Cash Out retirement fund!! Is it stupid for me??

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Cash Out retirement fund!! Is it stupid for me??

Chris C.
Wholesaler · Easley, SC · Member since 2010 · 340 posts · 249 votes

This flies in the face of everything that we have ever learned about retirement accounts.  So I want to start this by stating that it is stupid for 99% of the people out there to cash out retirement accounts but I would like feedback on my situation.

Brief update on my situation:

  1. I plan on retiring from my full time job in June of 2020/ Cash Flow will be very important
  2. I am 44 years old
  3. I will be living off my rental, fix and flip income, and other real estate related activities
  4. My company is freezing our pensions effective June 30th 2019.  We have the option of rolling over this pension or cashing it out.

My thought is to cash out my 401k and pension and payoff as much real estate related financing as I can with the funds left after taxes and penalties.  This will accomplish the following.

  1. Increase monthly cash flow by $1800
  2. After paying 10% penalty I will save $4400 over what I would pay in interest in 2 years / In other words, interest savings more than pay the penalty
  3. In my opinion the taxes are a wash as I would have to pay those now or when I retire.

There you go,  please poke holes in this plan and tell me what I am not considering.

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Michael Jones
Investor · Louisville, KY · Member since 2017 · 199 posts · 253 votes
7y

I am sure there are folks on here that will roast me for what I am about to say and tell me it was a mistake but a person armed with experience is not at the mercy of a person armed with an opinion in a debate.

I cashed out my 401k and took a total of 30% hit when I did it. Remember that you will pay the 10% penalty, taxes when you cash out and also will have to show the cash out as income when you file taxes. It will be over a 30% hit easily.

That was in April of 2015 and it is now April of 2019. That is four years when i count it on my left hand or my right hand.

I cashed out for one reason. I wanted to use the funds to buy rental property. 

I used the remainign two/thirds that was left of my 401k and begin to purchase four plex apartments.

They were affordable and I could gain a residential loan on them with a 30 year fixed.

I only had enough for the down payment for two of these buildings when I first cashed out.

Now I own 6 buildings and 28 units. Four years later.

My annual profit on these 28 units (Profit being what I get to keep after all bills, mortgages, taxes, repairs....everything is paid) is greater than the total amount that I had in my 401 k before I took the penalty.

Yes, that is correct. 20 years of saving into a 401k and four years later i make more per year than I had accumulated in my total 401k.

But here is the catch, if you are good at property management and buying the right properties to make a profit it will be a good decision. If you suck at buying the right properties, can not deal with people or being successful at collecting rents, placing the right tenants into the property etc..... you will cash out and just waist your money away just like investing in Enron or any other bad investment.

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  • Randy Bloch
    Rental Property Investor · Minneapolis · Member since 2019 · 257 posts · 244 votes
    7y
    Originally posted by @Chris C.:

    This flies in the face of everything that we have ever learned about retirement accounts.  So I want to start this by stating that it is stupid for 99% of the people out there to cash out retirement accounts but I would like feedback on my situation.

    Brief update on my situation:

    1. I plan on retiring from my full time job in June of 2020/ Cash Flow will be very important
    2. I am 44 years old
    3. I will be living off my rental, fix and flip income, and other real estate related activities
    4. My company is freezing our pensions effective June 30th 2019.  We have the option of rolling over this pension or cashing it out.

    My thought is to cash out my 401k and pension and payoff as much real estate related financing as I can with the funds left after taxes and penalties.  This will accomplish the following.

    1. Increase monthly cash flow by $1800
    2. After paying 10% penalty I will save $4400 over what I would pay in interest in 2 years / In other words, interest savings more than pay the penalty
    3. In my opinion the taxes are a wash as I would have to pay those now or when I retire.

    There you go,  please poke holes in this plan and tell me what I am not considering.

    Can clarify what you mean by rolling over your pension? I assume you mean you can take a lump sum and put it in an IRA

    1. My company is freezing our pensions effective June 30th 2019. We have the option of rolling over this pension or cashing it out.
    0Reply
  • Randy Bloch
    Rental Property Investor · Minneapolis · Member since 2019 · 257 posts · 244 votes
    7y

    As someone who has their net worth split about 50/50 between 401K and real estate I could do something similar  and retire of the cash flow.  I do not for a couple reasons

    1) Diversification - I don't want all of my net worth in real estate

    2) The money in 401K will continue to grow tax free.  So your statement about having to pay the taxes now or later is true, but your 401K is growing on the pretax amount

    3) I dont want to pay the penalty.  I can leave my 401K grow until 59.5 and use cash flow to get me from my current age to 59.5.  In 15 yr your 401k balance should double twice.  

    Not sure if you pension is equivalent to 401K?  Please clarify.

    6Reply
  • Randy Bloch
    Rental Property Investor · Minneapolis · Member since 2019 · 257 posts · 244 votes
    7y

    @Chris C

    One more point, I like having leverage on real estate investments to increase my returns.  I am going to likely get a PT job doing something that i like to make sure I have enough cash flow. 

    0Reply
  • Chris C.
    OP
    Wholesaler · Easley, SC · Member since 2010 · 340 posts · 249 votes
    7y

    @Randy Bloch Thank you for your reply and very valid points.  I will address then with my rationale for each.

    The pension will be frozen so I have to do something with it.  I can roll it directly into my 401k so for our discussion we will assume it and the 401k are equivalent.  I can also cash it out and pay the taxes and 10% penalty if I choose on the pension and/or the 401k account.

    My real estate to retirement account balance is about 75% real estate and 25% retirement accounts.

    1. Diversification is something I am concerned about also.  However for reasons that I could turn into a lengthy rant I am very risk averse to the stock market.  If I had more control of the 401k and could choose investment options not tied to the stock market then I may have a different opinion. Either way very valid point and something to consider.
    2. It is growing at the pretax amount however whats the value of the $1700 per month cash flow compared to the earnings on just the pretax amount?  Not sure that I am smart enough to put a value to this.  I am definitely saving my interest payments so is the stock market going to average a higher rate of return than my interest rate?  
    3. Very valid point that is more personal preference then numbers related.  I could make no argument to your opinion of this.  The only thing I would address is how much would my net worth increase without the burden of these loans and the additional cash flow?  Would the increase in net worth equal or exceed the gains in the 401k?  Could I make more with the interest savings and additional income than the 401k would earn in the same time frame?
    4. I will still have some leverage however I would like to get my cashflow up before I do semi-retire.  In the short term I am more worried about cash flow than return since I will be reliant on this cash flow in about a year.

    I have not made up my mind as to which way I am going to go on this.  I just want to make sure I fully hash out and understand every angle before making such a possibly risky decision.

    1Reply
  • Carl FischerPro Member
    Rental Property Investor · Ambler, PA · Member since 2015 · 2k+ posts · 1k+ votes
    7y

    @Chris C.

    There might be another option you have not heard of. A self-directed IRA (SDIRA). This type of IRA allows you to invest in alternative investing like real estate and notes. So if you have to cash out or rollover, you could rollover to a SDIRA and use your retirement funds to purchase real estate.

    There are some rules and regulations with these accounts, some of the main ones are listed below

    1. You are a prohibited person- you can not stay temporarily or permanently at any property the IRA owns. You also can not do any physical labor on the property (painting, construction, etc)

    2. The IRA is responsible to receive all rental income or profits earned by the property. - You can take the funds personally by taking a distribution

    3. The IRA is responsible to pay all bills incurred by the property. (The IRA can not pay you back) It is important to make sure property expenses are handled correctly.

    Bigger pockets has many posts on the topic of self-directed accounts.

    [email protected]215-283-2868
    6Reply
  • Chris C.
    OP
    Wholesaler · Easley, SC · Member since 2010 · 340 posts · 249 votes
    7y

    @Carl Fischer thank you for the information. I actually already have a self directed IRA and if I do not cash out I will probably move these funds there. I just didn't want to get things to complicated by bringing that up. I will be looking for a new SDIRA facilitator so I may be reaching out.

    0Reply
  • JD MartinBusiness Member
    Moderator
    Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes
    7y

    There's not enough information here to really make a suggestion.

    1. What type of pension - defined benefit or defined contribution?

    2. If defined benefit:

    a) How many years do you have in the system? Are you vested?

    b) What is the earliest you can draw on your benefit? Is there any reduction in benefit? 

    c). How much lump sum do you have available? Do you take only your contribution or the company's match/contribution when you cash out?

    d). How much is your monthly benefit at full retirement age and what is full retirement age?

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  • Bryan Lyde
    Wylie, TX · Member since 2018 · 75 posts · 55 votes
    7y

    My 2 cents, my CPA advised that if your time horizon is long enough(ie working years to invest earned income) and you are getting the returns from REI above that of which is in paper/market, then typically one could expect to break even in 7years on the upfront tax hit and penalty. Timing is important in the given tax year so you may want to wait until it's a light W2 year to do it.

    SD-IRa is good but if you leverage there will be UBIT tax considerations. Look into solo-401ks also, I believe this leverage tax issue goes away with those but I am not educated enough on these yet to know the specifics. I'm carl or another advisor can help on there.

    0Reply
  • Randy Bloch
    Rental Property Investor · Minneapolis · Member since 2019 · 257 posts · 244 votes
    7y

    @Chris C.  See response to your comments.

    1) When you roll over pension to an IRA the investment opportunities can be much greater than the stock market. You could SDIRA like @Carl Fischer suggested. Inside of SDIRA you can invest in almost anything (private placement, Gold Bars, REI, A passive business, crowdfunding REI) I am sure Carl could do this part more justice than me. Also, if you were to just roll it over to a IRA with brokerage house (Schwab, Fidelity) You could invest in a wide variety of ETF's, REITs or mutual funds that are or are not connected to stock market. You could invest in bonds, REITS, commodities. Not sure of your definition of the stock market so will stop there.

    2)  back of napkin calculation  

    Option A take current balance of your 401k and make assumption on your compound annual return until 59.5.  Calculate the tax you owe if you were to withdrawal subtract it from the balance.  I think 8% return pretax would be fair assumption.  Technically, it would continue to grow beyond 59.5 as you wont withdraw it all at 59.5, you will just start withdraws.

    Option B

    sum up the $1800 per month additional cash flow you receive every month until you are 59.5. Technically, you should calculate the future value of this because you are not getting this all at one time.

    Would be helpful to have a fee only financial planner that understands real estate help you with this model.  I am going to be consulting one of these with my exit plan as well.

    3) is accounted for in analysis above, because you don't pay the penalty in option A

    4) It really comes down to you are concerned with CF because you are semi retiring. I am pretty sure Option A is going return way more than option B, because you just have earn a rate return in your IRA that is greater than the interest rate on RE mortgages, which is probably lower than ~5%. That rate of return is going to be on higher balance because it is before tax and penalty. Plus you have the tax writeoff of the interest. I dont see anyway that option A is not higher....but you need CF to get to 59.5.

    Another option is to start taking withdrawals from you 401K to supplement the cash flow gap.  There are specific rule on you how to do this prior 59.5 and not pay the penalty, maybe a CPA can chime in how the equal payments withdrawal of 401k works without penalty? 

    I have given these scenarios a lot thought....as I am in similar situation at age of 45 looking to semi retire.  Well, I have never considered cashing out 401k, but I have 200K in cash and am debating do I pay off mortgages to get more CF, invest in more RE, or stock market.  I have decided you keep all my properties and the 401k as is and if i need to supplement my CF I will go get PT job that I like, perhaps in real estate.

    5Reply
  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    7y

    Almost any other investment will out strip a mortgage interest rate today. Putting you money in a managed moderately conservative income fund would easily return 10% (double mortgage interest savings) long term. You do not want to bury your money in real estate and be stuck with a measly 4-5% return based only on saving a interest payment. That is not investing it is hoarding money.

    Due to the opportunity value of cash the best/highest return will be made by spreading it around and maximising leverage. Leverage will increase your real cash flow where as using cash will reduce your returns on that cash due to lost opportunity value.

    If you want to maximise income you must use leverage not cash to generate it. Do the math comparing buying one property with all cash to buying 3-4 properties using maximum leverage, the numbers do not lie, leverage will come out ahead cash flow wise every time.

    Also if you are a conservative investor high risk real estate investing may not be for you. A couple of bad tenants will wipe out your cash flow since rentals are a very slow long term investment and the fix and flip market is about to take a turn. The market has reached a peak and flippers are begining to pull back.

    3Reply
  • George Blower
    Retirement Accounts Attorney · Southfield, MI · Member since 2017 · 3k+ posts · 1k+ votes
    7y
    Originally posted by @Bryan Lyde:

    My 2 cents, my CPA advised that if your time horizon is long enough(ie working years to invest earned income) and you are getting the returns from REI above that of which is in paper/market, then typically one could expect to break even in 7years on the upfront tax hit and penalty. Timing is important in the given tax year so you may want to wait until it's a light W2 year to do it.

    SD-IRa is good but if you leverage there will be UBIT tax considerations. Look into solo-401ks also, I believe this leverage tax issue goes away with those but I am not educated enough on these yet to know the specifics. I'm carl or another advisor can help on there.

    If you are self-employed with no full-time w-2 employees, you can set up a Solo 401k which allows for investing in real estate. Unlike an IRA, there is an exception to UDFI for income derived from real estate owned by the Solo 401k and acquired with non-recourse debt.

    1Reply
  • Chris C.
    OP
    Wholesaler · Easley, SC · Member since 2010 · 340 posts · 249 votes
    7y
    Originally posted by @JD Martin:

    There's not enough information here to really make a suggestion.

    1. What type of pension - defined benefit or defined contribution?

    2. If defined benefit:

    a) How many years do you have in the system? Are you vested?

    b) What is the earliest you can draw on your benefit? Is there any reduction in benefit? 

    c). How much lump sum do you have available? Do you take only your contribution or the company's match/contribution when you cash out?

    d). How much is your monthly benefit at full retirement age and what is full retirement age?

    My company is freezing the pension so I have no option but to roll it over or cash it out. If I leave it in the pension it will stop increasing in value so of course that would be the worst thing to do. I will be able to remove the full value.

    0Reply
  • Chris C.
    OP
    Wholesaler · Easley, SC · Member since 2010 · 340 posts · 249 votes
    7y
    Originally posted by @Bryan Lyde:

    My 2 cents, my CPA advised that if your time horizon is long enough(ie working years to invest earned income) and you are getting the returns from REI above that of which is in paper/market, then typically one could expect to break even in 7years on the upfront tax hit and penalty. Timing is important in the given tax year so you may want to wait until it's a light W2 year to do it.

    SD-IRa is good but if you leverage there will be UBIT tax considerations. Look into solo-401ks also, I believe this leverage tax issue goes away with those but I am not educated enough on these yet to know the specifics. I'm carl or another advisor can help on there.

     Good information thanks. I had considered the tax hit of doing the entire balance at once and will have to spread the disbursements out over a couple of years to keep my tax rate reasonable.

    0Reply
  • Chris C.
    OP
    Wholesaler · Easley, SC · Member since 2010 · 340 posts · 249 votes
    7y
    Originally posted by @Randy Bloch:

    @Chris C.  See response to your comments.

    1) When you roll over pension to an IRA the investment opportunities can be much greater than the stock market. You could SDIRA like @Carl Fischer suggested. Inside of SDIRA you can invest in almost anything (private placement, Gold Bars, REI, A passive business, crowdfunding REI) I am sure Carl could do this part more justice than me. Also, if you were to just roll it over to a IRA with brokerage house (Schwab, Fidelity) You could invest in a wide variety of ETF's, REITs or mutual funds that are or are not connected to stock market. You could invest in bonds, REITS, commodities. Not sure of your definition of the stock market so will stop there.

    2)  back of napkin calculation  

    Option A take current balance of your 401k and make assumption on your compound annual return until 59.5.  Calculate the tax you owe if you were to withdrawal subtract it from the balance.  I think 8% return pretax would be fair assumption.  Technically, it would continue to grow beyond 59.5 as you wont withdraw it all at 59.5, you will just start withdraws.

    Option B

    sum up the $1800 per month additional cash flow you receive every month until you are 59.5. Technically, you should calculate the future value of this because you are not getting this all at one time.

    Would be helpful to have a fee only financial planner that understands real estate help you with this model.  I am going to be consulting one of these with my exit plan as well.

    3) is accounted for in analysis above, because you don't pay the penalty in option A

    4) It really comes down to you are concerned with CF because you are semi retiring. I am pretty sure Option A is going return way more than option B, because you just have earn a rate return in your IRA that is greater than the interest rate on RE mortgages, which is probably lower than ~5%. That rate of return is going to be on higher balance because it is before tax and penalty. Plus you have the tax writeoff of the interest. I dont see anyway that option A is not higher....but you need CF to get to 59.5.

    Another option is to start taking withdrawals from you 401K to supplement the cash flow gap.  There are specific rule on you how to do this prior 59.5 and not pay the penalty, maybe a CPA can chime in how the equal payments withdrawal of 401k works without penalty? 

    I have given these scenarios a lot thought....as I am in similar situation at age of 45 looking to semi retire.  Well, I have never considered cashing out 401k, but I have 200K in cash and am debating do I pay off mortgages to get more CF, invest in more RE, or stock market.  I have decided you keep all my properties and the 401k as is and if i need to supplement my CF I will go get PT job that I like, perhaps in real estate.

     Thanks again for chiming in. I really appreciate the info and you are showing the holes that I was hoping someone would. The only thing that I have not shared is that the loans I would pay off are 8% loans. I specialize in Manufactured homes and there is very limited financing available for this investment type. Most of my financing for these are private money. That said even the bank financing I have on my conventional properties(not mobiles) is about 6.5%. Where is anyone getting 5% or below investment loans? I have excellent credit but those are the best rates I could find.

    0Reply
  • Chris C.
    OP
    Wholesaler · Easley, SC · Member since 2010 · 340 posts · 249 votes
    7y
    Originally posted by @Thomas S.:

    Almost any other investment will out strip a mortgage interest rate today. Putting you money in a managed moderately conservative income fund would easily return 10% (double mortgage interest savings) long term. You do not want to bury your money in real estate and be stuck with a measly 4-5% return based only on saving a interest payment. That is not investing it is hoarding money.

    Due to the opportunity value of cash the best/highest return will be made by spreading it around and maximising leverage. Leverage will increase your real cash flow where as using cash will reduce your returns on that cash due to lost opportunity value.

    If you want to maximise income you must use leverage not cash to generate it. Do the math comparing buying one property with all cash to buying 3-4 properties using maximum leverage, the numbers do not lie, leverage will come out ahead cash flow wise every time.

    Also if you are a conservative investor high risk real estate investing may not be for you. A couple of bad tenants will wipe out your cash flow since rentals are a very slow long term investment and the fix and flip market is about to take a turn. The market has reached a peak and flippers are begining to pull back.

     See my comments above about my interest rate. I have done the calculations for leveraging many times and have always tried to balance leveraging with security. Many people lost everything in 2008 by over utilizing leverage. Your last paragraph is exactly all the reasons to balance leverage utilization. I would not say I am a conservative investor but I am very experienced in real estate. When I start supporting my family with real estate I will be taking a more conservative approach to investing than I have utilized the last 10 years.

    0Reply
  • JD MartinBusiness Member
    Moderator
    Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes
    7y
    Originally posted by @Chris C.:
    Originally posted by @JD Martin:

    There's not enough information here to really make a suggestion.

    1. What type of pension - defined benefit or defined contribution?

    2. If defined benefit:

    a) How many years do you have in the system? Are you vested?

    b) What is the earliest you can draw on your benefit? Is there any reduction in benefit? 

    c). How much lump sum do you have available? Do you take only your contribution or the company's match/contribution when you cash out?

    d). How much is your monthly benefit at full retirement age and what is full retirement age?

    My company is freezing the pension so I have no option but to roll it over or cash it out. If I leave it in the pension it will stop increasing in value so of course that would be the worst thing to do. I will be able to remove the full value.

     Sorry, I missed that part. 

    My answer would still depend on what kind of dollars we are talking about. Very low 5 figures, you're probably not losing much given your age. Over 6 figures, you've got a decent batch of money to start with to compound. 

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  • Anthony GaydenPro Member
    Rental Property Investor · Omaha, NE · Member since 2014 · 2k+ posts · 3k+ votes
    7y
    Originally posted by @Chris C.:

    This flies in the face of everything that we have ever learned about retirement accounts.  So I want to start this by stating that it is stupid for 99% of the people out there to cash out retirement accounts but I would like feedback on my situation.

    Brief update on my situation:

    1. I plan on retiring from my full time job in June of 2020/ Cash Flow will be very important
    2. I am 44 years old
    3. I will be living off my rental, fix and flip income, and other real estate related activities
    4. My company is freezing our pensions effective June 30th 2019.  We have the option of rolling over this pension or cashing it out.

    My thought is to cash out my 401k and pension and payoff as much real estate related financing as I can with the funds left after taxes and penalties.  This will accomplish the following.

    1. Increase monthly cash flow by $1800
    2. After paying 10% penalty I will save $4400 over what I would pay in interest in 2 years / In other words, interest savings more than pay the penalty
    3. In my opinion the taxes are a wash as I would have to pay those now or when I retire.

    There you go,  please poke holes in this plan and tell me what I am not considering.

     There is a large penalty for cashing out a 401K. Basically it will be taxed as income. Also if it is a very large sum, you may be taxed at the highest tax rates. 

    Example

    Annual Income $80,000 

    Cash Out 401K $525,000

    total income for 2019 = $605,000

    tax rate 37% = $223,850

    10% penalty = $52,500

    tax + penalty = $276,350

    That is a huge hit. I cashed out a 401K a long time ago trying to pay off debt and I ended up with a large bill from the IRS and I ended up back in debt because I did not fix my spending habits.

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  • Randy Bloch
    Rental Property Investor · Minneapolis · Member since 2019 · 257 posts · 244 votes
    7y

    @Chris C.  am completely aligned with comment to Thomas on balancing leverage, especially as you semi retire.

    The mobile home interest rate of 8% is bit of twist....I would still probably not liquidate 401k, because you have tax benefit of writing off the interest.  I would analyze how tight your CF is going be if you have any other way to generate some cash flow or minimize expenses.

    As far as mortgage rates, what type of properties do you have? (SF, 1-4 unit, 5+) You should be able to get sub 5% with conventional financing on 30yr Fixed. Even if you went and got portfolio loan you could get ~5.5% ARM that is fixed for 5yr.

    You might want to consider the early IRA distribution exception, google rule 72t distribution. This would avoid the penalty and you could supplement you CF with. Would allow the remaining balance of your 401k to grow.

    https://www.investopedia.com/articles/retirement/02/112602.asp

    0Reply
  • Anna Ferntheil
    Member since 2018 · 19 posts · 10 votes
    7y

    I found myself in a similar situation-essentially wondering if it was worth it to cash out my retirement funds and take the penalty and invest it now. In some cases, the numbers make sense and the ultimate gain can exceeded the penalty. I ended up going the SDIRA route with my funds which I found had some problems (detailed below) and ultimately moving again to an eQRP/solo 401k account. Have you considered that option if you are planning on changing custodians soon anyway?

    I had a SD IRA and it was very frustrating trying to do everything through the custodian. The massive amount of forms required for any activity was very frustrating. In a short amount of time, some things that they had said I could do like "purchase property titled in my name" they were saying, well yeah but not that property you want.... I am sure they had their reasons but it was frustrating and it was never explained to me what the issue was in a way that made any sense other than they didn't want to deal with it. Also, I wanted to diversify and put some of my money into crypto-they had their own platform that charged pretty outrageous monthly fees just to use it.

    I ended up switching to an eQRP/SD IRA and have been very happy with it. I have almost 24 hour access to an adviser who responds almost immediately to my questions. I have since been able to purchase the afore mentioned land with no problems and set up a cryptocurrency trading account with no fees other than the standard trade fees. This also allows me to avoid some of the issues and taxes associated with financing a property to be owned through a SDIRA.

    Feel free to message me with any questions or if you want more information I can send contact info

    0Reply
  • Randy Bloch
    Rental Property Investor · Minneapolis · Member since 2019 · 257 posts · 244 votes
    7y
    Originally posted by @Anthony Gayden:
    Originally posted by @Chris C.:

    This flies in the face of everything that we have ever learned about retirement accounts.  So I want to start this by stating that it is stupid for 99% of the people out there to cash out retirement accounts but I would like feedback on my situation.

    Brief update on my situation:

    1. I plan on retiring from my full time job in June of 2020/ Cash Flow will be very important
    2. I am 44 years old
    3. I will be living off my rental, fix and flip income, and other real estate related activities
    4. My company is freezing our pensions effective June 30th 2019.  We have the option of rolling over this pension or cashing it out.

    My thought is to cash out my 401k and pension and payoff as much real estate related financing as I can with the funds left after taxes and penalties.  This will accomplish the following.

    1. Increase monthly cash flow by $1800
    2. After paying 10% penalty I will save $4400 over what I would pay in interest in 2 years / In other words, interest savings more than pay the penalty
    3. In my opinion the taxes are a wash as I would have to pay those now or when I retire.

    There you go,  please poke holes in this plan and tell me what I am not considering.

     There is a large penalty for cashing out a 401K. Basically it will be taxed as income. Also if it is a very large sum, you may be taxed at the highest tax rates. 

    Example

    Annual Income $80,000 

    Cash Out 401K $525,000

    total income for 2019 = $605,000

    tax rate 37% = $223,850

    10% penalty = $52,500

    tax + penalty = $276,350

    That is a huge hit. I cashed out a 401K a long time ago trying to pay off debt and I ended up with a large bill from the IRS and I ended up back in debt because I did not fix my spending habits.

    Very good point Anthony!...i did not think of this being at highest tax bracket....and that would horrible surprise. 

    0Reply
  • Randy Bloch
    Rental Property Investor · Minneapolis · Member since 2019 · 257 posts · 244 votes
    7y
    Originally posted by @Chris C.:
    Originally posted by @Randy Bloch:

    @Chris C.  See response to your comments.

    1) When you roll over pension to an IRA the investment opportunities can be much greater than the stock market. You could SDIRA like @Carl Fischer suggested. Inside of SDIRA you can invest in almost anything (private placement, Gold Bars, REI, A passive business, crowdfunding REI) I am sure Carl could do this part more justice than me. Also, if you were to just roll it over to a IRA with brokerage house (Schwab, Fidelity) You could invest in a wide variety of ETF's, REITs or mutual funds that are or are not connected to stock market. You could invest in bonds, REITS, commodities. Not sure of your definition of the stock market so will stop there.

    2)  back of napkin calculation  

    Option A take current balance of your 401k and make assumption on your compound annual return until 59.5.  Calculate the tax you owe if you were to withdrawal subtract it from the balance.  I think 8% return pretax would be fair assumption.  Technically, it would continue to grow beyond 59.5 as you wont withdraw it all at 59.5, you will just start withdraws.

    Option B

    sum up the $1800 per month additional cash flow you receive every month until you are 59.5. Technically, you should calculate the future value of this because you are not getting this all at one time.

    Would be helpful to have a fee only financial planner that understands real estate help you with this model.  I am going to be consulting one of these with my exit plan as well.

    3) is accounted for in analysis above, because you don't pay the penalty in option A

    4) It really comes down to you are concerned with CF because you are semi retiring. I am pretty sure Option A is going return way more than option B, because you just have earn a rate return in your IRA that is greater than the interest rate on RE mortgages, which is probably lower than ~5%. That rate of return is going to be on higher balance because it is before tax and penalty. Plus you have the tax writeoff of the interest. I dont see anyway that option A is not higher....but you need CF to get to 59.5.

    Another option is to start taking withdrawals from you 401K to supplement the cash flow gap.  There are specific rule on you how to do this prior 59.5 and not pay the penalty, maybe a CPA can chime in how the equal payments withdrawal of 401k works without penalty? 

    I have given these scenarios a lot thought....as I am in similar situation at age of 45 looking to semi retire.  Well, I have never considered cashing out 401k, but I have 200K in cash and am debating do I pay off mortgages to get more CF, invest in more RE, or stock market.  I have decided you keep all my properties and the 401k as is and if i need to supplement my CF I will go get PT job that I like, perhaps in real estate.

     Thanks again for chiming in. I really appreciate the info and you are showing the holes that I was hoping someone would. The only thing that I have not shared is that the loans I would pay off are 8% loans. I specialize in Manufactured homes and there is very limited financing available for this investment type. Most of my financing for these are private money. That said even the bank financing I have on my conventional properties(not mobiles) is about 6.5%. Where is anyone getting 5% or below investment loans? I have excellent credit but those are the best rates I could find.

    Maybe you could cash out refi your non mobile home properties? if you get rate of 4.5%...payment might stay the same, take the cash and pay off the mobile homes. You get the increase in cashflow and keep your IRA intact. Obviously, depends on how much equity you have and loan balances.

    0Reply
  • Anthony Wick
    Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes
    7y

    I can't think of any reason to pull out money early and take a 10% penalty hit. Not only would you take 10% penalty, what if you actually just spent that money? Now you're foregoing any money that you could have made. Let's pretend it's the average of 7% return in the stock market. You now are knowingly and willingly taking a negative 17% hit.

    0Reply
  • Aaron Arnold
    Rental Property Investor · St Joseph, MO · Member since 2018 · 38 posts · 20 votes
    7y

    @Chris C. Read the book Killing Sacred Cows by Garrett Gunderson. It doesn’t specifically say whether you should surrender your 401k but if you’re headed down that path it certainly provides some insight.

    0Reply
  • Bryan Lyde
    Wylie, TX · Member since 2018 · 75 posts · 55 votes
    7y

    @Anthony Wick, in my view the 7% paper return isn't net; its minus cap gains or whatever the longer term tax rate will be when pulled from a QRP. It would also be offset by the return on the RE investment if done relatively soon after liquidation).

    I would say if the REI investment is done right, returns should be above 20% (combination of Cashflow, mortgage paydown, appreciation, depreciation).

    Heck, find a good market and a 20% down payment on a property that appreciates 5% is a 25% return alone on that money. Not that anyone should count on appreciation; just an illustration of how easy it is to hit well above paper market rates.

    I'll see if I can find a link to an online resource that compares the two scenarios. seems like schwab or TD had something...

    1Reply
  • Chris C.
    OP
    Wholesaler · Easley, SC · Member since 2010 · 340 posts · 249 votes
    7y

    @Anthony Gayden Very good advice and I had already considered I would need to do cash outs depending on my yearly income for that year to avoid this situation.  I would not do it all in one year unless I calculated it would not push me to the next tax bracket.

    @Randy Bloch I had researched the 72t and that is definitely something to consider.  I did not realize that existed.  I have already cashed out my non mobile home properties and have been using that to payoff on the other units.  I have also sold a few rentals for debt reduction.  I am not trying to get fully debt free but I have built my portfolio out of my best properties and am now stream lining it.

    @Anthony Wick The scenario you are presenting would be very stupid and no where near what I am considering.  The reason I am considering it is that debt savings would surpass the penalty in less than 2 years and increase my cashflow by $1800 per month.  Matter of fact in 2 years, after paying the tax penalty, I would save an additional $4400 in debt service.  So in 2 years I would be $47,600 cash positive.  Of course you would have to deduct what my investment would of made in the stock market to determine if I would be plus or minus net worth.

    @Aaron Arnold just downloaded it to the kindle.  Thanks

    Not sure if it is best to quote everyone and have multiple post that blows up everyone's email or just @ mention with replies.  This is definitely harder to read but more email friendly. Suggestions?

    1Reply
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