Not CAN, but SHOULD I use my 401K?

Question

I've tried to find the answer to this question over the past few days and have been unsuccessful. Everywhere I've read, including on BP, it's a "YES!!!...you CAN use your 401k to invest in RE" (rollover SEP-IRA, borrow, cash out, etc.) but nowhere can I find out if you SHOULD use it. I'm curious as to whether the longterm impact on taking money out of your 401k would somehow negate any return on investment you receive from a cash-flow positive rental.

If all numbers work out with a 15% CAP rate, $1000 cash-flow, 40% cash on cash return, etc....is there a true downside to using your 401k as a down-payment on a property? Are their any horror stories out there?

If all numbers work out with a 15% CAP rate, $1000 cash-flow, 40% cash on cash return, etc....is there a true downside to using your 401k as a down-payment on a property?  Are their any horror stories out there?

Steven Hamilton II · Answer

Scott W.,

With a regular contribution to a ROTH you can indeed take it out even the next day; however, this whole discussion has been regarding rolling over funds from a 401k.

With a standard Roth IRA contribution I can remove it even the next day with no consequences.

Rollover funds are required to be in the account for 5 years before you can withdraw them penalty free.  If you withdraw the (now principal) funds before then they are subject to a 10% penalty.

In essence I could rollover this year and pay ordinary tax on it. And withdraw from there the next year to split up when I pay the 10% penalty.

My recommendation is that you roll it over and invest until you hit the 5 year mark. You can then even take distributions of property as your principal distribution.

-Steven the Tax Guy

Your guide to IRS laws, rules and regulations.

Steven Hamilton II · Answer

Bill Brady,

That would depend upon the return.  You have to do the calculations to determine if the juice is worth the squeeze. I have a client who just took a 45% hit on 150k removed from his 401k because he didn't talk to me first.  You have to look at the long term risk vs reward.  What could you earn inside your 401k or IRA. Even consider a ROTH IRA.  Because after 5 years you can remove the principal from the Roth IRA without any penalty.

-Steven the Tax Guy

Your guide to IRS laws, rules and regulations.

Michael Weeks · Answer

You need to use something to get something. I used my 401k 10 years ago to start with rentals, I've been having really good luck with my investments. Lot of my learning and knowlege came from this website [REMOVED] . The information might help you make up your mind

Scott W. · Answer

I learn something new on here everyday. Thx Steve for bringing this up. You do great work for us.

Bill Brady · Answer

A ROTH is different from the Traditional in that you can, indeed, take the principle out after 5 years penalty free.  Just read up on this yesterday.

This is all good information....thanks BP fam.

Scott W. · Answer

@ Steven Hamilton II - Even consider a ROTH IRA. Because after 5 years you can remove the principal from the Roth IRA without any penalty.

This is not true? You can take any principal at any time without a penalty. You're a CPA so you know this better than I but everything I've read says otherwise.

Thomas Miller · Answer

Bill,
Be sure to roll your 401k funds directly into a self directed real estate IRA. Be sure to have a custodian, and be sure to keep all transactions at arms length. Several custodians offer training resources online. Take the time to learn the rules. Not knowing can be costly.

Done right, real estate purchased using IRA funds can yield great returns. In an up market, like we have now, borrowing non-recourse funds to purchase additional properties has great potential now and down the road when you want to cash out later.

Bill Brady · Answer

Got it.  Yah...I'm definitely not thinking about cashing out.  I'm thinking more about taking out a loan against it instead.

Steven Hamilton II · Answer

Bill Brady,

He cashed out 150k  while in the 35% tax bracket.  He then also paid a 10% penalty on that early distribution.

Even if he was in the 25% tax bracket his highest income would've been in a higher bracket AND he would've still been hit with a 10% penalty. This means he still would've been paying a significant amount in the range of 35-33%.

-Steven the Tax Guy

Bill Brady · Answer

Great info Steve...thank you.  Out of curiosity, how did he take a 45% hit?  Was it a cash out and he took the tax hit or was it something else?

Not CAN, but SHOULD I use my 401K?

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