401k Withdraw Good or Bad idea?

39 Replies

I have this Idea of taking a 20% withdraw for a down payment out of my 401k to avoid PMI costs and down the road to grow my properties to gain financial independence. I understand all of the consequences like 20% fed tax/10%penalty and a 3.07% state tax for PA. I would be only looking to pull enough out for only a 20% down payment, Im 32 years old and have 120k+ in my 401k with a 7.5% inception gain. Now my plan is to do the BRRRR strategy, I can pay the 10% penalty back in a few years 2 ways, upping my contribution which was already the plan or I can pay it back with the cash flow out of the rental property. The contribution change would be the most ideal with changing withholding's in my check which I can afford. Im really hesitant on this decision because of the amount I would have to withdraw just to get my 20%. I have 60k withdraw room to work with before I would get pushed into the next tax bracket.

I know 99.9 percent of people would say DO NOT TOUCH YOUR 401k, but im thinking different. No Matter what I will be paying those taxes in later years after I withdraw them for retirement... and the Goal is always to make more money right? well ill probably have to pay more taxes in 30 years then I do now. I am projecting(based on my wife's job and my increases) we will be one tax bracket higher then we are now at retirement(24%) and those will change with ever election. So would it  make sense?

This is really the only option we have at the moment, we have a large HELOC out that we used to consolidate student loans and we do not have extra cash for a 20% down payment. We are patient and not rushing into anything.

Any insight would be highly appreciated and I am not trying to talk myself into this, I just think it makes sense. I will still work my full time job contributing to my 401k for the next 30 years times 2(wife) to save for retirement.

Has anyone else ever did this, or ran actual numbers on a done deal. I know real estate renting can make 10%+ return and that is much better than my 7%. My only take back is the cash flow might not be always saved, hence BRRRR, I would like to grow from 2 to 4 to 8 to 12+ units. I would have actual money on hand to wait patiently to make a move on a good deal.

I appreciate all help and opinions, please tell me how it is. Ive been debating this for the last few months and watching how the market and housing market with interest rates have been moving, Waiting for a market pullback to make a move. In the mean time ill be sitting here doing my diligence and reading all the great posts and educating myself in every aspect.

Thank you for your time.

You're going to Pull 28% of your purchase price to end up with 20% down after taxes. Assuming a $200k property that's pulling $56k and paying $16k in taxes/fees. How long would it take for the PMI to equal $16,000? (Modify up or down based on price compared to $200k assumed price.)

Did you calculate your tax rate based on your regular income plus the $56k all in one year? (Y]that might push you in to a higher state and federal rate.)

Trust your intuition. You already seem to believe in yourself and your logic is sound. I just helped a client do this same thing and it worked out well!

Hey @Bill Brandt thanks for the insight, yes we fall right at the front of the 22% bracket. so adding in the 56k we would still be in the same bracket. also it would take about 93 months to pay the 20% on a 200k loan with 172/month pmi. That could be the difference in a cash flow property. although in 93 months my 401k with 7% annual gain would be 58k more, but looking at this as an opportunity to get into the business and create more cash flow out with other properties in the future.

So according to your math. You'll save $16k in PMI over 8 years by paying $16k in taxes today. That's a bad deal. Plus you lose out on the $56k in tax free gains in the 401k.

So your options are $16k poorer today and $56k poorer in 8 years. Or $16k richer today and $56k richer 8 years from now. 

If your math is right the choice is obviously to pay the PMI.

You need to check the 401k loan option before withdrawing funds.  Also, it's possible, since you are under the age of 59 1/2, to complete a 401k withdraw, it may have to qualify as a "hardship".  The IRS just changed the guidelines regarding qualifications for "hardship".

Pay the PMI. You can often eliminate the PMI once you achieve 20% equity, either through paying down the debt or having the property appreciate in value. Usually this means you don't have to pay PMI for very long.

@Steven Hershey You mentioned that 99.9% of people say "Do not touch your 401k". Do you want to be in the 99.9%, or that 0.01% percent who are ultra-wealthy. The ultra-wealthy actually do not have 401k, they provide 401k plans for the 99.9%. Case in point, that's how I started. I took out almost all of my 401k shortly after I graduated from college and started my job. Now I am my own boss, run a private equity firm, own 47 units/ pads in the mobile home park business and going to be 74 before the year ends. I'd say go for it. 

If you're talking about a Hardship Withdrawal from your 401k, those can only be used for a primary residence if I remember correctly.  Daniel Hughes mentioned that the IRS just changed the rules relating to hardship withdrawals, so you should call whichever company handles your retirement plan (Fidelity, etc.) and ask them what the options are.  The IRS sets the overall rules, but each employer can be more restrictive and have their own specific rules and processes for loans and withdrawals.

I used to work for Fidelity Investments and processed these kinds of transactions (Hardship Withdrawals, Loans) on a daily basis.  It sounds like you're aware that a withdrawal could potentially bump you into another tax bracket, but if you are currently qualifying for anything based on income--financial aid for your kids' school, Marketplace healthcare subsidies--you might screw yourself right out of it with a big withdrawal.




@Greg Powers

I so strongly regret tapping into my 401k. I’m your age, and it took years to build it up. Being young you have time value on your side when it comes to the most powerful wealth building tool...compound interest.

If you take out 56,000 today so 64,000 remains, assuming 8% returns you would have 644,000.

If you don’t touch it ever again, 120,000 compounding at 8% is 1,207,000.

You are stealing 563,000 from your future self.

If I had just saved for another year and not been so anxious to buy my first couple of deals, I’d be in a much better financial position. It only hurt me in the long run.

I HATE paper assests. They have their place, but a 401k as a retirement vehicle is a broken system. It always has been - it was intended to be used as a supplement to a company-sponsored pension plan but almost no company in modern times has one. They've abandoned that system due to cost. I currently work for a Utility company and the year before I was hired, they abandoned their pension plan and instituted a cash-balance plan instead. They deposit extra money but it's up to you how to invest it...

I think that instead of having cash just sit there earning a menial amount of interest, or stock investments in companies you do not have management control over, having your own company(ies) that produce a monthly check that you take to the bank is FAR more valuable. You can leverage on that cash flow (albeit only 75% of it) and purchase even more properties/businesses which increase your cash flow....it's a positive feedback system.

Financial gurus always say what the value of your account would be in x years earning y interest compounded over z time. So what if my 401k account is $2.3 million in 30 years? Adjust the cost of living. 30 years ago, my mother was making approximately $25,000 as a starting wage as a nurse. Today that starting wage is $60,000 (in metro NY). That's a dollar value loss of 2.5x! Let's extrapolate in 30 years...the starting wage (an indicator of the cost of living) would be $150,000. A 401k account that could grow to $2 million would be worth only $2mil/150,000 = 13 years of a constant standard of living. As you age, your costs only increase, not decrease! Healthcare, end-of-life care, long-term care, medical costs,... So what, after the 13 years you drop dead? Become a moocher on your children? Is that a life of dignity?

I'm not talking about the extra $300 per month rental income so that you can finally buy that TV you always wanted. I'm talking about mercilessly reinvesting everything and increase your velocity of money 10x to become unstoppable.


Updated about 1 month ago

Investingpirate.com

Check with your 401k plan administrator if you may borrow against your 401k and avoid the withdrawal penalty.

 

Already looked into plan specifics, im allowed to withdraw any amount but with penalty. I cannot afford a 401k loan per month and it wouldn't let me take out the amounted needed anyway, $211 max biweekly. My credit is pretty good 782, so would i qualify for a lower % down? Here are some numbers ive been looking at.

properties between 80k - 155k with a 20% down payment id have to withdraw 33k from 401k to get my 20k if needed. I would only do this for my first property and with changing my withholding's and taking my 401k contribution from 12% to 18% would give me a $50 less paycheck biweekly only until my penalty is paid back 2 to 3 yrs. I would have to mess with some numbers to see how bad it would affect my tax return. @Greg Powers then i would not be stealing from myself, If i wanted two down payments i would need 40k which means id need to take around 65k out(half of my 401k) and with changing contributions to 18% id have about the same in it at retirement.

I really want this to work but if paying the PMI makes more sense then maybe that is how ill do it instead of messing with 401k money. @Paul Enzinger I only have paper assets other than my house, but i totally agree with you that is why im trying to work my way into the physical asset class. have friends that do it and its been working out very well for them.

this is all great feed back and i appreciate everyone's time. I really just dont know. Should i sit down with an accountant and do my taxes at all different withdraw levels? my wife and I lend the government a lot of money every year just to get it back at the end.... should i just increase my withholding's and wait  until i have money saved up? im pretty antsy to get into the business but i do not want to make the wrong move.

401k

 now - 121k invested, 12% contribution, yrs to work 30 * 7%return + 7%/yr company match on salary = 2.5mil at retirement.

withdraw(65k to get 40k) 60k invested 18% contribution, 30yrs to work * 7% return + 7% company match = 2.5mil

would it really matter? other than my yearly tax return amount? 

@Steven Hershey I liquidated the basis of my Roth 401k retirement (left the gains in until I'm in a lower tax bracket to pull out) to scale my portfolio.  Here were the benefits for my situation just by purchasing turnkey initially. 

1. No tax hit to pull the $ out (this only applies to a basis in a Roth that has been open for a certain amount of time).  I don't think this applies to you.

2. I was able to create cashflow NOW (not wait for appreciation in paper assets) at @12%+ with the assets I purchased.

3.  I received another @3% in loan paydown by the tenant.

4. I received another @40% ROI from appreciation in 2 years.

In the end, I more than doubled my invested money tax fee in 2 years with the monies locked up in my retirement.  

I also took a small portion of that and did 10 more BRRRRs and 3 flips.  With that, I created large equity builds, have cashflowing assets, with little of my capital locked up in the deal.  My streams of income are such, that I can scale fairly readily into MF assets.

I never would have gotten to this point if my monies were locked up in a 401K.  My advice, have a solid plan, know the flip side, mitigate your risk, and work the plan.

I would typically advise to not pull from a planned retirement account and pay the extra tax and penalties, rather, pay the PMI OR find out if your plan has borrowing provisions, if so, you can borrow up to 50% of your vested interest up to $50k Max from a 401k. The borrowing provisions would have an interest rate you need to pay but you are paying yourself. The PMI looks to work out much cheaper for you in the long run, especially when you consider that with appreciation, both market and forced, you can revive the PMI quicker and not have to take it all the way to term to delete it. Run your numbers over again with this in mind and I'm confident you will see that.

Originally posted by @Steven Hershey :

Already looked into plan specifics, im allowed to withdraw any amount but with penalty. I cannot afford a 401k loan per month and it wouldn't let me take out the amounted needed anyway, $211 max biweekly. My credit is pretty good 782, so would i qualify for a lower % down? Here are some numbers ive been looking at.

properties between 80k - 155k with a 20% down payment id have to withdraw 33k from 401k to get my 20k if needed. I would only do this for my first property and with changing my withholding's and taking my 401k contribution from 12% to 18% would give me a $50 less paycheck biweekly only until my penalty is paid back 2 to 3 yrs. I would have to mess with some numbers to see how bad it would affect my tax return. @Greg Powers then i would not be stealing from myself, If i wanted two down payments i would need 40k which means id need to take around 65k out(half of my 401k) and with changing contributions to 18% id have about the same in it at retirement.

I really want this to work but if paying the PMI makes more sense then maybe that is how ill do it instead of messing with 401k money. @Paul Enzinger I only have paper assets other than my house, but i totally agree with you that is why im trying to work my way into the physical asset class. have friends that do it and its been working out very well for them.

this is all great feed back and i appreciate everyone's time. I really just dont know. Should i sit down with an accountant and do my taxes at all different withdraw levels? my wife and I lend the government a lot of money every year just to get it back at the end.... should i just increase my withholding's and wait  until i have money saved up? im pretty antsy to get into the business but i do not want to make the wrong move.

401k

 now - 121k invested, 12% contribution, yrs to work 30 * 7%return + 7%/yr company match on salary = 2.5mil at retirement.

withdraw(65k to get 40k) 60k invested 18% contribution, 30yrs to work * 7% return + 7% company match = 2.5mil

would it really matter? other than my yearly tax return amount? 

 The math is not right.   A 401k grows tax free.   So even if you pay tax in the end, during the next 30 years you get the investment return on the whole sum, not subtracting 25% in taxes each year.   

And you dont get a company match on the withdrawl.   

And an s&P 500 fund does not require capital reserves

It is your money, do what you want, but the math is clear.   401k wins

@Steven Hershey . Unless I missed it somewhere in this thread, there's a big issue which may be getting overlooked. I believe you're talking about buying an investment property. If so, are you assuming you can put down less than 20% and pay PMI like you would on your primary residence?

If so, this is a flawed assumption. Without seller financing or some wildly expensive financial product, you cannot put down less than 20% on non-owner occupied investment property. If that's the case, I recommend going "Dave Ramsey" on your debt first. It sounds like you're pretty leveraged with the student debt on the HELOC. Not a good thing if you're buying at the top of a real estate market which has had a long run up. Consider reducing your 401k contribution to the minimum which maxes out your employer match or suspend contributions altogether for a while if you want to be more aggressive. If you have car payments consider downsizing to cheaper. It will take you longer but you'll do REI better and smarter.

@Steven Hershey check your 401k loan options. You can borrow against it, and pay yourself back. Also if it's your first home, you can borrow x amount. I believe you can skip the penalty, however you would have to check into that. It was 15 years ago when I did it and don't remember all the details.

You can borrow against your 401k - set amounts, usually home purchase or general purpose but only one loan at a time. Also, they have fixed pay back periods. Check your plan rules 

@Steven Hershey , go with the PMI. I disagree with some posters saying to pull it out of your 401k. Keep your hard earned money working for you. Yes it's slow and the return may only be 7-8%, but so what? This is, one bucket of your wealth building.

For the property. It's an investment property. Put down 15%. Use bank's money. Leverage to control another asset. Include PMI when working up your numbers, etc. And if you must, you can buy out the PMI at closing. I bet, it'll still be cheaper than the 10% penalty and tax you incur by taking your money out.

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