Cash Out Roth 401k to buy more units

Buying & Selling Real Estate
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Cash Out Roth 401k to buy more units

Brian Babbage
Rental Property Investor · KY · Member since 2018 · 24 posts · 18 votes

Wondering what folks think about cashing out a Roth 401k to put that money to work in RE. 

I currently have a fully vested Roth 401k through my employer that has a sizable chunk of cash (definitely 2 down payments in my market). I stopped contributing a few months ago to start funneling more cash toward purchasing properties. I am now thinking about leaving my Job to take another higher paying W2 opportunity. I am considering taking the 10% penalty for early withdrawal from a Roth 401k so that I can unlock that money and put it to work in RE. My reasoning here is two-fold 

  1. I am more bullish on RE long term than the Market (and even more bullish on RE vs Market short term). 
  2. The consistency of the cash flows coming from rentals could expedite my being able to leave my 9-5 faster, therefore focusing more time on RE, therefore building a portfolio that provides something closer to financial freedom faster. 

For additional context I have an SDIRA already that I invest through, and I know I could potentially roll the 401k into that and possibly avoid the penalty, but I am hoping to have this cash in my personal accounts so that once the money is invested I can be closer to quitting my 9-5 and focusing on RE full time. 

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Anthony Wick
Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes
7y

This question seems to come up every month. I can't believe anybody would advise you to take your 401k, pay taxes, and then pay the 10% tax penalty for early withdrawal. Look, you'll have to pay taxes at withdrawal, whenever that is. That's fine. But willingly taking a 10% penalty?! How much is your 401k making now? How much is real estate making now? You'll have to not only beat the stock market consistently, but you'll have to beat it by 10% to get all your money back. 

I don't fault anybody that lowers their 401k contributions to the level of a company match (never give up free money). I don't fault anybody taking a loan from their 401k and paying themselves back. Neither of those requires taxes to be paid and/or penalties to the IRS. Also, the amount of your withdraw matters, because of the progressive tax rate. Post your real numbers if you're comfortable and let us see in writing how much taxes and 10% penalty will be. When I retire, I'll meet with my CPA and discuss the best withdrawal rate for the money I need/want and the taxes I could pay. If my CPA says to take it all out immediately and pay at the highest tax rate (which is what you'll be doing), then I'll get a new CPA. 

Oh ya, you're also thinking about doing this when the real estate market is at a high point. It's not like you're taking advantage like many people did in 2010 and scooping up properties at their low. 

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  • Michael Seeker
    Investor · Louisville, KY · Member since 2011 · 1k+ posts · 1k+ votes
    7y

    @Brian Babbage - my understanding is that if you roll your Roth 401k into a Roth IRA after leaving, you can withdraw the contributions without any taxes/penalties.

    Where are you getting a 10% penalty?

    I'm with you on investing in RE over the stock market if you have the deals available to do so.  Even if you have no cashflow and just pay down an 80% loan you'll get 10%+ returns with the added benefit of "losses" on your taxes.

    If the deals are there and this is your best source of cash, I'd say the 10% penalty (if there is one) shouldn't be a barrier at all.

    1Reply
  • Michael Glaspie
    Real Estate Consultant · Fayetteville, NC · Member since 2017 · 151 posts · 144 votes
    7y

    @Brian Babbage look into a Qualified Retirement Plan (QRP). This will give you a much wider range of investment opportunities. And @Michael Seeker is correct with the ability to withdraw contributions with 0 penalty. It is when you withdraw gains, employer contributiions, or interest earned is when you begin to see the taxation. And as long as you roll it over, then you can avoid the early withdrawl penalty as well. As you are aware, if you closed the account you would be hit TWICE; 1) on gains, employer contributions, & interest and 2) on early withdrawl penalty. 

    As long as you have considered all of your options I dont think there is a right or wrong answer. 

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  • Scotty Gifford
    Realtor · Houston, TX · Member since 2018 · 24 posts · 11 votes
    7y

    @Brian Babbage

    It is possible to avoid the 10% penalty, but it involves getting a 401k lawyer, being in the correct state, Texas is one of them.

    Cost is around $4000 to get it done.

    A 10٪ penalty on $100,000, is $10000, so there are some savings. If you have enough money you would like to take out.

    Note you still have to pay income taxes on your money, but you have to do that even at 59.5 too. Sadly there is no avoiding that income taxes.

    All the better reason to move that money into a taxes Advantage asset like real estate!

    I know tons of people that have done it. Send me a personal message if you want to learn more and I can pass on the info..

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  • Tom Makinen
    Member since 2019 · 226 posts · 115 votes
    7y

    @Scotty Gifford  Ummm no.

    You only pay 10% penalty on the earnings, not the contribution because he already put that in with post tax money (ROTH 401K).  For example if he contributed $100K and earned $10000 from it, his tax is 10% of that $10000.  If it is a traditional 401K, he would have to pay a lot of taxes.  Depending on his income, it could be 40-50% off that $110K balance as he has to pay income tax on the $110K and then another penalty on top.  Not worth it.

    I don't know if Roth 401K has it, but you might be better off taking a 50K loan out and call it a day.  Although some employers force you to pay it when you leave, so you might want to double check.  Also if your employer offers 401K match, please don't waste it.  Roth 401K is post tax anyway, so stop contributing if you think you have enough money for retirement.  

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  • Scotty Gifford
    Realtor · Houston, TX · Member since 2018 · 24 posts · 11 votes
    7y

    @Tom Makinen

    I was referring to a regular 401k account..

    And yes you can avoid the 10% penalty.

    Not the income taxes. As the withdrawal will count as income, which will be on top of your regular income, which depends on your tax rate, Because it will count as income just like if you waited to take the money out after 59.5. No getting around paying the taxes.

    You will need to live In a state with community property state, be marriage, and it Won't work on a IRA account.

    On a Roth IRA you would be allowed to

    Withdraw your nontaxable contributions to the account are distributed before the taxable earnings. If you don't withdraw more than the amount you contributed to the account you won't owe income tax on the distribution.

    Early withdrawals from Roth 401(k)s are prorated between contributions and investment earnings, some portion

    of the Roth 401(k) distribution is likely to be taxable.

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  • Brett B.
    Rental Property Investor · n/a · Member since 2019 · 143 posts · 117 votes
    7y

    I'm going to play devil's advocate here...  I cut back my contribution to my Roth 401k to 6%, which is the max for the company match.  Assuming your company has a match as well, you are leaving free money on the table.  I agree real estate will be a better investment, but some kind of retirement account may be beneficial so you don't have all your eggs in one basket, and will be a nice bonus when you "retire".

    Now with all that being said, I have also toyed around with the idea of liquidating my Roth 401k.  It really depends on your goals and how fast you want to scale and how much of your own capital you really need to be doing deals.  Is it worth paying the penalty and ending any compound interest you would have made over the years?  Play around with the 401k calculator that I linked below.  It is really eye opening to see how the money grows over the years.  

    https://www.bankrate.com/calculators/retirement/401-k-retirement-calculator.aspx

    Have you considered using a HELOC or partnering with someone with the capital to fund another deal? I think cashing out a 401k should be more of a last resort option.

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  • Anthony Wick
    Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes
    7y

    This question seems to come up every month. I can't believe anybody would advise you to take your 401k, pay taxes, and then pay the 10% tax penalty for early withdrawal. Look, you'll have to pay taxes at withdrawal, whenever that is. That's fine. But willingly taking a 10% penalty?! How much is your 401k making now? How much is real estate making now? You'll have to not only beat the stock market consistently, but you'll have to beat it by 10% to get all your money back. 

    I don't fault anybody that lowers their 401k contributions to the level of a company match (never give up free money). I don't fault anybody taking a loan from their 401k and paying themselves back. Neither of those requires taxes to be paid and/or penalties to the IRS. Also, the amount of your withdraw matters, because of the progressive tax rate. Post your real numbers if you're comfortable and let us see in writing how much taxes and 10% penalty will be. When I retire, I'll meet with my CPA and discuss the best withdrawal rate for the money I need/want and the taxes I could pay. If my CPA says to take it all out immediately and pay at the highest tax rate (which is what you'll be doing), then I'll get a new CPA. 

    Oh ya, you're also thinking about doing this when the real estate market is at a high point. It's not like you're taking advantage like many people did in 2010 and scooping up properties at their low. 

    3Reply
  • Pat LulewiczBusiness Member
    Realtor · Raleigh NC and Greensboro, NC · Member since 2019 · 395 posts · 392 votes
    7y

    @Brian Babbage when you move jobs, consider rolling your 401k over to a self-directed IRA. No, you can't contribute to your own projects or those of family members, but if you have/find any partners, you could provide the funding for their purchase/rehabs as a note investment, and they may consider doing the same for yours. Definitely do your homework and due diligence on there, but may be something that'll give you better returns without the penalty.

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  • Brian Babbage
    OP
    Rental Property Investor · KY · Member since 2018 · 24 posts · 18 votes
    7y

    @Scotty Gifford @Tom Makinen

    If there is no tax on contributions for the 401k early withdraw then this becomes much more compelling, as my gains have not been very significant (Less than 2k) and same with employer match (1.8k). I have close to 22k in the account and have started to invest in cheap duplexes (ranging from 50-70k, so this amount would allow to put down 20% on a couple of these. 

    I guess dicussing my goals here might help as well. I see RE similar to my SDIRA & 401k. I am looking to grow my portfolio to ~100 units and pay them off streadily. I do not see myself needing the cash flow that these kick out as my current salary is pleanty for me to live off. To that end I will be reinvesting excess cashflows to either scale the portfoilio or pat down mortages (whichever gives me the best return at any given moment). 

    @Anthony Wick Personally I would much rather have 30-50 units fully paid off by the time I am at retirement age with constant and steady  cashflow being spit out than be beholden to the swings in the market. I will continue to take the meager match my employer gives (25% match of 6% of salarty), but I don't see the harm in cashing out the 22k from the old Roth 401k and then start over with my new employer and deploy that 22k into cash flow producing assets. 

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  • Anthony Wick
    Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes
    7y

    @Brian Babbage

    Cashing out the $22k? So it was maybe $40k? Or did you cashed out $22k, turning it into $14k? Real estate also has a "market" and risks. I max out my 401k each year, also have a Vanguard brokerage account I put money into, invest in real estate, and stopped my Roth IRA (retiring before 59 1/2 and not waiting for minimum age to withdraw if needed).

    Diversification is a great methodology in my opinion. Stocks, bonds, real estate, savings, etc.

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  • Anthony Wick
    Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes
    7y

    @Brian Babbage

    Wait. I read your last post again. Are you saying you'll only pay the 10% penalty on gains, not contributions?! As I understand it, that is not correct. I'm assuming you have a 401k, not Roth IRA as well. And if it is a Roth, it's been 5 years since your first contribution? I'm not a cpa, so I would absolutely be 100% sure what the tax consequences are before I cashed out any retirement funds.

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  • Andrew Flora
    Rental Property Investor · North Vernon, IN · Member since 2018 · 136 posts · 192 votes
    7y

    I absolutely would not.   I like to be diversified.  If your real estate fails you, you will still be able to retire with your retirement accounts, if you put it all in real estate and fail you have no plan b.  When you turn 60 you could withdraw some to buy a couple properties but I would never advise anyone to do what you are considering.  Fund real estate and your Roth both aggressively and you will be rich.

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