Cashing out 401k to invest in RE

Private Lending & Conventional Mortgage Advice 49.4K Posts 7.1K Discussions

Has anyone cashed out their 401k to try and get a greater return on their money and use the proceeds to invest in RE? I have contemplated doing this.

I took a loan out against my 401k to do it...

You could also roll the 401k into a SDIRA to avoid the tax implications and invest through there. More restrictions there which may limit your potential versus just taking the tax hit and going balls to the wall, but I haven't delved too deeply into that comparison.

One of our BP members @Greg B. did such a thing I believe.

@Daniel Thomas If you no longer work for the Employer who the 401k was with you can roll it over to a self directed IRA and use it to invest in real estate. This is what I did. If you are still working for the employer then you can borrow the money and essentially pay yourself back with interest . this is a win win situation. If you cash out and are under 59 1/2 you will be hit with ordinary income tax and a 10% penalty , IMO too big a price to pay even if you are not in a high tax bracket.

My wife and I will both have state pensions. Not sure if I should factor that in or not.

@Daniel Thomas ,

You will be giving away too much money. You could consider rolling over part of it into a ROTH SDIRA this will allow you to pay some tax on the money and move it into an account that you will no longer be paying any tax on.

I strongly suggest in most cases the loan from the 401k. As you can deduct the interest you are paying yourself.

It would take some significant tax planning to split the tax hit. In which case you will lose a lot more than you should allow. The first step to making money is don't lose money.

If your state taxes retirement income at say 5% and you're in the federal 25% tax bracket and plus 10% early withdrawal penalty. You are looking as losing 40% of the money.

If you're in the 28% bracket the loss to taxes is 43%.

The juice isn't worth the squeeze. Consider the possibility of rolling it over.

-Steven the Tax Guy

Your guide to IRS laws, rules and regulations.

Medium hta logoSteven Hamilton II, Hamilton Tax and Accounting | [email protected] | (224) 381‑2660 | http://www.HamiltonTax.Net

Yes I did do this in 2005 and never looked back. Cashing out is not for everyone and I would not do it if you don't have a viable plan.

Here is my argument about the 401k thing.... A 401k is a tax DEFERRED entity. You will pay income tax on the money at some point in time. The pitch was that you would be in a lower tax bracket upon retirement. Maybe, maybe not, but you will still pay income taxes on the money eventually. So the argument about paying the income taxes is a non issue for me.

The other part of the argument is the penalty, 10%. Agreed, it is a penalty, but it is surmountable.

My thing is, I put MY money into an account to defer MY income. The money is supposed to grow for decades. The actual growth will depend on your choice of investments. You may even break even over the decades or LOSE money. However, the managers that promote the investments(including fund managers) ALWAYS make money. Even in 2001, when my 401k funds lost 40% of value my fund manager was making money and never even picked the phone up to warn me that I need to make some adjustments.

The fund manager that you pay for is not looking out for your interests. Your finances are not something you can give to someone else to trust to manage. That was a tough lesson for me.

Now, while you are putting you income into the 401k for decades with the possibility that it may lose value, the 401k is NOT putting money into your pocket each month. You will not enhance your standard of living from a 401k.

What if I took that same money and put it into something that could pay me now AND pay me later? Hmm. It was a no brainer to me. I paid the penalty and income taxes and invested into income producing property.

Here's another point... Yes, my real estate investments may lose money occasionally. It could happen. However, I don't have to pay someone else to lose my money if it happens. I can take full responsibility and not have to rely on someone else to try and sell me something that will only benefit them.

Real estate investing has been a great choice for me.

Your mileage may vary.

One more example: My wife has a 403b. We stopped contributing years ago. It has been invested in domestic and international growth equities for about 25 years now. In all of those years the value of the fund has grown a whopping 10% AND has still never put one dime in my pocket. 10% growth over 25 years, I know I can do better than that on my own. :-/

Much like the poster above, my wife and I cashed in old 401k's. During the stock-market crash, I transferred our old 401s into self-directed iras, when things calmed down last year, we paid the penalties & dumped the cash into down payments for two rentals. It wasn't our entire nest-egg, but the deal worked for us.

What's the actual return on your 401k in a "safe" investment? In our case, we were getting a few hundred a year on $60k in a money market account. Now we're netting that every month, and call it skill or luck, the properties have increased in value significantly.

The tax arguement doesn't wash with me, I'm 100% certain my tax rate will never go down, better to pay it now & invest in something useful that I can control.

Wow, what's plan B if things go to pot?

Originally posted by Ryan M.:
Wow, what's plan B if things go to pot?

Oh, you mean when "safe" "professionally managed" investments lose half their value in a 90 day period of time?

At least then I can light them on fire & get the satisfaction of watching them burn. I'm told the fenced lots would be good land to raise chickens & pigs on. When you burn a house down, you get fire trucks & sometimes a news chopper might fly over. The neighbors come over & tell you how bad they feel for you...

My Vanguard statement wasn't nearly as satisfying. Even with both accounts there, the statement was only perhaps ten pages or so - not much of a fire from those...

@Ryan M. , plan B would be the same as if your 401k was worth 60% of its value when you retire. You will be required to work more or share expenses.

The thing is you ask your question as if the 401k is guaranteed. It's not. You have no downside protection. You cannot get out if things are going bad. You can shift investments.

With RE I can decide to sell, mortgage, 1031, rent, or occupy.

Its certainly everyones own decision but when re is bought typically your name is on there if things go bad which did/is happening to a lot of landlords they come after you personally. I had lunch the other day with a former agent that had things go south for him, lost all his rentals including his house and now rents a apartment with his family.

Again, not stirring the pot but these things happen.

I have actually been thinking of doing this. I have an old 401k from a job I had 3 years ago. The 401k is in a medium risk category and after 3 years it is worth $100 less than when I left that job. So help me understand, I will pay a 10% penalty off the top, then I will pay tax on the remaining balance? Will the remaining balance be added as ordinary income or does it get hit at its own tax rate? I am self employed so I tend to do very well on taxes. Last year I was at 15% due to all of my deductions.

Thanks

Originally posted by Ryan M.:
Its certainly everyones own decision but when re is bought typically your name is on there if things go bad which did/is happening to a lot of landlords they come after you personally. I had lunch the other day with a former agent that had things go south for him, lost all his rentals including his house and now rents a apartment with his family.

Again, not stirring the pot but these things happen.

When you hear of landlords losing their portfolio, its typically because they paid way too much for properties in the first place. In our market, you can pay 35k-50k for a house that sold for >100k 5 years ago. I think you can really limit your downside risk by making educated purchase decisions.

Almost everyone who cashed in an IRA or 401k seems to have done so to invest in real estate. You can move that IRA or 401k to a self directed IRA or 401k and still invest in real estate. So you have the best of both worlds.

I personally lend out of both my 401k's and my IRA, because it is easier to manage than real estate. I don't hold real estate in either one, I hold it in individual LLC's.

@Steven Hamilton II had a good breakdown of the cost of cashing in

Medium small logoAnn Bellamy, Buy Now, LLC | 800‑418‑0081 | http://www.buynowhardmoney.com

I am doing very well with the six properties I have. I thought since I will have a pension it might be best to cash out the 401k and pay off all the mortgages and then pay cash for a house every two to three years with the rents from the properties. Seems like this may give a better income in retirement then the 401k would. Any thoughts?

@Ann Bellamy has hit the nail on the head why would you pay a large tax on cashing out a 401k when you can invest by rolling over to a self directed IRA. The tax you would pay would then remain available to invest . No one knows what future taxes will Look Like but you can control what you distribute until age 70 1/2 when you must start taking modest distributions which will be taxed as ordinary income.

@Daniel Thomas If you can roll over the 401k you could purchase real estate now in a self directed IRA and buy property while it has substantially declined. You could also use the net income to buy additional properties as they are earned. If you are still working you can accomplish similar results by borrowing from you 401k and using that to invest in real estate. IMO these are much better alternatives to cashing out and taking a substantial loss before you even start to make money.

Originally posted by Michael Lauther:
Ann Bellamy has hit the nail on the head why would you pay a large tax on cashing out a 401k when you can invest by rolling over to a self directed IRA. The tax you would pay would then remain available to invest . No one knows what future taxes will Look Like but you can control what you distribute until age 70 1/2 when you must start taking modest distributions which will be taxed as ordinary income.

I question the wisdom of "hoping" your taxes will be lower in the future. You *are* going to pay taxes on any money in your 401k or IRA plan, or you'll be dead and it won't matter to you.

Those are your only choices.

I hate to see so many people stuck in a "loop", afraid of paying taxes, even on fairly insignificant amounts of money, when there are better options out there.

Every one is different, every situation is different, but there are deals that are *worth* doing, even if you have to pay some taxes.

My first deal with former IRA funds was a $70k property, purchased with about $20k down. It rents for $950 per month. After less than a year of ownership, Zillow says I could get $95k for the property, but the most recent comp was a few days ago @ $120k. Paying the taxes made that deal *possible* - I could not have done the deal without the IRA money.

It was an extraordinary deal, in an extraordinary time, and I probably couldn't do another like it today, without months of work, and a pile of luck. But I don't need to score like that every day. Just a few deals like that can make retirement possible. If you've got more time than money, sometimes you have to break the "rules".

@Mark W. ,

Depending upon the amount of your withdrawal you will add the FULL withdrawal amount to your income. You will then pay an extra 10% in tax on the withdrawal amount.

So if you withdrawal 50k you will pay tax in your bracket, assuming it was 50/50 in the 15 and 25% brackets. You would pay approximately 15k in tax which in this case comes to 30%.

You may want to consider a Roth account as you can pay the tax now, invest in real estate, and withdraw the principal worth tax free after enough appropriate 5 year time after conversion has passed.

@Daniel Thomas , I guess the point here is to think long and hard about it, as depending upon the amount withdrawn you could be looking at a substantially higher tax bracket plus penalty and possibly state taxes. I'm lucky to be in a state that does not tax retirement income. As I said before the Roth Accounts can help stimulate growth especially in a positive income situation. You can also put yourself in a situation where if you withdraw principal you will pay no tax on it after you meet the 5 year rule on conversions. You will then be able to withdraw those funds tax free.

You can then withdraw amounts designated to principal after the 5th year after conversion tax free. Withdrawals on earnings will only be subject to an early withdrawal penalty.

You will want to talk with your accountant to figure out the details that work best for you and your goals.

-Steven the Tax Guy

Your guide to IRS laws, rules and regulations.

Medium hta logoSteven Hamilton II, Hamilton Tax and Accounting | [email protected] | (224) 381‑2660 | http://www.HamiltonTax.Net

Oh and for those who are/were investing in the stock market. Why would you 1. trust someone else with complete control of your money? 2. Why would you invest in something you don't understand? 3. Why would you just stick with a plain boring fund. If your money didn't grow it is because you didn't work with it.

-Steven the tax Guy

Medium hta logoSteven Hamilton II, Hamilton Tax and Accounting | [email protected] | (224) 381‑2660 | http://www.HamiltonTax.Net

Originally posted by Greg B.:

Here is my argument about the 401k thing.... A 401k is a tax DEFERRED entity. You will pay income tax on the money at some point in time. The pitch was that you would be in a lower tax bracket upon retirement. Maybe, maybe not, but you will still pay income taxes on the money eventually. So the argument about paying the income taxes is a non issue for me.

Greg -

Potentially lower income tax bracket is only *HALF* the "pitch" in favor of deferred taxes. The other half is compounding effects...and these effects FAR OUTWEIGH the benefits of the income tax bracket.

Here is a very reasonable example of that:

Let's assume -- for the sake of argument -- that you're 30 years old and currently in a 20% tax bracket. And let's assume that the day you turn 65 and cash in your entire retirement fund, the government screws you over (some more) and ups you to a 40% tax bracket.

By your reasoning, you would rather have been paying the 20% taxes for the last 35 years rather than 40% taxes on everything on your 65th birthday, right?

Well, let's look at some actual numbers:

Let's assume you start with $10,000 on your 30th birthday. You are able to generate 20% return on your money year-over-year (you're a good real estate investor).

Scenario #1: You don't tax-defer any gain (i.e., no retirement account) and any gains you make on that $10,000 is taxed at 20% per year.

Scenario #2: You start with that $10,000 in a retirement plan (i.e., it is tax-deferred) and after 35 years, it is taxed at 40% at withdrawal.

Without going into all the math, here are the results...this is how much money you'll have at the end of 35 years and after all taxes are paid:

Scenario #1: $6.85M

Scenario #2: $17.75M

So, using these very reasonable parameters (35 years of investing, starting with $10K and earning 20%), if you tax defer your gain, and even if your tax bracket doubles the day you decide to withdraw, you will have earned more than 2.5 times as much by tax deferring the gain.

Now, if your tax bracket stays exactly the same at 20%, you end up with about 3.5 times as much money. And, if the first half of the pitch plays out (your tax bracket is lower in 35 years), you could end up with closer to 4 times your money.

As you can see, the lower tax bracket benefit is almost meaningless compared to the compounding effect benefit of tax deferment.

All that said, I'm not saying there's a right or wrong answer for every case, but this is one other thing that really needs to be considered prior to making a decision. As Steven said, you can be throwing away a LOT of money, and not just on taxes/penalties, also on long-term cash.

I’m not convinced guys. No credible investor assumes anymore that they will be in a lower tax bracket after retirement than before. A simple time value of money calculation will show how much more money you will have paying a 40% tax rate at retirement on money that accrued tax free through your working career, than paying 40% along the way and as well as 40% at retirement. This should be intuitive.

The only valid reason to dissolve a retirement account would be if you really need the money now. If it’s truly a life changing amount and you really need the cash, well, you have no choice. To claim its sound financial planning is folly. There are too many other options.

Paying the tax and converting to a Roth (thereby eliminating the taxes at retirement) could make sense. The time value calculation would be based upon your age and anticipated returns and tax brackets over the course of your life. The sooner you have to retirement, the more certain these estimates are, but the less likely the decision to convert will make sense. It’s really just math and nothing to get emotional over.

To do your real estate investing with after tax money and then get mad and kill your 401k because Facebook tanked is also silly. There are many self-directed options available for real estate investing in a retirement plan. You’re not limited to stocks in a retirement plan anymore.

I can promise you, the closer you are to retirement, the greater you'll appreciate sacrificing the immediate returns for those that accrued tax free.

Jeff

Jeff S and @JScott I am 52 years old. I do remember the sales pitches given to me when I was in my 20's and starting the 401k participation. I was not an investor, I was an employee. I was raised by a poor family with little discretionary income. I had no financial training so how was I to know what to question?

The pitches were made, promises were made by many of my employers. Several of those businesses are no longer around. I do understand that the higher compensated employees are limited by the participation of the lower income employees. So there is more pressure, sales pitch, etc on the lower income guys to participate.

I distinctly remember that after I was enrolled and participating for about 2 years a letter came out from my employer that the fees for running the 401k were now going to be deducted in a different way. This was the first I had ever heard about 401k management fees. So they were going to take out management fees even when the fund is under performing and I do not have the option to shop around for a better deal. I did not appreciate the deception and attempted to remove myself from the fund. Nope, cannot until you resign. Lesson learned, no control over my money.

Also, in the early years, choices of investment funds were limited and information about those investments was limited. If you asked questions you were a pot stirrer and trouble maker.

Later, with a different employer, I was offered more choices of investments and it appeared this employer was more up front about information concerning the 401k. Things were good.

Years later, I left that employer and rolled it all into an IRA. To my knowledge there were no SDIRA's at that time. I was dealing with a local financial planner with a national company. The mix of funds was recommended by her and I agreed. The big word at that time was "diversify" to protect your portfolio. Ohhhh sounds great! I'm in.

2001 hits and the protected, diversified portfolio loses 40%. No calls, no emails, no postcards from her. I can't even get her to talk to me. I am working 60+ hours a week and paying fees to the pro. What was I paying her for? Lesson learned, don't fall for the polished sales pitch.

I did remove my portfolio from her and self managed my IRA with no load funds. I recovered my losses but still did not feel comfortable about the whole stock market thing. Lesson learned, I can manage my own finances. That is when I cashed out and made my changes. I have no regrets about this move.

I can still check what that portfolio would have done if left alone. I am still way ahead of it and I am far more in control of my situation than I ever have been.

Were are all different people. We all have had different levels and types of education. We have all had different opportunities in our lives. Life is not one size fits all. I am a big boy and I am making my choices in life. I consider myself more of an investor now than an employee. Life has taught me some tough lessons and more to come I am sure.

I know what has worked for me and I have given you my justifications. We each have to make our own choices and live with them.

Good luck to all.