Why Using a 401(k) Hardship Withdrawal to Begin Investing in Real Estate is Simply Too Costly


Earlier this week I engaged in Forum debate over an early 401(k) withdrawal. The person asking the question really wanted to break into real estate and was wondering what the crowd thought about taking an early 401(k) withdrawal, commonly known as a “hardship” withdrawal. My inner CPA took over, and I attempted to explain why I thought this was a bad idea.

I’m going to save my thoughts on contributing to a 401(k) for next week. Right now, I want to focus purely on whether or not it makes sense to take a hardship withdrawal.

I’ve run the numbers and offer them to the BiggerPockets community as proof that I was both right and wrong. I argued two premises: (1) that the 401(k) early withdrawal is extremely costly and (2) that if you have to take a 401(k) withdrawal, you may want to focus on improving your financial situation prior to jumping into real estate. While I stand by my second argument, that if you have to take a hardship withdrawal from your 401(k) you shouldn’t get into real estate, my first argument was incorrectly stated. I should have argued that the 401(k) withdrawal is extremely costly in the short run. Here’s why.

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Taxes, Taxes, Taxes

An early 401(k) withdrawal is subject to your marginal tax rate, plus a penalty rate of 10%. A common misconception is that your withdrawal will be penalty free as long you are purchasing your first house with it. While it’s true that this exception exists for IRA withdrawals, the exception is specifically excluded for 401(k)s.

Related: You Should NOT Bank on Your 401k For Retirement. Here’s the Superior Alternative.

If you take a $10,000 withdrawal to help aid your purchase of real estate, assuming your marginal tax rate is 25%, the tax on the withdrawal will be $3,500 (25% + 10% penalty), leaving you with a real value of $6,500 after the withdrawal.

A poster in the Forum made the point that you wouldn’t pay taxes on the withdrawal until April 15th the following year. This will allow the person to accrue earnings on the money, assuming it was invested until that time. A good point indeed, but it comes with flaws.

For instance, if you were to sink the $10,000 into property, an illiquid asset, and come tax time you have an extra $3,500 due – will you have the ability to pay for that tax? You can’t just draw the money out of the property. Since you took a hardship withdrawal, you likely have little in reserves. So how do you pay for it?

Additionally, in order to accrue earnings on the withdrawal to cover that whopping tax bill at year end, you have to assume that it was immediately invested in order to give the growth enough time for the withdrawal to make an ounce of sense. How often have you seen a closing happen so perfectly that you’d feel comfortable timing your withdrawal down to the day? That’s what I thought.

Foregone Earnings: The Hidden Cost (in the Short Run)

Forgone earnings are very real, especially when talking about retirement withdrawals. The impact to your finances can be massive, but generally only in the short run. What is the short run? Well that depends on how well you reapply your capital and at what rate earnings are accruing.

Say your 401(k) grows at a 6% rate each year. By taking a $10,000 withdrawal, you lost out on $600 of earnings. So now you have to reapply that capital as quickly as possible in order to make up for those lost earnings and cover the pesky tax cost of the withdrawal.

The total cost of your withdrawal will be $4,100 ($3,500 in taxes, plus $600 in lost earnings). There’s no way around that cost. Assuming you are able to reapply your capital quickly, can you make a 41% return on your $10,000? Probably not.

What if you don’t reapply your capital quickly and tax time rolls around? Now your $6,500 in post-tax withdrawal has to make a 63% return just to break even. See how costly this 401(k) withdrawal can get?

Let’s take this a step further. What we haven’t factored into the math is the continued earnings on the $10,000 if left in your 401(k). So let’s assume your 401(k) will continue to earn 6%, but if you draw the money out, you can reapply the post-tax money ($6,500) at a generous 12% rate. Under these assumptions, it will take you seven years to simply break even on your withdrawal decision. That’s a long time just to break even. Don’t believe me? Take a look at the numbers:

401(k) Pic

But this is a double edged sword, and this is where I should have clarified my argument. You see, after seven years, the decision to withdraw the money today actually benefits you — and benefits you dramatically. At the end of 20 years, your $6,500 withdrawal will have grown to $62,700, whereas if you had left it in your 401(k), you would only have $32,000. But remember, the stark difference is due to your ability to successfully reinvest the capital. I applied a rate of 12%, which may or may not be achievable for an amateur real estate investor.

It’s Too Expensive; Here are a Few Solutions

As you can see, a hardship withdrawal from your 401(k) is simply too costly a solution to your money problem. It will take you seven years just to break even on your decision. That’s a long time and a big risk.

A poster mentioned that it’s only a couple grand, so what’s the big deal? True, it’s a small number, but the real indicator of whether or not this move makes sense can be measured on a percentage basis. Measuring decisions on a percentage basis levels the playing field and allows a transparent look at how the decisions will pan out. For instance, making $1,000 off a $10,000 investment is generally a good return. But making $1,000 off a $100,000 investment is considered a poor return. We returned the same dollar amount, but the percentage return varies drastically.

I measure all financial decisions on a percentage basis. Percentages can be applied to every financial decision, regardless of the amount of capital involved. Applying a percentage to the 401(k) early withdrawal shows at least a 35% loss on the withdrawal. Add in the foregone earnings of 6%, and now we are at a 41% loss. I don’t know a single person that would claim taking a 41% haircut in year one is a smart idea.

Related: Real Estate Notes vs. 401k: Which Investment Wins Out Over 30 Years?

The immediate solution is to simply stop contributing to your 401(k) and get your finances in line. This way, you avoid the 10% penalty fee on your money and the foregone earnings on the principal amount in your 401(k).

The second option is to take a loan from your 401(k). You can loan yourself $50,000 or half of your balance, whichever is less. The loan has a timeline of 5 years, unless applied to a primary residence, and you must pay yourself interest. The downside here is that most plans require you to pay the loan back within 60 days of leaving your job.

The third option is to leave your job and roll your 401(k) into an IRA. You will have more flexibility with your investment options, and you will have the ability to choose low cost funds.

I’ll talk about the company match and whether I think a 401(k) is a good overall investment vehicle next week, but my overarching point is that a  401(k) early withdrawal is simply too costly and should be avoided at all costs. So costly that it takes seven years to recover from your decision. Play smart, folks!

Investors: Do these numbers surprise you? Where do you stand on this Forum debate?

Let me know your thoughts in the comments section below.

About Author

Brandon Hall

Brandon Hall, owner of The Real Estate CPA, is an entrepreneur at heart who happens to be good at taxes. Brandon is a real estate investor and CPA specializing in providing business advice and creative tax strategies for real estate investors. Brandon's Big 4 and personal investing experiences allow him to provide unique advice to each of his clients. Sign up for my FREE NEWSLETTER to receive tips and updates related to business and taxes.


  1. Angel Rosado

    Once again great article Brandon! This topic has been heavily on my mind but more on the loan withdrawal. I think I have to focus on calculating the numbers

    On a loan side, What’s your point of view on the earnings that you’re losing and paying taxes twice, upon repayment of the loan and withdrawal of the 401k in retirement.

  2. Ray Arends

    Nice article Brandon! I’m on the fence as far as the 50k loan from my 401k goes. The payment on a 50k loan is around $900 a month – a rather hefty amount for me. The only way I could swing it is to use 30k of the loan to eliminate some other debt. Add that to the 30k HELOC and I would have some reasonable downpayment cash.

  3. Sara Cunningham

    Great article and very timely for us. We just returned from Puerto Rico and are about 10 years away from early retirement. My husband wants to buy a vacation property out there or in some other island, coastal area. So do I however not at the expense of a 401k which is what he wants to do. We also have 2 IRAs each traditional which have small sums in then a Roth with larger amounts in. I’m still not convinced to use them either.At least this article gives me the ammo I need to put him off using his 401k.

  4. Brian Eastman


    Thanks for putting some numbers behind this discussion. Math does not lie. Even if one can generate twice the rate of return in their property investment, the payback is 7 years. If you shrink the gap between the performance of the 401k and the real estate investment, the payback becomes even longer.

    As a society, we Americans are very impatient. Sometimes that can create the drive to go out and succeed, but more often it produces poor financial decisions based on some emotional factor without a careful consideration of the math. And financial planning is all math.

  5. Michael Swan

    Hi Brandon,

    I cashed in all my IRA money a few years back and bit the bulleti and never looked back. We now have accumulated over $4,000,000.00 in apartments and single family residences. The big problem you talk about is the taxes at 20%. This will occur if you take this money at 30, 40, 50, 60, 65, or 70 years old right? Could taxes be higher in 10, 20, or 30 years? Who knows what the tax structure will be then. That argument is thrown out right there. Now we are left with the BIG TABOO 10% penalty. I now have $4,000,000 in total worth due to taking a measly $400,000 and cashing in my IRA. That money is in my control now!! No speculative stocks, mutual funds, risky ponzy schemes that even the financial planners that manage your money are snookered to invest your money due to the high returns tauted. Last, what an illogical argument to put real estate in an IRA or 401. Don’t even get me started. I Now have over $100,000.00 in tax deferred cash flow coming in every year and I know where every quarter, dime, knickle, and penny goes. I feel so aware and in control, you can’t even imagine the feeling, can you? My investments are all based on tax deferred cash flow and I never sell without a 1031 exchange. I will just defer, defer, defer, and die. Then, my child will inherit at a stepped up basis and deferral will start all over again and he can defer, defer, defer, and die and give it to his kids some day. I am in the process of 1031 exchanging all my pricey San Diego real estate after a short 5 years of investing and finding higher cash flowing Apartment complexes in Northeast Ohio presently. You gotta love this life!!! Don’t be fooled by such illogical arguments. I don’t want to wait 20-25 years at some unfulfilled promise and have other people control my money. There was a 10 year period recently where the stock market stayed virtually the same. The financial planner say to diversify. I call it deworsify. That means put one dollar and place in one pocket (small cap), another in other pocket (mid cap), left back pocket (large cap), and right back pocket International, and then bonds, cd’s safe supposedly in shirt pocket. Then If two go up in value then two may go down in value and they say that adds safety. I say, logically if you take 2 out of one pocket and place it in the other pocket, then you are still at zero. That’s what happened to my IRA or 401k for 10 years. What a joke!! I will put all my eggs in one basket from now on and then guard it with my life. I have done all of this, while keeping a full time teaching gig making currently $70,000.00 taxable. Of course, after 4 short years, I am earning over $100,000.00 tax deferred, while daily growing my total value of all real estate owned and increasing the value of my Apartment complexes by using the best product, best price, and best service business model. I am finding ways to increase NOI daily, ultimately increasing the value of my apartments, according to the banks. Summarily, I can 1031 exchange or refi if I prefer and take all money out, that I invested, TAX FREE. My refi loan would not be taxable. Another option is to 1031 exchange into a much larger complex that cash flow at a much higher rate than I traded it in for. Last, I can do a value/reposition deal and get the best of both worlds. Where else can you take a measly $400,000.00 and in the next 5 to 8 years have under control nearly 50 million of real estate cash flowing, tax deferred over $500,000.00 per year. What a country!! When I learned that my ladder was leaning against the wrong building (financially speaking) four years ago, I put the pedal to the metal and after my son graduates college in about 4 or 5 years, we will be financially free. Now that I think about it, we are making about $130,000 taxable per year presently and $90,000 taxable with my wife’s job as an instructional assistant for special Ed, we are financially free!! Tell me any othe vehicle that could do this, and is perfectly legal, besides winning the lottery. Challenge you to do so!!

    If you change the way you look at things, the things you look at change right before your eyes!!

    Is your ladder leaning against the wrong financial freedom business model building? I know mine was. Feel free to reach out to me and discuss how you can do it too. I sure do love this stuff. Below is my go to cell number. Do you need a solid mentor that doesn’t want anything? I have always been a teacher and would love to see you succeed. I believe in abundance for everyone, not a scarcity, mentality. Everything I have accomplished in Real Estate and will accomplish in real estate is available. Seek and you shall find!!

    858 722-7377

    • Brandon Hall

      Hey Michael – thanks for the story. While I don’t doubt you are as successful as you claim you are, I am skeptical that you got there by cashing out your 401(k).

      (1) “I now have $4,000,000 in total worth due to taking a measly $400,000 and cashing in my IRA” – It’s highly unlikely that the money you used from your IRA/401(k) is the sole reason you now have $4MM in real estate. In fact, cashing in this much money would boost you into the 39.6% tax bracket. So on average, we can assume your $400k withdrawal was taxed at 35%. Add an extra 10% penalty and your withdrawal is up to a 45% loss before you even got started. So now you turned $220k ($400k x [1-.45]) into $4MM in real estate. Oh, and you did it in four years. See how this can make people skeptical? What gives? What else aren’t you telling us?

      (2) “Of course, after 4 short years, I am earning over $100,000.00 tax deferred” – it’s a great feat to reach that level of passive cashflow. I’m assuming by tax deferred, you mean your depreciation covers your profits. Regardless, $100k on $2MM in equity (according to your profile) is a measly 5% return. In fact, I’d wager that your 401(k) was on average seeing the same returns, if not higher. It seems as if you’ve allowed one bad financial decisions (cashing out your 401(k)) turn into another (bad returns on investment) which is exactly what I’m trying to get people to avoid. Of course this is another piece of the puzzle you aren’t telling us – what is your strategy? You talk about cashflow, but that can’t be your main strategy as it’s providing you with a poor return. So what is your appreciation play?

      (3) You have $2MM in equity – this is what I can’t wrap my head around. How, in four years, did you turn a $220k post tax withdrawal into $2MM in equity? Not saying it isn’t possible, but highly unlikely. So what else haven’t you told us? What’s the other side to the story?

      • Michael Swan

        Hi Brandon,

        Hold on to your hat here Brandon. I realized in February of 2011 that my ladder was leaning against the wrong financial building. Sooooo, I started to use my savings, refinancing my personal home, and taking out my IRA’s and 401K money through the course of a little over a 3 year period and each time I took out that money, I took out enough to put 20% down on cash flowing San Diego single family condos. We averaged between $25,000-$30,000 for each down payment. If you know anything about San Diego Real Estate, it has tremendous appreciation potential. In 2011 when we started investing, we were stealing properties with excellent cash flow by short sales and REO. Our original goal was to replace lost W2 earnings, that I realized was occurring. I simply wanted to replace about $12,000.00 in W2 earnings I was fearful of losing in 2012. We then over the course of a 2-3 year period had accumulated 10 dirt cheap condos. In about the beginning of 2014 something miraculously started to occur. My Condos started to appreciate wildly. Many doubled in value as of today. I being a teacher here in San Diego for a Catholic School and a Community College too, am I life long learner and from 2011-present have soaked up so much information from experts in the area of creating wealth through real estate, realized my return on equity was at a minuscule 3%. That was unacceptable. We also started pooling our money together in my family and started in the beginning of 2015 to buy high cash flowing single family in Ohio. We have 8 right now in Ohio. We loved the cash flow alone. Then, here is the real kicker. Upon all my learning and investigation, I found out, that all this cash flow was tax deferred, it really blew my mind. Thirty years in the rat race and in a few years if I play this right, I could surpass all W2 earnings with cash flowing rental real estate. Then, I realized if I take one or two pricey San Diego Condos and do a 1031 exchange, I can buy a million dollars worth of Multifamily Apartment complexes, with no money out of pocket. When I realized I can trade $8,000.00 tax deferred cash flow per year in for approximately $30,000-$40,000 per year in Ohio, where I have my other single family, already with a property manager I trust, I was all in. Soooo, now fast forward to Aug 4th of 2015, and yes, I have control of over $4,000,000.00, 2 personal residences valued at over $1,100,000.00 in equity combined, 6 condos in San Diego, valued currently at $1,500,000, 8 single family in Ohio valued at $300,000, those have no mortgages. 3 apartment complexes in Ohio vslued at $1,600,000 appraised value this month. Soooooo, when adding, I come up with $4,500,000 in total real estate. Due to our personal residences having $600,000 in Equity, Ohio single family we paid cash for that $300,000 in value, $600,000 equity remaining in my six San Diego Condos, and $450,000.00 down payment money for the three Apartment Complexes in Ohio, Sooooooooo, the total net worth is about $2,000,000,00. My success is primarily due to buying low in San Diego and riding the wave,. The real X factor is moving dead equity into higher cash flowing properties. Specifically, Apartment Complexes. I love the control this gives me to increase NOI. Thus, the banks say I have increased the NOI, increasing the value of the complex. Two years later, 1031 exchange and use all that appreciation to buy a bigger complex and do this again and again. Defer and increase deferred cash flow. Keep repeating this process until you die and your kid or kids inherit at a stepped up basis. This all was due to investing in San Diego real estate, before Warren Buffett came out and said, if he had management and systems to match he would buy over 150,000 single family. People here thought I was making a big mistake. Why buy when it is sooooooo low. They said property values will never go up like that again. I was buying for cash flow at the time. Appreciation just happened. I recently heard that people with low 600 credit scores and under 600 credit scores are getting loans again. Based on history, California will be the first to have prices Real Estate prices to escalate rapidly and also the first to plunge rapidly. I will sell all my pricey San Diego rental property in the next 12-15 months. We should be at an unsupportable peak at that time. That means not enough high paying jobs to support that price level. I see soooooooo many million dollar or greater homes out here it would make your head spin. Those same homes were going for $700,000.00 or less 4 or 5 years ago.

        Regardless, without us slowly purging our IRA and 401K, this never would have happened. By January 1st, we should have $144,000 cash flow per year and we still have 6 rental properties in San Diego that we will trade in by 1031 exchange in the next 12-15 months. The plan is to continue this business plan and in 7 or 8 years time have approximately $50,000,000.00 in total worth of all Real Estate. Also our net worth will be approximately $16,000,000.

        If you reach for the stars, you may not get there. However you may grab a handful of clouds. Certainly, you won’t grab a handful of mud!!


        Isn’t life grand!!

        • Brandon Hall


          This was the explanation I was looking for. First off, congrats on the success. That’s a heck of a story.

          You have to realize that you were uniquely positioned to take advantage of a down real estate market. Not many people who are looking to cash out their 401(k)s are in the same position, especially in today’s environment. You made a great move, but it’s one of those VERY rare times when cashing out makes sense.

          On the tax deferred cash flow: be careful getting too comfortable. Eventually, your tax shelter will run dry (deprecation/amortization) and you will be stuck with large cashflow that you can’t protect. You may find yourself heading towards a higher tax bracket toward retirement. Even if you 1031 exchange, your cost basis does not increase, meaning you can’t take more depreciation. So now you are 1031ing into bigger properties that produce larger cashflows but you can’t shelter that income.

          Not to say it’s not a great strategy, it certainly is. Just understand what’s coming!

          Thanks for your contributions!

        • Lili Ofulue-Eze

          Hello Swarny,

          I live in California and I am just starting out. I have been seeing good deals in Ohio. Please tell me what area is the best place to invest in Ohio.


        • Lorin k.


          Why did you pick Ohio as a state to buy real-estate? Are you interested in funding other investors So you do not have to do all the hard work of maintaining these properties? I am on the hunt for a investor to get me started. I have found properties that were cheap at the time but did not have the financing to buy them at the time.

  6. Susan Maneck

    If you do any self-employment for which you receive a 1099 you are eligible for a Solo40K. What I did was roll my IRAs into the Solo401K. The advantage of a solo401K is that the issue of having to pay it all back if you lose your job never arises. It is also cheaper and easier to manage than a self-directed IRA. While I was looking for investment property I found a house I liked so much I bought it to live in myself with a loan amortized over 15 years. The house was only 30K and I pay myself about $250 a month. I then rented my old house for $830 a month. I also bought two other properties which I hold within my solo401K. Oh, and I loaned myself 15K more from the solo401K so I could pay off a credit card which I had used to buy another house outside of the IRA. Of course if you buy property within a solo401K or a self-directed IRA you can’t take out the rent until you are 59 1/2.

  7. Kevin Entner

    My own story and experience…

    In 2005 we cashed in a $240k 401k (netting about $168k) and used the proceeds to help purchase a 9-unit apartment building for $700k. In 2008 we refinanced that property (which is now a 10-unit after adding an additional permitted unit) and pulled out most of our original downpayment to purchase an 8-unit building. In 2012 we refinanced the 10-unit building again, pulling more cash out to pay down other real estate related debt. Today that $240,000 has grown to approximately $900,000 in equity, including our equity in the 8-unit building as well. We also see about $3200/month in cash flow from those two properties.

    In 2011 we cashed in another $150k 401k to purchase two bank-owned condominium units. Today, those units are worth approximately $250k and cash flow about $1,300/month.

    Those units are not the only ones we own, but the cash flow from them, along with our other properties, allowed me to semi-retire when I was 49 (I’m now 52). I say semi-retire as my wife and I manage our own properties. Had I left the money in our 401k’s, I certainly wouldn’t have been able to do that. We still have two other retirement accounts worth about $300k that I keep eyeing, but have decided I will probably leave alone to diversify a bit. But who knows…

  8. Ronald Perich

    A couple of nice examples where cashing in the 401(k) made sense for some folks.

    I am not a fan of the 401(k) for a person looking to actively work on their retirement. On paper (and I eagerly await Brandon’s next post), other investments including REI can significantly outperform this choice – even with an employer match. I recently uploaded a spreadsheet that shows why.

    However, I caution us to remember that the examples above are from individuals who are taking an active role in their wealth building. Unfortunately, most of society does not take such an active role.

    Something like 80% of 401(k) participants did not make one election change last year? They simply set and forget.

    For those of you thinking of starting a REI career, and think cashing out your 401(k) is the way to go, you best be ready to work at it from this point forward. Because if you are like most people, six months from now you’ll have no properties and have spent the money on something else.

    For those willing to work at it? Cashing out is akin to taking a pretty hefty hard money loan. Only difference is you are only paying points up-front and no interest in the long run (other than lost earnings, which you should make up for with the new investment).

    I personally like the loan option, if available. Much more flexible and you are returning the money back to yourself. Short term pain is made up for by the long-term gain.

  9. Shar Day

    The second option came in very handy for me, borrowed against my balance on a 4 year timeline @ about 4.25% interest rate. It was a last minute option for me when the bank wanted proof the funds was coming from my own personal savings. Am 2 years into paying back. Payments are automatically deducted from my pay before I get it.

    With my payment options, a payment plan can be setup if I happen to leave the company. One downside I see is, once you get the loan you can prepay it down, but it has to be the full balance at the time of payment. So if I have an extra grand or so, I can’t pay down the balance unless i’m willing to pay the whole balance.

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