Is it worth pulling from 401k to buy first property?

Question

I don’t have a large amount of cash at hand, but I have a nice nest egg in my 401k. Can someone help me with pros and cons of withdrawing from my 401k (and the crazy tax hit) to buy a rental property (buy and hold)? What kind of cap rate would I need for this to meet the same return that this money would earn in my 401k?

Jonathan Taylor Smith · Answer

Hello @Kenny Hill - My first rental property purchase was funded with a loan from my wife's TSP account (Military 401K). Because it was a loan instead of a withdrawal, there was no tax hit. There was just the interest expense, essentially paid back to yourself, and whatever gain you might have made on those funds if they had remained invested. The loan was paid back over 24 months and I still own that property (and many others) 11 years later. I've since done the same thing several more times. TSP allows up to two simultaneous loans.

Kenny Hill · Answer

Your responses line up with my thoughts as well. Thanks for the feedback, and I will look into the 401k loan option.

Nicholas L. · Answer

@Kenny Hill

short answer - no. you're going to have to save up more. returns on non value add LTRs are terrible right now so to take money out and pay a penalty to invest in property you lose money on doesn't seem like a good plan.

hope this helps

Aaron Zimmerman · Answer

I would consider a loan from your 401(k) first. I would shy away from a withdrawal as there’s a 10% penalty plus ordinary income tax. To justify the withdrawal the deal would have to be incredible. If this is your first property, that’s going to be difficult to achieve but not impossible. You’d probably want a 12% return at least to justify additional work of rental property and lost earnings potential on the 401k.

Alex S. · Answer

Agreed, cap rate ignores leverage and the 401k comparison is really after-tax. Run the rental on cash-on-cash plus the 10% penalty and ordinary income tax on the withdrawal, and see if it still clears what the 401k would compound to.

Brett Synicky · Answer

@Kenny Hill Have you considered an SDIRA or (if self employed) a Solo 401k? This way you wouldn't have to compare the two since they're not separate. With one of these plans, the plan itself could own the real estate. No distributions, no taxes incurred by you. The downside is you don't get to personally benefit (today) from the RE owned by your retirement account. Those investments are for your future self or whenever you take a distribution. The upside is, that instead of ONLY investing in Wall Street, your IRA/401k can take part in an investment that's made more money for more people than any other asset class.

Ashish Acharya · Answer

Kenny, I’d be very careful about comparing the rental’s cap rate directly to what your 401(k) might earn. The first thing I’d calculate is the after tax cost of getting the money out of the 401(k), including any applicable income tax and early distribution penalty.

Then compare that with the rental’s full after tax return: cash flow, appreciation, principal paydown, leverage, depreciation, and the eventual tax when you sell.

One alternative worth checking is whether your specific 401(k) plan allows a 401(k) loan. That can be very different from taking a taxable distribution, although it comes with its own rules and risks.

I also wouldn’t use the rental’s depreciation benefit alone to justify the investment. The property should make sense on its own numbers first, and then the tax strategy can improve the after tax outcome.

The better question isn't really “what cap rate matches my 401(k)?” It’s “what return does this rental need to generate after accounting for the cost of accessing my retirement funds?” That’s the comparison I’d model before making the move. Happy to connect!

Is it worth pulling from 401k to buy first property?

Is it worth pulling from 401k to buy first property?

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