Hey Bigger Pockets.... I had an idea and need your opinion. I just closed on my 7th property, and for the first time made two purchases in one year. Unfortunately, my cash reserves for down payments are gone but I don't want to wait till I save up another 25% that the bank requires for a loan, so here is my plan.
I want to cash out some of my 401K to use either as down payment or full payment for another unit. I understand that I would get penalizes 10%, and I would have to pay tax on the money as extra income, but if I find a real estate investment that has a return of 8-9%, I can have the 10% penalty paid back to me on the first year of owning the property and then I can utilize the future returns right away rather then waiting till I'm 62 with 401K. In addition, I can boost my 401K contributions after the first year to catch up again since I'll have the 8-9% return from the real estate investment.
Let me know your thoughts, and also any idea to get down payment (The bank doesn't want to know me unless I have 25% down payment)
I would not take a loan or cash out. Both are usually a bad idea
Can you transfer your 401k into a self-directed IRA or solo401k?
If so, you could purchase the property inside that account and possibly leverage it too with a non-recourse loan if you needed.
I would not do this. The taxes and penalties are not worth it. Also it is good to be diversified when you do retire.
Try to be patient and save up the income after expenses from your other properties and any other income you have until you have the down payment.
Also to add if you are still contributing to your 401k you could also stop contributing today and use the money you were contributing to save for a downpayment.
@Amy Beth 's idea isn't the quick or sexy choice, but its a sound idea. If you stop 401k contributions you can raise that 25% down payment faster and without a 10% penalty. I like that idea or doing a 401k loan.
Where are you equity wise on your other properties? It might make sense to evaluate that as well as any potential for a value-add and refi on one of them.
For example: If you bought a property with 25% down 5 years ago by paying the mortgage and with some modest appreciation you might have 30-35% equity in the property. If there is an opportunity to improve the property, you might be able to spend a modest amount and get that to 40% equity. At that point you could do a cash-out refi and pull out 15% of equity to use towards a down payment on another property.
When making this type withdraw you must not only consider the 10% penalty, but also that the monies from the withdraw could be taxed at a higher rate. This is true for both Federal and State taxes. After the penalty and taxes many people are only left only 60% of what they withdrew. And if your state taxes are high, it could be less than that.
A lot of people will say don’t take a loan on your 401k. This is definitely true if you are planning on leaving your job anytime soon. But, I believe it can be a beneficial way to get the money you need. A lot of experts will say loans can stop your account from gains in the markets. However to combat that, Your loan in your 401k like a stable value or money market fund when you figure out your overall risk assessment, so you still don’t miss out if the market goes higher.
You can take a loan against your 401k and pull the lower of the two: up to 50% of the value or $50,000. I used this strategy back in 2014 to purchase three fourplexes. The loan has since been repaid. I think it's a fantastic strategy.
However, I would not take the penalty. And as others have stated, it is a good idea to have some diversification.
You should talk to someone who is very familiar with this, and can give you some expert guidance before making the move. I recommend discussing with @Dmitriy Fomichenko here on BP.
You first need to make sure that you qualify to take such distribution. To learn about the rules, please see the following.
Also, as stated, if this is a former employer plan you may want to consider transferring it to a Solo 401(k) plan if you are self-employed, as the solo 401k plan can be invested in real estate.
Sorry for the late reply. I didn't realize the post had some many replies. Thank you everyone for your suggestions.
I talk to my accountant and he basically said the same things I already knew about the penalties and then being taxed on the monies as income, but he also mentioned that on a 8-9% return a year investment it would benefit you after a few year. However, I'm not ready to take a 30%-40% tax hit on a 401K withdrawal.
Also as @Amy Beth mentioned. Being diversified when retired is a good option also.
@Kevin Sobilo I definitely have good equity on some properties, but i never liked the idea of financing 100% or the property especially since in my area the returns on your investment are not as high as some people mention on bigger pockets. I also only take 15 year loans since I want to retire my 9-5 job ASAP so that means my expenses are much higher then 30 year terms
So at the end of the day, like Amy mentioned. I might just have to hold off and save some cash! but I'm open so ideas!