Exiting Coroporate America and Rolling over 401k to REI

Ironton, OH · Member since 2015 · 104 posts · 31 votes

Hello BP! I have a family member looking wanting to exit his corporate job and start investing in RE. He has $1m+ in his 401k. What are the best tax strategies to mitigate the tax burden and avoid the 10% hit on being under age 55?

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Patrick M Nichols

Attorney · Boston, MA · Member since 2018 · 109 posts · 63 votes

My attitude (not as an attorney, but as a citizen) is that tax rates are currently about as low as they will ever be in our lifetimes and likely to go up in the medium to long term. Without getting overly political, the Trump tax cuts (TCJA) failed their ostensible purpose to stimulate the economy and the federal deficit is not sustainable.

Having said that, I think the conditions are ripe to roll over traditional 401ks into Roth 401ks or Roth IRAs. You would pay tax now, but "cleanse" the money of tax going forward. Of course, there are a large number of complex variables.

A Certified Financial Planner would need to look at the specifics to make sure making such a major move would in fact save you money.

The nice part about an IRA is that you could also do a self-directed IRA allowing you to directly invest those funds into property. Good luck!

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Lauryn Meadows
OP
Ironton, OH · Member since 2015 · 104 posts · 31 votes
7y
Also he’s looking for a tax strategist/ financial planner (one that knows real estate) in his area as well.
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Patrick M Nichols
Attorney · Boston, MA · Member since 2018 · 109 posts · 63 votes
7y
My attitude (not as an attorney, but as a citizen) is that tax rates are currently about as low as they will ever be in our lifetimes and likely to go up in the medium to long term. Without getting overly political, the Trump tax cuts (TCJA) failed their ostensible purpose to stimulate the economy and the federal deficit is not sustainable.
Having said that, I think the conditions are ripe to roll over traditional 401ks into Roth 401ks or Roth IRAs. You would pay tax now, but "cleanse" the money of tax going forward. Of course, there are a large number of complex variables.
A Certified Financial Planner would need to look at the specifics to make sure making such a major move would in fact save you money.
The nice part about an IRA is that you could also do a self-directed IRA allowing you to directly invest those funds into property. Good luck!
4 Reply
Ashish AcharyaBusiness Member
CPA, CFP®, PFS · Sarasota, FL · Member since 2017 · 5k+ posts · 3k+ votes
7y
Originally posted by @Lauryn Meadows:

Hello BP! I have a family member looking wanting to exit his corporate job and start investing in RE. He has $1m+ in his 401k. What are the best tax strategies to mitigate the tax burden and avoid the 10% hit on being under age 55?
If one of the main issue is tax impact, he needs to carefully analyze this with the professional.
There are benefits if done with correct strategies. One of them is NUA, net unrealized appreciation. If he has some stock in the plan, he can save substantial amount of tax with correct kind of distribution( lump sum distribution)
In general, If his family has a business that has expected loss to nol carryover, that would be right time to rollover the IRA as the tax would be minimized or go away. Paying tax on 1M would be a big hit on the cash flow of the family.
Generally when a person quits a job and starts a business, he/she has start up losses, and we recommend rolling over the Ira to Roth at that time without tax impact.
As you can see he really needs to sit down with a professional, we are not talking about 40k rollovers here.
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Carl FischerPro Member
Rental Property Investor · Ambler, PA · Member since 2015 · 2k+ posts · 1k+ votes
7y
@Lauryn Meadows
If he wants to do real estate roll it over to a self directed Ira. No taxes no penalties and he is able to invest in RE. He can decide to convert to a Roth anytime as @patrick m Nichols implied. He should aalso consider a company and open a 401k or look at other opportunities.
[email protected]215-283-2868
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Steve Vaughan
Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
7y
Biggest mistake I see is folks quitting, then trying to get a loan. Get the loan for your RE purchase before you quit. Lenders ask about current employment and how long you've been there, not how much longer you plan on working. I literally quit the day after my heloc funded when I 'retired' and moved to a new state in 2002.
Had I waited even a day later to apply, no line of credit for me.
I would consider rolling to an SDIRA for lending or flipping, but not holding RE. Tons of rules and a lot of the tax benefits like depreciation can't be taken when you own a tax-advantaged asset inside a tax-advantaged account.
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Lauryn Meadows
OP
Ironton, OH · Member since 2015 · 104 posts · 31 votes
7y
@Steve Vaughan I was just thinking the same thing. I had the same issue last year when I was laid off from my W2. Good point!
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George Blower
Retirement Accounts Attorney · Southfield, MI · Member since 2017 · 3k+ posts · 1k+ votes
7y
@Lauryn Meadows
Regarding using retirement funds to invest in real estate (either via a Self-directed 401k or Self-directed IRA), here are some initial considerations...happy to continue the conversation!
1. If you (or your family member) purchase(s) via an IRA (as opposed to a 401k), you will need to open an IRA account at a specialty trust company which allows for investments in real estate. Unless you invest via an LLC owned by the IRA, you will not have checkbook control over the funds which means you need to run transactions (e.g. income, expenses, etc.) through the trust company who will need time to process the transactions and generally charge fees for each transaction. On the other hand, keep in mind that there are costs associated with maintaining an LLC (such as the $800 annual franchise tax in California).
2. If you are self-employed with no full-time employees, you can set up a Solo 401k through a 401k provider which allows for investing in real estate. In that case, you can simply have the account at a bank or brokerage where you will have direct checkbook control.
3. In either case, all of the income and expenses will need to flow in and out of the retirement account.
4. In either case and if you will use debt to acquire the real estate, it must be non-recourse financing. See more at the following link: https://www.biggerpockets.com/blogs/9552/70408-ira... If debt-financed real estate is acquired via an IRA, any income attributable to such investment will generally be subject to unrelated debt finance income tax.
5. In either case, you can't live on the property or otherwise use it for personal use.
6. In either case, you can't work on the property as it must be a passive investment (e.g. you must hire someone to fix the toilet and can't pay the expense with non-retirement funds).
7. In either case, you must purchase/sell real estate from/to an unrelated person and the real estate can't be titled in your name personally (e.g. in the case of the 401k, it would be titled in the name of the 401k and you would sign as trustee of the 401k).
8. In either case, you should verify that you are eligible to transfer the funds from your existing retirement account (e.g. if the funds are in your current employer 401k, you will likely not be able to transfer until you quit your job).
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Justin WindhamPro Member
Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
7y
@Lauryn Meadows
A self-directed IRA can be a nice option for those funds. If he is self-employed a Solo 401k will provide additional benefits:
- Compared to an IRA, Solo 401k contribution limits are roughly ten times higher.
- There is no custodial requirement for the 401k.
- You don't need the additional expense and administration of an LLC to have checkbook control.
- There is a built in-Roth component whereas IRAs are either traditional or Roth, not both.
- A spouse can also participate in the same Solo 401k plan.
- The Solo 401k has additional tax benefits over an IRA when investing into real estate using leverage.
- The penalties for prohibited transactions are less severe, though it's best not to utilize this benefit :)
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Lauryn Meadows
OP
Ironton, OH · Member since 2015 · 104 posts · 31 votes
7y
@Justin Windham thank you for this great info!
1 Reply
Lauryn Meadows
OP
Ironton, OH · Member since 2015 · 104 posts · 31 votes
7y
@George Blower thank you so much for all of this info! I’m going to pass it along.
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Proctor Hayes
Financial Advisor · Haverhill, MA · Member since 2019 · 2 posts · 1 vote
7y
@Lauryn Meadows
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Proctor Hayes
Financial Advisor · Haverhill, MA · Member since 2019 · 2 posts · 1 vote
7y
@Lauryn Meadows
Smartest thing you could do is utilize a little known alternative funding instrument sometimes referred to a a ROBS transaction or rollover as business start up. They're complex, so you need an expert, but it's a great way to capitalize on pre tax retirement savings for business but avoid the usual taxable income and early withdrawal penalty. Best of all you're not taking on any debt which increases your ROI.
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George Blower
Retirement Accounts Attorney · Southfield, MI · Member since 2017 · 3k+ posts · 1k+ votes
7y
@Proctor Hayes
@Lauryn Meadows
While a ROBS 401k Business Financing plan is certainly a powerful tool, it requires much more than merely investing. To start, your family member would need to use the funds to operate a business where the person is working as a bona fide employee. Is this what is contemplated?
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Lauryn Meadows
OP
Ironton, OH · Member since 2015 · 104 posts · 31 votes
7y
@George Blower my family remember has mentioned and done some light research on ROBs. I believe once he actually cashed out or rolled over his 401k he’d be working primary in the investing business. However I doubt he’d allocate a salary at first. Does that make a difference?
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Dutch Langley
Flipper/Rehabber · Matthews, NC · Member since 2019 · 198 posts · 239 votes
7y
We are rolling over funds to a Solo 401K. That will be used for our passive RE activities. (Important info to understand). We have an LLC with just the two of us...no employees so we qualify to do have this type of account. Our other funds will be used for active activities in combo with either private lending/HML. Until BP I didn't know about the Solo 401K and the advantages of such an account.
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George Blower
Retirement Accounts Attorney · Southfield, MI · Member since 2017 · 3k+ posts · 1k+ votes
7y
@Lauryn Meadows
Taking an initial salary is not required. What is more important is that the activity of the entity constitute an active operating company and not mere investing activity.
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James Rodgers
Financial Advisor · Charlotte, NC · Member since 2018 · 16 posts · 22 votes
7y
When you leave your employer you have several options on what to do with your qualified plan like a 401(k).
1) You can leave it with your employer indefinitely
2) You can roll it over into another qualified plan - IRA, New 401(k) etc.
3) Cash out - He will owe ordinary income tax and the 10% tax penalty which you mentioned. If you simply cash out there's not a lot of options to avoid the 10% hit by the IRS.
In order to determine what his next best step would be is his goals for that money.
- Does he intend to leave it earmarked for retirement? If so, it may be best to simply move it to a new 401(k) or into an IRA.
- Does he want to access it for purposes of real estate investment? If so, again, moving to a self-directed IRA may be beneficial or if he is going to own his own business, a Solo Self directed 401(K) may also work.
Your family member should discuss his future goals with a financial professional and/or tax strategist to take that next best step. They will ask the same types of questions I highlighted above and determine what the best options are. I would recommend speaking to an advisor who either invests in real estate already or help existing investors so they know how to "speak the language".
Hope that helps, and good luck to him!
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Caleb Heimsoth
Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
7y
@Lauryn Meadows. I believe it’s 59 and a half. Roll over to self directed IRa. Don’t withdraw it. Lend money to people, don’t own real estate directly. Too many rules. Follow @steve Vaughn’s advice
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