Becoming Self Employed, Cash Out 401k?

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We've read many hours on BP throughout the last couple of years! SO much knowledge & great advise!

I'm hoping someone can make sure we're on the right track...My hubs & I have been part time flipping for a few years while he held down a full time other job. We've done around 10 flips. He's finally decided to pursue our flipping business full time :) I will continue with my 24 hr per week other job for now. We've got a couple rental properties & are looking to acquire a few more once everything settles down (moving, buying land & building a smaller home). We don't want to be rich, just live comfortably :) Our question is what to do with the approx $100k in his 401k? We're going to need at least half for our next flip since we're using our acquired cash to build our next home. Should we do a loan on the 401k? We were told today that we could roll the $ into an IRA & could take a loan up to 90% to acquire our flips with NO tax penalties if we paid it back within 6 months. It sounded to good to be true & everything we've read says that info is incorrect. Does anyone know? Of course everyone is not in the RE business says it's a terrible idea to use ANY of the 401k for RE investing. But you're going to get taxed on it eventually. The $ will be used to MAKE $. We realize it will put us in a higher tax bracket & essentially be taxed twice but it seems worth it to us (we're 38 & 40 yrs old). We'd love to go from 80+ working hours per week to around 30 within the next 10 years. We're currently living in a flip (for 2 years) to avoid capital gains tax but this is a one time deal since we're building. Also, we've currently got an LLC for our flips & rentals. We're looking into an S or C Corp to allow hubs pays himself to help with taxes? Any advise for anyone tackling RE full time? He's been at his "regular" job for 17 years so we're just trying to get a feel of self employment. I know the Obama BS insurance is crazy, so we're going to try & keep income under $74k per year to avoid the extra $1k per month on that along with the higher tax bracket. Ughhh! We're heading to our CPA next week. He's a good CPA with a good reputation but doesn't "specialize" in RE (we're in a small town & he's the best we have :) Any advise from the professionals would be GREATLY appreciated! *I forgot to mention I've looked into the self directed IRA but it doesn't seem like something that would be beneficial to us since hubs does 90% of the work on the flips himself. IRA? 401K? Loan? Cash out? Thanks, Nicole

You should roll your 401k into a self directed IRA, however, it's my understanding that if your IRA invests in real estate deals you can't benefit personally. In other words, your IRA can't loan you money for a flip that you will profit from personally. The 401k can invest in flips, loans, options, etc... but all profits should flow directly back to the IRA to avoid self-dealing penalties. So short answer...roll the 401k into an IRA and use real estate investments to grow it for retirement. Clear as mud?

Good recommendation by Rodney, but even better options would be truly self-directed Solo 401k plan. Since you are self-employed you will qualify for it and it is superior to SDIRA. It comes with the Participant Loan feature allowing you to borrow from your account up to $50K tax free, which is not available with an IRA.

Any investment made with your Solo 401k (you have virtually unlimited investment options) grow tax-deferred (or tax free if you chose to utilize the Roth sub-account of your Solo 401k) and do not require a custodian consent, unlike with SDIRA. This means lower cost, speed in executing transactions and checkbook access to your retirement funds. 

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As noted above, the Solo 401(k) may be a great option for you.  It would allow you to borrow a limited amount of your current plan for your own use (i.e. such as your personal flip), and the balance could be invested at arms' length into real estate, private lending, etc.

Another option would be a Rollover as Business Startup or ROBS plan.  This would allow you to basically make your entire retirement savings (if you choose) a shareholder of your real estate development company.  With that structure, you can be hands on involved in running the business that is partially funded with the retirement plan.  There are no taxes for accessing the retirement plan capital to fund the business.  Of course, the underlying business will be a taxable entity.

There is some good information here on BP on both plan formats.

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I agree with Dmitriy. A Solo 401k is one of the great benefits of being self-employed. As long as you do not have any full time W2 employees, you are eligible for the plan.

Compared to an IRA, Solo 401k contributions limits are roughly ten times higher and unlike the IRA, there is no custodial requirement for the 401k. You can take participant loans from the plan, you don't need the additional expense and administration of an LLC to have checkbook control, and there is a built in-Roth component. A spouse can also participate in the same plan. There are additional tax benefits compared to an IRA, and there is generally greater privacy. The plans are often quicker to setup and cost less money over time especially compared to most IRA LLCs.

If your husband does his own work on the flips, you might find yourself doing some investments outside of the plan (with no prohibited transaction rules to trip you up) in addition to making more passive investments with the plan. This way, you can get both retirement and non-retirement money working for you.

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I don't know your complete financial picture, but I wouldn't recommend cashing it out or converting it to a self directed account. Keep it in the 401k (or rollover to a regular IRA if 401k fees are high). I consider my 401k (invested in stocks and bonds) as my ultimate cash reserve / emergency fund for if things go south.

Can't make your business work without cashing it out? Then keep burning the candle at both ends and build up a bigger cash reserve.

Cash is king. 

@Chris Lopez , I am wondering why you are against self-directed IRA/401k? Do you think investing in stock market is safer than alternative investments such as real estate, trust deeds, tax liens, etc?

@Dmitriy Fomichenko I didn't say I was against it.

I said based on the info that I know about them, make sure they have a big cash reserve. Leaving a full-time job is a big deal. Mixing that in with investing real estate can create situations where you need a large chunk of cash to cover personal finances or deals going south. In that scenario, it's prudent to have 1 year of expenses set aside. 

My advice was to make sure they maintain high cash reserves. Money in the stock market is liquid. Money in real estate generally is not.

I believe in a diversified portfolio. 

I've also been through a cash crunch myself in the past. I never want it to happen again to me or other people. It sucks. 

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I think the idea of creating your own company 401k is a great idea especially if you do not have w2 employees. If you have employees then a self directed IRA may be the better choice. You may also have a simple IRA for the business as well.

You can only borrow 50% of your 401(k) or $50,000 whichever is less. If you want the cash/profits for personal use go ahead and borrow $50,000 from your 401(k) and then pay it back after the flip. If you want to keep your taxable income low then buy Real estate with your IRA/401(k) instead of borrowing it.

 As far as keeping your money in traditional assets such as stocks and bonds it does have merit from a diversity standpoint. However, you always must look and see where the greatest profit and lowest risk is and then make your decision on what you want to do.  I personally do much better in real estate then I do in the stock market.  I feel I have more control over the real estate then I do the stock market and I'm also getting up in age and I can't afford a big drop in the stock market.  

You have great advice from the other BP contributors I hope this helps you make a decision. I also have a video and spread sheet comparing IRAs to 401ks if you need more info on the subject. PM if you want it. 

@Chris Lopez , I agree with you that having good cash reserve is essential, especially for someone going into business for himself without stable paycheck coming in. However an IRA should not be used or counted on as such reserve. And IRA designed to provide future benefits, not immediate benefits. Plus, if they were to tap into an IRA they would have to pay taxes (which likely would put then into higher tax bracket) and penalties. A Solo 401k plan on the other hand comes with the Participant Loan feature allowing to access up to $50K (or 50% of the balance) at any time for any reason. Also, self-directed doesn't mean funds have to be invest in real estate only. Investment options are virtually limitless and portion of the funds can be invested in liquid assets as well as conventional investments such as mutual funds or stocks.