy the property. We made enough income monthly to cover all carrying costs of the property, plus a used Jeep Wrangler 4x4 (for the snowy months).

    Here's the kicker. I got a fee appraisal one year later in an effort to refinance out the PMI, however, unfortunately it didn't meet ARV to refi. It did, however, document that the appreciation in one year from purchase (per fee appraisal) plus the income from STR for the first year exceeded the combined taxes and penalties to withdraw the down payment from my 401(k).

    The 401(k) is a retirement asset.  If I cash it out and invest it in another long term asset, isn't that still a retirement asset, be it repositioned?  There is certainly much greater risk on a leveraged mortgage rental property than a long position mutual fund account, but based on my age and time to maturity, my portfolio could absorb some risk for greater returns.

    I am in no way saying to do what I did. You have to do what's right for you. Especially in evaluating risk, If your guestimate is too risky and you lose everything, there is no do over button. You just lost everything. I just wonder how many who tell you to do a specific approach have done it themselves. I have. Also, I cashed out. If you are doing a loan against your funds, you only have this as your worst case scenario if you bail, not your actual. And if there is equity in the property, a 75% LTV HELOC against that equity might just be enough to write a check to your 401(k) to make it whole in an emergency departure.

    Good luck!

    P.S. Fast forward three years, the property is now a long term rental (with the PMI expired) cash flowing $600+ per month. RIP Air BNB.

    0Reply
  • Chris Babcock
    Member since 2018 · 63 posts · 52 votes
    7y

    @Justin O'Malley

    I didn't read every single post  prior to writing this but having taken a 401(k) loan I can say:

    - When I took it out, I said to myself "I will stick it out at this job for 5 more years to pay this thing back"

    - I took a decrease in take home pay to pay it back (obviously)

    - In retrospect I am glad I took out the loan as it lead to a good cash flowing property

    - I do not believe that the money out of my 401k would have been earning the same return that it is earning in my rental based on current market conditions

    - I am young enough (as are you) to make a fumble now and recover before I retire

    - (Not related to 401k) I am remotely familiar with the Denver market and believe that it is hyper inflated and would advise you to proceed with caution in that market especially if it means tying up your existing assets

    1Reply
  • Account Closed
    Rental Property Investor · Brooke Park Drive · Member since 2018 · 1k+ posts · 2k+ votes
    7y

    You single my brotha? First find a wife, for economies of scale, then with two paychecks your REI dreams will become reality.

    0Reply
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