Cashing out a Roth 401k
Dawn AnastasiPro Member
Rental Property Investor · Milwaukee, WI · Member since 2013 · 6k+ posts · 4k+ votesI have been told all my life in saving into my 401k that you need to save the maximum that you can. So for many, many years I have been saving the absolute maximum allowed by the government every year into the company sponsored Roth 401k with the employer matches.
All that money just sitting there; I feel as though I could do a lot more with it in real estate. Especially when I see myself losing $15k in one year. But taking any out, that would be going against everything I've been preached to over many years, so that's why I hesitate.
Anyone else feel that way? It's like after the zombie apocalypse, feeling bad for taking stuff from a grocery store without paying for it.
If you've been in that situation, what have you done?
As a Chartered Retirement Planning Counselor, I have to caution against taking the money out early. Even with a Roth 401k, there are some penalties for early distributions. On top of that, if you are still an active employee with the company that offers the 401k, you may not even be able to withdraw the money and have to rely on just taking a loan from it.
That being said, I always tell people it's all about diversification. A 401k, Roth 401k, or IRAs, are just one aspect wealth building. You never want to put all of your eggs in one basket, but if you are investing in real estate as well as tucking money away in a tax-advantaged retirement account, you're simply diversifying, not only in the investments, but with the tax strategy as well. We have no idea what the future holds, so having money invested in various ways will allow you to structure your withdrawals later in life to make the most of it.
If you are unhappy with your Roth 401k performance, change it. It's been the best bull market in decades in recent years, so if you lost money recently, you may need to adjust your holdings. You have a decent amount of control and can park the money in steady income-producing investments, the stock market, or any combination that your plan allows. So I'd look at how your 401k can compliment your total investment portfolio, including real estate, and structure your investments so that it makes sense for your end game scenario. It shouldn't just be seen as a single account/investment and then ditch it without first examining how it plays into your total financial picture. Maybe the answer is to reduce how much you put into the 401k and direct more of it toward real estate, but until you sit down and look at the numbers you'll never know.
@Bobby Beard you sure can!
You need to establish self directed Solo 401k, then rollover your SEP there and you will be able to use those funds to buy real estate or any other non-traditional investments. Now, keep in mind that it is not you, but rather your 401k that owns the investment, so all of the gains and income from the property will go back into 401k tax-deferred! There are prohibited transaction rules that you need to be aware of, but you can easily educate yourself about that.
You will be able to continue minimizing your taxes by deferring portion of your income into Solo 401k (it allows you to shelter up to over $50K per year!!), invest in real estate, do private lending, etc. and grow your wealth tax-deferred (or tax free if you choose to use Roth sub-account that is available to you with the Solo 401k Plan).
thank you @Dmitriy Fomichenko for the info! More research!
Dimitriy is absolutely correct regarding the Solo 401k exemption from the UBTI rule... EXCEPT for one circumstance. That circumstance is when the Solo 401k investor is a completely "Passive" investor in real estate that utilizes acquisition debt. I know this because we put together passive real estate investment deals that can accept qualified funds, as investors. So we had our CPA dig into this exception, before we started telling folks about it. Our CPA discovered the exception to the exception...if that makes sense.
By the way, in all cases the acquisition debt MUST be "Non-recourse" debt, no exceptions.
But there is another way to invest in "passive" real estate deals, with any type of qualified funds account and avoid UBTI altogether.. That is to pool together enough investors to buy the real estate with no debt... An all cash acquisition.
Then in a couple of years, if the mortgage market is still good, you can (cash-out) finance up the property say to 50% - 65% LTV, get the majority of your money back, and do it again. The key word to remember with UBTI is "Acquisition" debt.
Alan
For what it's worth I would recommend keeping the 401k. If you keep the $ invested in an index fund or a no load mutual fund you will gain about a 8% annualized return. This is likely less than most your cap rates on your rei but still serves 2 important functions. First it allows you to be diversified. If real estate values tumble or vacancy spikes you will not regret having your money diversified. More importantly the true benefit of a 401k is the tax savings. By contributing that money, it was not counted as taxable income by your state or the federal government likely earning you an instant return on that money of around 35%. Not only would you have to pay those taxes if you withdrew early, but you would also loose a 10% penalty. On top of that you would loose any employer matches not yet vested and pay transaction costs to sell your current investments. When it's all said and done you will only see 50 cents on the dollar of what you have invested. Maybe you can then increase your average returns by 5% or so, but even if you do it takes a long time to make up lost ground and you've put yourself in a much less favorable risk adjusted financial position. Don't feel as if you need to understand everything about the stock market to invest. Warren Buffet once said something along the lines of farmers need not understand the bio-chemistry of the photosynthesis process to grow corn, nor do they need to check the corn 14 times a day, they need only to plant it and take reasonable care to ensure it's in an environment where it can grow. Translation: Keep your 401k, buy index funds, don't overthink it, and don't get too greedy. Pigs get fat. Hogs get slaughtered.
Alan,
can you explain a little further what you mean by acquistion debt?
Dimitriy is absolutely correct regarding the Solo 401k exemption from the UBTI rule... EXCEPT for one circumstance. That circumstance is when the Solo 401k investor is a completely "Passive" investor in real estate that utilizes acquisition debt
Hi Beverly,
Sure, it is what it sounds like. When buying an investment property, with a new First Mortgage. That mortgage is "acquisition debt"..
Alan
....what a lot of people don't understand is that with Roth IRA and 401k....it's a long term investment. Put the money in there and forget about the yearly ups and downs. @Thomas Dowell ...you are a couple years out of college, you shouldn't need your 401K for 30 years...so who cares about the yearly ups and downs...28 years from now, you can start looking at that. The compounding interest on even a moderate monthly contribution can be huge. I'm all about diversification...no way I'm putting all my eggs in one basket.
I am neither a tax expert or a financial planner, but I would add one thing to this conversation for us all to think about: If we're highly motivated, successful investors and entrepreneurs, what are the chances we'll want to wait until 59 1/2 to retire? NOT ME! You don't necessarily need to call it "retirement" because I don't believe in the concept of retirement. But as I understand it all of these options (any tax preferred investment vehicle) restricts your access to any of that money until the age of restriction within that vehicle. With 4% interest rates, and even with slightly elevated home prices at present (especially relative to what some of us missed 3 years ago), and all-time record breaking S&P 500 as of yesterday it would be hard to convince me to not put all of the money I could get out of my rollover IRA to work as downpayment in long term rentals. I understand you'll only 'bring home' about 55% of the money that's currently showing in your account...but how powerful is instantly accessing 50-100k to use as leverage in good cash-flowing real estate. Would be interested to hear @Jeff Brown comment on this thought. He's written a lot of thought provoking articles on the topic.
Shoot holes in my argument, please. I may pull the trigger tomorrow.
William, I have been having similar thoughts on the stock market. Economic growth has been pretty weak for years, yet the market has skyrocketed. With the fed printing so much money to prop up the market, to me it is difficult to imagine how this doesn't have an unhappy ending at some point.
I am neither a tax expert or a financial planner, but I would add one thing to this conversation for us all to think about: If we're highly motivated, successful investors and entrepreneurs, what are the chances we'll want to wait until 59 1/2 to retire? NOT ME! You don't necessarily need to call it "retirement" because I don't believe in the concept of retirement. But as I understand it all of these options (any tax preferred investment vehicle) restricts your access to any of that money until the age of restriction within that vehicle. With 4% interest rates, and even with slightly elevated home prices at present (especially relative to what some of us missed 3 years ago), and all-time record breaking S&P 500 as of yesterday it would be hard to convince me to not put all of the money I could get out of my rollover IRA to work as downpayment in long term rentals. I understand you'll only 'bring home' about 55% of the money that's currently showing in your account...but how powerful is instantly accessing 50-100k to use as leverage in good cash-flowing real estate. Would be interested to hear @Jeff Brown comment on this thought. He's written a lot of thought provoking articles on the topic.
Shoot holes in my argument, please. I may pull the trigger tomorrow.
There are a few factors you may be overlooking.
First, if your money is in a solo 401K you have control over investing. Build that up through REI rather than the stock market, by all means. Anyone in REI can set up an entity to hang a solo 401k on. I did exactly that, with help from @Dmitriy Fomichenko at Sense Financial. The big advantage to a solo 401K over self directed IRA is no taxes for using non-recourse loans to increase your purchasing power.
Second, if you invest it as a Roth investment in your 401k, the principle can be taken out any time after 5 years from when the account is opened without penalties since it has been taxed already. So even though the earnings are not available until 59.5, the invested money is available fairly soon. So you can grow tax free retirement money and then use the base investment as early retirement income that has already had the taxes paid on it. Kind of a have your cake and eat it too situation, in my opinion.
I was in the same situation. I had several large"ish" 401k's from different companies that were performing only in a mediocre manner. For a long time I just let them ride. Then like you, I received the notice that several of my 401k's took a huge nose dive. At that point I decided to educate myself on the ins and outs of 401k's. For me the most logical step was to roll-over the ones that I could into a 401k that I had more control over and that had more depth and breadth of investment selections than just the standard mutual funds and bond funds. That is what I did. I rolled them all into a Schwab One account and then was able to choose what I wanted to invest in. For me the biggest worry was losing the company stock that I had built up over the years. Most of the things that I had learned said that if I do a roll over that I have to sell the company stock and that would not be a good thing for me. The guys at Schwab arranged to transfer all of the company stock into my new 401k for me, which I was pleasantly surprised about. I also had several other "personal" IRA's (both traditional and Roth) just sitting around. I am in the process of rolling all of those into a Self-Directed IRA for use in Real Estate investing. I will keep my Schwab 401k because I enjoy the investment aspect and since directing my own portfolio I have done much better as far as returns go than the old systems.
Here are two of my favorite Warren Buffet quotes:
“Risk comes from not knowing what you're doing.”
“Wide diversification is only required when investors do not understand what they are doing.”
If you talk to financial planners, they will tell you to diversify as a way to “not lose money”. That is just faulty reasoning from my perspective. You (Dawn) seem to know quite a bit about Real Estate and investing. I would encourage you to concentrate on that and not worry about diversification.
Yes, you will report the value of the money you converted to a Roth as taxable income for the year in which you do the Roth conversion. Check with your CPA relative to when you can have "access" to some of the Roth funds. You have access to Roth contributions at any time, however funds converted to a Roth from another retirement account are subject to early distribution penalties if taken within 5 years of the tax year the conversion was done. Here is a summary from Motleyfool.com:
The penalty rules regarding conversions are a bit different than those for annual contributions, which may be taken at any time for any purpose free of income taxes and penalty. An early withdrawal of a conversion contribution has a different twist. The early withdrawal penalty applies to a distribution of conversion money from a Roth IRA when:
You're right about the UDFI in a solo(k) Albert.
UBTI and UDFI are what result in UBIT.
I just posted a excerpt BP blog post from publication 598 yesterday that talks about these topics exactly.
Just to briefly revive this discussion I wanted to add my thoughts. It seems that everyone pushes the 401k save for your "old" self when you hit 62 mindset. This is assuming you want to "work" until you are 62. In my discussions with my financial adviser we worked out the number of needing 2.5 million when I retire to have a monthly income of $5,000. They are ballpark figures but I feel they are critical in this discussion.
If I am working until 62 to retire with 5k a month..........when each property I own generates a couple hundred a month in cash flow........isn't the goal then to hit 5k a month in income. Forget the 401k, employer match, etc. The goal is consistent income each month to "retire". Why not get there early by breaking free of the over marketed and over pushed 401k? I think the key is STRICT money management.
I recently cut my 401k contribution in half so I could save the other 50% of my contribution to buy rentals. The price to rent ratio really favors investors in my market so $250/door cash flow is fairly easy to achieve if you know where/how to invest. I have enough in my 401k if I cashed it out that I could buy 2 properties in cash. Each one would yield $500/month cash flow with no debt service....I would be 20% of the way to my "retirement" monthly income goal. I work and save for 10-15 more years continually saving and investing in properties that by the time I am 40ish (27 now) I have exceed the 5k a month income and can "retire." I feel that active cash flow investing would get individuals to their monthly income goals much quicker then 401k type investing. Has anyone committed fully and done this?