Cashing out 401k to invest in RE

137 Replies

Hi @Ann Bellamy , you posted this a while ago:

"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."

Can you (or @Steven Hamilton II or @Michael Lauther ) explain what you mean by lending out your IRA? And what is "holding it in LLC's" mean?

I'm so excited to have found this thread because I never knew about SDIRA's (despite being an Econ major & a brief stint as a broker back during the dot com bubble). Anyway, I've had cash sitting in my IRA for some months not knowing what to do with it. I share Greg B.'s mistrust of Wall Street. Sooner or later there's going to be another crash that's for sure.

Anyway, I cannot THANK all of you enough for this info. How come this amazing info is not widely disseminated???

@Emma S. lending out your IRA as used in this context means to lend your funds usually secured by real estate and collect interest instead of holding an equity position in real estate. Holding a mortgage for instance.

LLC stands for limited liability company and it is a legal entity that can be used to own real estate and insulate ones self from individual liability. They can also be used inside a self directed IRA to gain Check book control of the funds to invest in real estate or tax liens etc.

Hope this helps understand the thread but feel free to contact me if you need help or further explanation.

@Emma S. , to elaborate a little on what @Michael Lauther said:

A self directed 401k or IRA is an entity in and of itself. When you fund it with cash, that cash just sits there until you direct you custodian how to invest it. (As opposed to a convention IRA where you typically choose among several plans or funds that the custodian offers). So since I am a hard money lender already, I occasionally use the funds in my IRA and 401k to fund one of my loans. Think of my IRA as the bank.

As Michael already explained about an LLC, think of it as a more flexible version of a Corporation. Because there are restrictions on what you can do with an IRA or 401k, I don't use it to own real estate, simply because for me, that is a pain. Just a personal choice, but you can't do any work yourself on a property that is owned by your IRA. That includes mowing the lawn or screening tenants. So I own real estate in LLC's for liability protection, so that if I were sued for an accident on my property, the liability is limited to only that property in that specific LLC.

I do also have an IRA where I set it up so the IRA owns an LLC. I am the manager of that LLC and I lend money from that LLC also.

And this information is widely available, just google "Self Directed IRA" or SDIRA and you will find endless information. The reason that conventional stock brokerages don't disseminate the information is that they don't want the increased burden of managing a self-directed model. In addition, if you are savvy enough to make your own investing decisions, you don't need the additional layer of commissions that a traditional commissioned broker receives. So "we don't do that" translates to "you can't do that (with us)" which then translates to "that's illegal". It is a common misconception that true self-directed IRA's are illegal.

Let me clarify, it is not illegal to screen a tenant for an SDIRA. You can do just as much as you can with a stock that you are investing into. You would not be penalized for doing a minuscule job. You can however, occasionally provide services as long as the IRA pays out FMV for the services. Many don't realize that. You cannot benefit from it, nor can the IRA benefit from you.

I can understand both sides of this equation but I chose to cash out my 401K from a previous company I worked for and used that as a down payment on another rental property. Yes I paid a 10% penalty and made that back within a couple of months on the cash flow so that penalty was a mute point. I also don't consider the tax implication as you will pay tax now or later and I'm pretty sure taxes are not going to go down. Lets not forget the tax deduction we all enjoy from rental property so saying you are in a 25% bracket means you will owe x dollars in tax. That's not true by any stretch of the imagination unless you have zero dollars to itemize and zero deductions related to your real estate.

To each his/her own but for me cashing out that 401K was the right move. Pay the penalty, captured the cash flow and have repaid myself every penny I spent. So I now have another rental property producing cash flow and all of my down payment back. For some it won't make sense and for others it will. Do what's best for you.

@Daniel Thomas . As you can see there are different schools of thought. I went with a solo 401K and am making great returns. For RE investment I buy outside my 401K to maximize the tax benefits and have a lot more flexibility. That gives a two pronged approach to retirement (assuming SS may not be worth much in a few years).

I switched from a traditional IRA to a ROTH IRA where I have enjoyed 10-12% interest for the last three years investing mainly in Trust Deeds through my financial advisor. I am now using a portion of those monies to purchase an investment property out of state which yields 20% net income yearly. There are strict rules to doing this such as you cannot "co-mingle" funds, must be kept 100% in IRA account.

Can a self-directed IRA lend money to an LLC who uses the money to buy a property? Or can the IRA only own an LLC who then lends to another LLC?

Originally posted by Dawn A.:
Can a self-directed IRA lend money to an LLC who uses the money to buy a property? Or can the IRA only own an LLC who then lends to another LLC?

Yes Dawn, but neither you nor any prohibited party can own more than 50% of the LLC. Read here.

Jeff

Originally posted by @Mark H. :
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...

Mark H., This might be the best comment I've ever read.

I really appreciate this thread. I have a 401k from an old company laying around I may look into rolling it into a self directed option for real-estate. Thanks everyone who posted.

Originally posted by Patrick G.:
Originally posted by Mark H.:
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...

Mark H., This might be the best comment I've ever read.

I really appreciate this thread. I have a 401k from an old company laying around I may look into rolling it into a self directed option for real-estate. Thanks everyone who posted.

Lol.. thanks!

A quick recap, a year later.. since hindsight is 20/20..

~$30k in a tax deferred ira.. converted to about $20k after taxes. 25% down + closing costs on a $70k rental, loan of about $50k @ 5%.. piti of $400~ish, pulling $950/mo in rent. Model matches now closing at ~$140k.

Kinda glad I paid the tax, needless to say..

I am currently thinking about doing this.

Michael Lauther

If you are 55 at the time you leave your current employer you can take the monies in your 401(k) without incurring the 10% early withdrawal penalty provided you don't get another job. You still have to pay the taxes.

Originally posted by @Steven Burrows :
I am currently thinking about doing this.
Michael Lauther

If you are 55 at the time you leave your current employer you can take the monies in your 401(k) without incurring the 10% early withdrawal penalty provided you don't get another job. You still have to pay the taxes.

@Steven Burrows ,

If you do this. I recommend that you split your distributions between two calendar years. I.E. Take out half in December and half in January.

All,

I really like all the feed back in this discussion. So glad I found and join BP.

@steven Hamilton

I like your suggestions. I think I'll wait until Jan 1 to make any moves with my 401K which is over 250k. My ytd earnings at the time I was let go in Aug was already at 125k and I don't want to be pushed into a higher tax bracket.

Originally posted by @Steven Burrows :
All,
I really like all the feed back in this discussion. So glad I found and join BP.

@steven Hamilton

I like your suggestions. I think I'll wait until Jan 1 to make any moves with my 401K which is over 250k. My ytd earnings at the time I was let go in Aug was already at 125k and I don't want to be pushed into a higher tax bracket.

@Steven Burrows ,

I'd run ALL of the numbers including with your deductions to figure out what you want to do. I'd also consider rolling some into a solo 401k if you start your own small business.

I will be cashing out my 401k at the end of the year. I want to have money to put down on multiple properties. I have only made 10% on my money in the last couple years. I know I can make more than that through real estate with a solid plan.

THis is how my wife and I bought our first rental property. Our real estate agent at the time did mention the self directed fund to us, but we just didn't know enough at the time to follow through. However I do not regret the decision at this point. The return on the rental property is far greater than what the money was earning as a pension and 401K

Hello,

I am new to the website and would appreciate as many opinions as I can get regarding my question. Thank you for the help and the opportunity to post on this site. Here is my question:

I have a friend who is invested in rental properties (roughly 75 units). He is well established in an area with a high rental population so the numbers all look good. He is looking for someone to buy into the company so he will have liquid funds to make another fairly large purchase, which is why he approached me. My situation is this; the funds I will be using are tied up in an old IRA. I can convert this IRA into a self-directed account but it seems the long term tax advantage may be to simply cash in the account, pay the 10% penalty (since I’m under 59 ½), pay the tax and have the ‘cash’ to do with what I please. This way, any cash flow that we receive can be reinvested or split accordingly. While using the self-directed option may give me more purchasing power initially, it seems that any income derived from this will be taxed at a later date as ‘earned’ income. Since I will be buying into an existing partnership I was hoping to get opinions for those that have done one or the other?

Thanks for any and all opinions.

Any income derived from IRA-owned property will flow back to the IRA. You will only pay tax on this money when you take it as a distribution in retirement (much as you would a return on investment from a stock purchase in your IRA) and it will be taxed at your then-tax rate in retirement (which would theoretically be lower than your current tax bracket).

If you invest the money outside of your IRA, with personal funds including funds you've taken as an early distribution, you will also pay tax on income generated by that investment as well, possibly at capital gains rates. You should consult with an accountant - is it worth the tax and penalty you will pay now to take an early distribution, plus the capital gains on any sales of properties and income tax on any rental-income earnings that you will pay when investing personal funds?

Perhaps you should converting your IRA to a Roth IRA if future taxation is a concern to you. You'd pay the tax now on the converted amount (but no early distribution penalty), and all the income generated by any properties held by your Roth IRA would be tax-free at distribution.

@Michael Lauther , going back to your point about taking out a loan against a 401k if you're still with the employer (my situation), can you explain a bit more about how the interest goes back into the account? It seems too good to be true.

Thanks!

Hi @Gautam Venkatesan - right, but my question was more to confirm that the actual interest I'm paying goes back into my very own 401k account and is basically like another contribution from me. Usually interest goes to the lender, and in this case I would think that would be my investment company, but I guess this is considering me to be my own lender.

So my next question would be if there are any add'l fees or charges. I will call my investment advisor but would be appreciative of any individual experiences as well.

Thanks!

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