Leveraging 401K to invest in real estate

21 Replies

I am thinking about leveraging my 401K savings to invest in real estate. Does anyone have experience with that and would like to share their story? What are the pros and cons of doing that? Thanks!

Jia, retirement funds can be used to invest in real estate. In order to do that you need a Self-directed IRA. You do a direct rollover of your 401k funds into newly established SD IRA and then IRA can buy real estate. The owner of the property will be the IRA, not you. And you personally can not benefit from the investments. All income must go back to the IRA.

Also, if your 401k is with the current employer you probably won't be able to touch that until you leave that company.

Just helped a client with this on their first flip, very simple when you have all your documents in order.

@Jia Liu

I'm considering borrowing from my 401K to do some RE investment.  Not sure if that's the info you're looking for.

For my work 401K, I can borrowing up to 50% of my account (up to $50K) with an interest rate of 5.25%.  I can repay the loan back from 1-5 years.  The re-payment will be after tax, deducted from my pay check.  If I leave the company before I finish paying back the loan, I can either continue paying back until maturity, or pay 10% penalty and treat the loan balance as income / early withdraw.

Check with your HR on your 401K loan rules.

Henry

@Henry J. got it. Thanks for sharing. I have a 401k with a previous employer. My current one is too small to borrow against.
@Dmitriy Fomichenko . When you say all income goes back to IRA. Can I work out with the IRA bank on how much goes back to the IRA? For example can I do 50/50? 50% goes to IRA and 50% cash flow? When do I start owning the property? When I finished paying the IRA back the amount I took out?

Jia, that won't work, you can not use any income from the asset owned by your IRA personally. IRA designed to provide you with benefits at retirement (after age 59 1/2). If you take early distribution you will be taxes on that amount plus you have to pay penalties.

If you are looking to create a cash flow that you can use today then you must look outside tax-deferred accounts. 

@Jia Liu If you borrow money against your 401k, then you are essentially giving yourself a loan.  This loan is just like any other loan and must be repaid on time except in this case the interest from this loan is repaid to you.  Failure to properly repay these loans can have very serious penalties and tax consequences.  You own the property as soon as you close on it, and it is owned in your name, and is not owned under your 401k unless you were to change your retirement account into a self directed or solo K. 

While loaning yourself this seed money can be useful under certain circumstances, often times the loan must be repaid in a relatively short time frame.  While the mortgage itself may be a 30 yr loan, the loan against your 401k that you used as the down payment may only be a few years in duration.  A 50k loan at 5.25% interest rate is only 275 a month if it had been a 30 yr loan, but if you are required to pay that money back in only 5 years then the monthly payments jump all the way up to 950, which would destroy any cashflow and cause you to pay out of pocket every month.  So borrowing 50k to purchase a 200k home at 25% down payment would cause a total monthly payment of 975+830 = $1805/month, not counting taxes/insurance.

Some 401k providers allow for a 15yr repayment cycle, which helps reduce the problem.

I am looking to do the same thing. i want to borrow against my 401k and either: -find a deal that cashflows even after the 401k payment -Use the 401k money to get into a distressed property and BRRR it, using the refi money to pay back the loan after 6 months to a year -Or use the money to help fund a flip, paying back the money post sale
Originally posted by @Ben Zimmerman :

@Jia Liu If you borrow money against your 401k, then you are essentially giving yourself a loan...

Some 401k providers allow for a 15yr repayment cycle, which helps reduce the problem.

15 year loan is only allowed for the purchase of primary residence. Loan for any other purpose is a 5-year loan. 

@Jia Liu - I have used a 401k loan as @Henry J. has referenced. One thing I didn't find out until recently though is that the $50k limit on the loan is actually a limit for a rolling 12 months. Which means if you only use the loan for 3-6 months while doing renovations on a property before getting longer term financing you have then wait another 6-9 months to be allowed to use your 401k again.

Also you should be able to combine 401k from your previous employer to your current one. I did it a few years ago when I transitioned employers. So that may help you out there as well. 

In an ideal world I'd suggest that you find a way as an engineer in the bay area to do some consulting work and generate 1099 income. This way you can set up a Solo 401k with someone like @Dmitriy Fomichenko . This will allow you to both take out a loan for you to invest in directly without violating the self-dealing laws. And then you can with whatever is left do private lending or note investing or direct acquisitions in your 401k as well. It's sort of the best of both worlds, in my humble opinion anyway, if you can generate the active income. 

What @Dmitriy Fomichenko said !

I would caution against it anyway but that is just my approach. Why not be diverse in your strategy. Focus on using retirement accounts, mutual funds, etc for a more long term approach while building your REI portfolio as well. This would provide exposure to multiple investment opportunities. One long game option (retirement accounts) and one short game / wealth option (real estate cash flow and equity build up) - Again , not that it is a bad idea to borrow from a 401k or use a self directed IRA - I just think that it is the easy route and that you should get more creative in your financing. Let the retirement accounts do their job and make friends with some local investors, lenders, private money lenders, etc for your REI.

@Jia Liu - If you have a 401(k) from a previous employer, this is a moot discussion. You should rollover that 401(k) to an IRA. 401(k) plans are very expensive. Not only do you have the fees of all the mutual funds that they hold, but you also have the plan fees eating away at your principal. Once it is in a self-directed IRA, you won't have to worry about borrowing in order to invest in real estate. Your IRA will be able to invest in real estate.

If you are trying to generate income for yourself today, you can use a loan from your 401(k), just keep in mind that the money is no longer invested and earning a return inside your 401(k). If your investment goes bad and you lose money, you will have a double kick in the pants when you default on your loan and you get the 10% penalty for early distribution.

@Jia Liu

If you want to invest your retirement funds in real estate and will need to incorporate a non-recourse loan, you may want to consider opening a solo 401k if you are self-employed instead of an IRA. Reason being, unlike IRAs, UDFI does not apply to solo 401k plans.

Following are the similarities and differences between the solo 401k and the self-directed IRA.

The Self-Directed IRA and Solo 401k Similarities

  • Both were created by congress for individuals to save for retirement;
  • Both may be invested in alternative investments such as real estate, precious metals tax liens, promissory notes, private company shares, and stocks and mutual funds, to name a few;
  • Both allow for Roth contributions;
  • Both are subject to prohibited transaction rules;
  • Both are subject to federal taxes at time of distribution;
  • Both allow for checkbook control for placing alternative investments;
  • Both may be invested in annuities;
  • Both are protected from creditors;
  • Both allow for nondeductible contributions; and
  • Both are prohibited from investing in assets listed under I.R.C. 408(m)

The Self-Directed IRA and Solo 401k Differences

  • In order to open a solo 401k, self-employment, whether on a part-time or full-time basis, is required;
  • To open a self-directed IRA, self-employment income is not required;
  • In order to gain IRA checkbook control over the self-directed IRA funds, a limited liability company (IRA LLC
  • must be utilized;
  • The solo 401k allows for checkbook control from the onset;
  • The solo 401k allows for personal loan known as a solo 401k loan;
  • It is prohibited to borrow from your IRA;
  • The Solo 401k may be invested in life insurance;
  • The self-directed IRA may not be invested in life insurance;
  • The solo 401k allow for high contribution amounts (for 2017, the solo 401k contribution limit is $54,000, whereas the self-directed IRA contribution limit is $5,500);
  • The solo 401k business owner can serve as trustee of the solo 401k;
  • The self-directed IRA participant/owner may not serve as trustee or custodian of her IRA; instead, a trust company or bank institution is required;
  • When distributions commence from the solo 401k a mandatory 20% of federal taxes must be withheld from each distribution and submitted electronically to the IRS by the 15th of the month following the date of each distribution;
  • Rollovers and/or transfers from IRAs or qualified plans (e.g., former employer 401k) to a solo 401k are not reported on Form 5498, but rather on Form 5500-EZ, but only if the air market value of the solo 401k exceeds $250K as of the end of the plan year (generally 12/31);
  • When funds are rolled over or transferred from an IRA or 401k to a self-directed IRA, the amount deposited into the self-directed IRA is reported on Form 5498 by the receiving self-directed IRA custodian by May of the year following the rollover/transfer.
  • Rollovers (provided the 60 day rollover window is satisfied) from an IRA to a Solo 401k or self-directed IRA are reported on lines 15a and 15b of Form 1040;
  • Pre-tax IRA contributions on reported on line 32 of Form 1040;
  • Pre-tax solo 401k contributions are reported on line 28 of Form 1040;
  • Roth solo 401k funds are subject to RMDs;
  • A Roth 401k may be transferred to a Roth IRA (Note that from a planning perspective, it may be advantageous to transfer Roth Solo 401k funds to a Roth IRA before turning age 70 ½ in order to escape the Roth RMD requirement applicable to Roth 401k contributions including Roth Solo 401k contributions and earnings.);
  • Roth IRA funds are not subject to requirement minimum distributions (RMDs);
  • The fair market value (FMV) of assets held in a self-directed IRA is reported on form 5498;
  • The fair market value of assets held in a solo 401k are reported on Form 5500-EZ;
  • At termination, the solo 401k is required to file a final Form 5500-EZ and 1099-R; and
  • At termination, the self-directed IRA is only required to file a form 1099-R.

@James Masotti , great tip on the 12 month limit. Thanks! I have been contributing to my employer 401k for some years now. At this moment, I am actually leaning towards stop funding my 401K altogether (or maybe decrease my contributions). My rationale is as follows. If I am going to save money in a 401K and then take a loan against it and pay interest to invest in real estate, why not just cut the middleman and just simply put the money in a savings account for real estate? I intend to be a millionaire by age 60 anyways :D

@George Blower  , @Thomas Rutkowski - I am not self-employed (yet). What's the benefit of combining a 401k from my previous employer to my current employer vs rolling the 401k from my previous employer to an IRA as @Thomas Rutkowski mentioned? 

Jia Liu, if you are looking to become self-employed and be able to eventually draw an income from the comepany, you should look into a ROBS (Roll Over Business Start-up). With this you create a C Corp and create a 401k for your new corporation. You can then roll-over the balance of your former employer's 401k into the new corporations 401k. The new 401k can invest in the C Corp and you have those funds in the new corporation. You can also take a loan from the new 401k if needed.

I am going through this now. Let me know if you want more details.

You will be borrowing the money at a large interest rate since you be taxed and penalized. Plus the loan limits will be far shorter than your mortgage.

I think it is beat to not touch the 401K. Instead if U prefer to invest in real estate and can’t afford to invest in both I would completely stop investing in your 401K today. Instead put that money that you were investing into the 401 K each paycheck into an account until you have enough saved for a down payment and other related costs (construction, etc). Perhaps you have some extra money in your budget or can cut back on other expenses to save up even more money faster.

With the ROBS I describe above there is no tax or penalty on the 401k funds. Your 401k Just invests in your new C Corp. As you draw a salary you can then actually (and it is advised to) pay into the C Corp’s 401k which can be invested in a normal diversified portfolio.

As a family looking for our financial independence and to be able to earn a long-term salary, the ROBS is the best method I have found to legally gain access to my retirement funds without paying tax or penalty and be able to get paid from the earnings. With a Self-Directed IRA I don't believe you can earn or use the money other than investments.

I should state I am not a lawyer or CPA, just going through this process myself.

Originally posted by @Jia Liu :

@James Masotti , great tip on the 12 month limit. Thanks! I have been contributing to my employer 401k for some years now. At this moment, I am actually leaning towards stop funding my 401K altogether (or maybe decrease my contributions). My rationale is as follows. If I am going to save money in a 401K and then take a loan against it and pay interest to invest in real estate, why not just cut the middleman and just simply put the money in a savings account for real estate? I intend to be a millionaire by age 60 anyways :D

@George Blower  , @Thomas Rutkowski - I am not self-employed (yet). What's the benefit of combining a 401k from my previous employer to my current employer vs rolling the 401k from my previous employer to an IRA as @Thomas Rutkowski mentioned? 

 If your employer offers a match, make sure you put in at least that much, otherwise you're throwing away a guaranteed 100% return on your investment. Beyond that I understand the rationale behind not contributing. 

On another note why are you waiting to become a millionaire by 60? As an real estate investing engineer in SFO...you should be there within a few years not a few decades :-)

@Jia Liu

One of the benefits of the solo 401k over the IRA is that a solo 401k is not subject to UDFI.

@Jia Liu

If you have access to a previous employer 401k plan, you may want to consider rolling that to a self-directed IRA (or a Solo 401k if you have self-employment activity) rather than transferring it to your current employer's plan. The current employer plan will be more restrictive than a self-directed IRA or Solo 401k.

Originally posted by @Jia Liu :

@James Masotti , great tip on the 12 month limit. Thanks! I have been contributing to my employer 401k for some years now. At this moment, I am actually leaning towards stop funding my 401K altogether (or maybe decrease my contributions). My rationale is as follows. If I am going to save money in a 401K and then take a loan against it and pay interest to invest in real estate, why not just cut the middleman and just simply put the money in a savings account for real estate? I intend to be a millionaire by age 60 anyways :D

@George Blower  , @Thomas Rutkowski - I am not self-employed (yet). What's the benefit of combining a 401k from my previous employer to my current employer vs rolling the 401k from my previous employer to an IRA as @Thomas Rutkowski mentioned? 

I would NEVER roll an old 401(k) into a new one. Again, the fees in corporate 401(k) plans are very high. Roll it into an IRA, Self-directed or not.

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