Growing Your 401k vs. Liquidating it to Invest in Real Estate: What’s More Profitable?

by | BiggerPockets.com

Should you liquidate your 401k to start investing in real estate? This question has frequented the BiggerPockets forums over the past few years, eliciting mixed answers.

Most financial advisors and older folks will tell you that it’s better to contribute to your 401k and let it grow tax-deferred. Meanwhile, the younger folks in pursuit of early financial freedom are skeptical of this advice—and rightfully so.

The thought the young folks have is that if you are in your 20s and in pursuit of financial freedom, it is likely you will be financially free well before you hit the age of 60. Therefore, the amount in your 401k will not really matter. It will just be an added bonus as you hit your “golden years.”

As a Millennial, my initial thoughts aligned with these young folks. However, I do highly regard the advice of my elders, so before fully advocating for this, I figured it would make sense to do an analysis to see if the numbers make sense and to explore some other options.

In the first part of this article, I show you the analysis I performed comparing what your annual returns would need to be as a 25-year-old taking out your 401k to start investing in real estate.

You will see that at first glance, it may seem to make sense to liquidate the 401k, but be sure to keep reading, as there are better options. As a disclosure, I am neither a financial advisor nor a CPA. I am just obsessed with the notion of financial freedom and love exploring ways to expedite the journey.

Related: How to Use Real Estate to Retire MUCH More Comfortably Than Your 401K Would Allow

Let’s dive in to the analysis.

Assumptions

  • Age: 25 years old
  • 401k Balance at Year 0: $15,000
  • 401k Return: 7% assumes 401k is held in stocks, bonds, mutual funds, etc.
  • Income Tax Rate: 30%
  • Capital Gains Tax Rate: 15%
  • Withdrawal Penalty: 10%
  • Annual Contribution to 401k: $3,000 pre-tax
  • Annual Contribution to Other Liquidated 401k Investments: $2,100 because you save 30% less after the assumed 30% tax
  • Tax Savings from Reducing Income by Contributing to 401k: invested and earning 7.0% annually

The Analysis

At 25 years old, you are probably taking your first steps in your journey towards financial freedom. Age 60 seems very far away, so you are likely tempted to take that out now and use it to expedite your journey towards financial freedom—especially after seeing the two tables below:

*Calculated by (Investment balance x Tax Rate) + (W2 Savings – Taxes Paid on Gains)

*Calculated by (Investment Balance – Annual Contributions) x Capital Gains Tax

**Calculated by (Taxable Return Exclusive of Contributions + Contributions)

Given the assumptions mentioned above, the 25-year-old will have to earn 8.50% annually on his/her liquidated 401k to achieve the same type of returns as they would on their current 401k.

Is this achievable? Absolutely, especially with the wealth of knowledge here on BiggerPockets and the four wealth generators of real estate.

Hold on a second, though! It’s not black and white. Liquidate it or leave it. There are other things to consider including in your reserves, as well as other creative ways you can reap the high returns of real estate, tax-deferred.

First off, the reserves.

In order to qualify for any conventional-type loan that is sold to Fannie or Freddie, you need to have a certain amount of months of reserves (or liquidity). Lenders consider your 401k as part of your reserves, so losing ~40% of it through liquidation will be a huge hit. Not only that, but using what you have left for a down payment will be a double kill.

There is a high probability that this will either prevent you from taking out a conventional loan or at the least increase the cost significantly.

But don’t worry. There are better options.



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

The Best of Both Worlds

In the analysis above, we assume your 401k is handled by a financial advisor and is diversified amongst a plethora of mutual funds, index funds, bonds, stocks, etc. that garner a return of 7%. The analysis suggests that despite the tax-deferred earnings, there is a high probability that you can attain a better annual return on a liquidated 401k (8.50%+) by investing it yourself.

Fortunately, there is a way for you to invest in these same high-yielding assets (i.e. real estate) with your 401k without taking the penalty. Rather than having your 401k held with a financial advisor and being diversified amongst asset classes that return ~7% annually, you can move it to a self-directed IRA or a solo 401k to manage yourself. With these self-directed accounts, you can invest in almost anything. Even real estate.

Notice how I said almost anything. The one limiting factor is that you cannot get a conventional recourse loan with your 401k. That means that the low-down payment, owner-occupied loans are not available. In other words, you CANNOT house hack with your 401k or self directed IRA. This is for investment property only so most lenders will require at least 15% down and sufficient cash flow.

But Crraaaiiiigg, I WANNA HOUSE HACK.

House Hacking with Your 401k

Good news! You can! Despite what I said above, you can still use your 401k to house hack. Just not directly.

How?

You can give yourself a loan from your 401k for the lesser of $50,000 or 50% of your 401k’s balance. This can help with your down payment on a house hack.

You will be paying your solo 401k interest of approximately 4.0%. This is certainly not the best use of your 401k money, but if you do not care much about the balance of your 401k and are looking to invest in real estate to achieve early financial freedom, this may make sense.

So, rather than going ahead and liquidating the 401k, use it to your advantage. The net proceeds you would get when taking it out and when taking a loan against it are almost equivalent. Still, by taking a loan against it, you are not getting penalized and your 401k is still growing tax-free.

Warning! Before making the loan request, be sure to talk to your lender. Taking a loan out against your 401k does reduce the amount of your reserves and therefore may impact your ability to get financing.

So, What Should You Do?

First off, I need to disclose again that I am neither an accredited financial advisor nor a CPA. I just love this stuff. While I am sure there are many ways to creatively use your retirement funds, I am sharing with you what I have learned and what seems to me are the most plausible scenarios.

The most optimal way to use your 401k is to either move it into a self-directed IRA/solo 401k or to take a loan out against the funds to help you invest in real estate. Which of those scenarios to choose is entirely up to you and dependent on your goals.

If your goals are to accumulate maximum net worth, then the self-directed account makes the most sense. Invest the solo 401k/self-directed IRA in real estate (or other higher yielding assets) tax-deferred. This way, you can experience both the phenomenal long-term returns of real estate as well as tax deferred growth.

If your goals are to attain early financial freedom and you don’t care much about the returns of the 401k, it makes more sense to take the loan out against your 401k, use the proceeds from the loan to assist with your down payment, and pay your retirement account a relatively low interest rate of ~4%. Depending on the balance of your 401k, this will free up to $50,000 for you, which will be more than enough to get started on a house hack.

What’s your strategy of choice when it comes to the 401k—and why?

I’d love to hear from you in the comments!

About Author

Craig Curelop

After developing a huge love for real estate investing and personal finance, Craig decided to join the BiggerPockets team as a financial analyst. Over the past few years, he has looked at hundreds of financial models of startup companies. His experience will help BiggerPockets reach the next level as a startup company. Craig has a passion for helping others get out of their “comfort zones” to get what they want and achieve the “impossible.” In his spare time, Craig enjoys traveling, hiking, exercising, and sports of all kinds.

92 Comments

  1. gino barbaro

    I blew up my 401k and invested in a terrific deal. I paid the 10% penalty but had write offs to eliminate the tax. It is a very individual decision. If you have a great deal, then consider liquidating. If you have not started a 401k, consider putting money into savings.
    Read the book by MJ Demarco Millionaire Fastlane. Great book on financial freedom.
    The prognosticators want to have you believe 8% over 50 years. Good luck getting 8% for 5 years.

    • Craig Curelop

      Thanks for the comment, Gino! Sounds like you made the right decision, but many times it is tough to tell at the time whether that decision is right. If you took a loan out against the 401k instead, wouldn’t you be able to invest almost the same amount of money while experiencing similar returns while still keeping the 401k?

      Also thanks for the book recommendation. Millionaire Fastlane is a great book! One of the ones I couldn’t put down.

    • Paul B.

      Actually, it’s much easier to get an 8% return in the stock market over a longer period of time, based on past history. A five year period is not always enough for a good return, which is why one should put money they’ll need within five years in the market. But over a 50 year span, the average returns are often something like 8%.

      • Craig Curelop

        Paul,

        Are you considering all of the factors to increase your return in real estate? If you purchase a property all cash and are just counting on the appreciation, then yes, the market is probably better. But if you us leverage (3.5%-20% down), while taking into account cash flow, tax savings, loan pay down, and appreciation, you will be certainly making more than just 8% on your money.

        • Paul B.

          Craig, I was only commenting on the stock market, not comparing it to real estate. A good real estate deal should return much better than 8%.

          I suppose I should have been more clear that when I said it is “easier to get an 8% return over a long period of time” I meant “easier as opposed to a short period of time, since the stock market is volatile.” Not “easier to get an 8% return in the stock market as opposed to real estate.”

  2. Nate Reed

    A caution on 401k loans: loans are paid back with after-tax dollars. If you borrow pre-tax dollars, you will be taxed twice: once when you repay the loan, and once again when you receive a distribution in the future. I really hate the idea of being taxed twice, so just thought I’d mention that.

    Also, there are issues with buying real estate in a self-directed IRA. If leverage is employed, then you might be subject to UBIT and/or UDFI. I’ll leave it to readers to Google for more info. If leverage is not employed, then you are losing one of the most amazing benefits of real estate. Plus, when you purchase real estate in a retirement account, you are giving up the tax deductibility of depreciation, which is another great thing about RE.

    • Darin Anderson

      The double taxation issue is always cited by financial advistors as a reason not to do 401-k loans but it is simply not a real issue because people don’t think through the alternatives. If it was a real issue it would be worse than the alternative but it is almost always equal to or better than the alternative.

      1. If you are borrowing from the 401-k to lend to your real estate business then you get to deduct the interest you paid from your business income. So it is not repaid with after tax money. No double tax. That one is simple.

      2. However if you are borrowing from your 401-k to do something not tax deductible then you are paying back 4% to your 401-k (which will get taxed again). However your alternative is to borrow the money from a bank or credit card or private lender and paying them likely considerably more interest also with after tax dollars. So your personal bank balance will be less after paying higher interest and your 401-k balance will grow by the 4% interest you paid. The fact that the interest you paid in is going to be taxed when you pull it out does not matter when compared to the alternative? The interest you paid to the bank or the credit card was also taxed so there is no difference?

      The easiest way to see this is to do a thought experiment. Lets assume stock market returns of 4% for the year so that the results are comparable purely based on the tax ramifications and not based on investment returns. Presume a 100K 401-k balance that you borrown 50K at 4% interest for 1 year. Further lets assume a 10K personal bank account balance with no other income or expense. At the end of 1 year you repay the full 401-k balance.

      50K in 401-k invested in stocks at 4% return plus 50K loan at 4% interest = 401-k balance of 104K
      Personal bank balance after paying 2K interest = 8K.

      Now lets say you borrow the 50K from a bank at 6% and leave all 100K in the 401k to grow in the stock market.

      100K in 401-k invested in stocks at 4% return = 401-k balance of 104K
      Personal bank balance after paying 3K interest to bank = 7K.

      So the 401-k loan option leaves you with a higher total net worth and the same amount of money in your 401-k that will need to be taxed in the future. The fact that the interest was paid back with after tax money and is supposedly double taxed is a completely irrelevant red herring that advisors always list as a reason not to do a 401-k loan. I don’t blame you Nate for listing it. You are just repeating what you have heard from financial advisors for years. It is very frustrating to me that they keep repeating this and convincing people to believe it when it is so demonstrably wrong.

      (notice if the bank loan was at 4% same as the 401-k then the personal bank balance is 8K and its a complete wash).

      The only potential downside to the loan is that if you left it in the stock market perhaps it would have returned you better than the 4% return you are paying back to yourself. That’s the option that should be listed as the downside but it is the only one that is real. The supposed double taxation issue is not a real issue. It’s just one of perception that sounds so real when you hear it that almost everyone accepts it without working through the details to see that it is wrong.

      • Nate Reed

        A credit card or bank loan is not the only alternative to a 401k loan. There are others:

        1) Use your cash savings.
        2) Don’t contribute to the 401k, thereby avoiding the 10% penalty of an early withdrawal. Pay the taxes today instead of tomorrow. That will increase the amount available in #1.
        3) Leave your job and liquidate the 401k. Pay a 10% penalty for failing to save enough after-tax cash to fund investments that beat the 401k.
        4) Sell other investments.

    • Cindy Larsen

      Nate,

      I agree with most of what you said, but, regarding the tax deductability of depreciation being “lost”by investing from a retirement account, you are not actually loosing anything.

      Disclaimer, I am not a tax orofessional nor a financial advisor.

      If you invest outside of a retirement account, your Net Operating Income is taxed at whatever your ordinary tax rate is. Depreciation is deducted from your NOI before it is taxed, so yes, you pay less taxes. However, investing from a tax free retireement account (Roth IRA) or a tax deferred retirement account (401k), you pay ZERO taxes on your NOI.

      Example: Your Marginal tax rate is 25%, and your Income on a 4 plex property is $48,000.
      You don’t get taxed on the whole $48000 because you get to deduct a whole list of things: property taxes, expenses, mortgage interest, and depreciation.
      Depreciation = (purchase price)/27.5, which is almost 4% of the purchase price.
      This is cool, because, unlike all other deductable expenses, you don’t pay anything out of pocket for depreciation, you just get to take a deduction. This ismpart of what make leverage so cool. If the property cost $500k, and you put $100k down (20%) each year you get to deduct $500,000/27.5 = $18,181.18 from your rental income before it is taxed. Since your are in the 25% tax bracket, depreciation saves you $18,181.18/4 = $4545.30 on your taxes in that rental income. This is almost a fourth of your downpayment, each year! So, maybe you only end up paying taxes on $8000 of your $48,000 rental income, after all the deductions. And the property only adds $2000 to your tax bill that year.

      The bad news is that when you sell the property, all of the accumulated depreciation is added to your taxable income in the year of sale. if you keep that property 10 years, and then sell it, you would have accumulated $181,818 of depreciation, which would then be taxed, as part of your income that year. Due to the high tax bracket this would put you in, you would pay far more tax than the taxes you were saved from paying by depreciation. This is why people do 1031 exchanges, to avoid depreciation recapture.

      Investing from a retirement account, that same exact property, unleveraged, would add zero $ to your tax bill. Just like if you invested in the stock market, your gains are tax free.

      You can use leverage from within the retirement account. If you do, the amount of your rental income that can potentially be taxed is porportional to the amount of debt. In our example above, you put 20% down, so 80% of the value of the property is debt, and therefore 80% of the rental income is potentially taxable income: this is what UDFI or Unrelated Debt Financed Income means: the part of your rental income portional to the debt on the property. As your equity increases, the percentage if the income that counts as UDFI decreases. The UDFI is taxable, but, the first you get to apply of all those same deductions to that income.

      So, in our example, 20% of the $48,000 income is not taxable, but the remaining 80% = $38,400 is taxable. After we apply 80% of our deductions, including 80% of the depreciation, we end up with 80% of the taxable income we did before: $8000x.80 = $6,400 of taxable income instead of $8000.

      Now the bad news: UDFI is not taxed as ordinary income: it is taxed using a different IRS tax table, called UBIT or Unrelated Business Income Tax, which has much higher tax rates. So, the first few years, until you pay the loan down some, you might want to arrange to make your taxable income be smaller, by investing some income back into your property: do more repairs the first few years of the loan, and some small capex investments (any individual purchase less than $2,500, (appliances for example, or flooring) can be 100% depreciated in the year the item is purchased. After all this property is in your retirement account, you cant get at the profits anyway.

      Meanwhile the principal part of your mortgage payment reduces the UDFI. Notice that the principal accumulated on a leveraged property is being paid from by the rent the tenant is paying: in effect, the tenant is contributing directly to your retirement account. When your equity is at 25% instead of 20%, then only 75% of your rental invome is UDFI subject to UBIT. The other 25% of the income is tax free.

      So, my strategy is to improve the property, reinvest any profits into paying down the mortgage, and eventually have the entire property generating income, tax free. Along that path , if the property appreciates significantly, you can have it appraised (paying the fee from your retirement account, of course), and the UDFI percentage will change: In our example, if the $500,000 appreciated by $100,000, over a few years it is now worth $600,000, but our debt of $400,000 has bee paid down by $40,000 through standard mortgage payments, and additional principal payments from rental income profits.
      This means that the debt of $360,000 is now only 60% of the property value. So the UDFI is 60%.

      Without leverage, you probably couldn’t buy this property from your retirement account: with leverage, you can. If you put your profits into improving your property, you minimize the taxes on the leveraged part of your property, and force appreciation, which minimizes you taxes still more. And your equity grows, as does your ROI.

      Even better, than leverage, you can invest together with other people’s retirement accounts, instead of borrowing from the bank. For example, if 10 people each invest $50,000 from their retirement accounts to buy that $500,000 property, there is no debt, no interest to be paid, no UDFI or UBIT. And the ROI is amazing, and tax free forever if you do it from a Roth IRA. And depreciation becomes irrelevant.

      • Nate Reed

        @Cindy Larsen: Sounds complicated. 🙂 Just investing after-tax dollars is straightforward. With 1031 exchanges, it can be just as good as a Roth, but without the restrictions and the UDFI/UBIT issue. You can start taking distributions whenever you want.

        “there is no debt”
        I can’t see doing any deals without debt. The ROI will always be higher with leverage.

        • Nate Reed

          I don’t want to completely discount the cost and effort of setting up a 1031 exchange. I’ve never done it before, but it seems to get done often.

          I agree Roth’s are great. That’s the only account type that makes sense for RE.

  3. Nate Reed

    Personal story: Liquidated a 401k and emptied most of my IRA’s last year to do two deals. The first one is a longer-term hold (mostly a yield play plus some value-add potential) and is paying me 6% right now. I hope to double my investment in 3-5 years, but it’s too early to say whether it was worth paying the tax/penalties. The other one has tripled my equity ($70k to $210k) and I expect a return of capital in January, about one year after closing. I would not have been able to do these deals *and* leave my capital in retirement accounts.

    • Craig Curelop

      Nate, thanks for sharing! You will have to keep us all posted on the first deal.

      As for the second deal, it sounds like you are doing quite alright. Would you have been able to do JUST the second deal with either a self-directed retirement account or taking a loan against it?

      If the first deal only yields you 6%, then maybe the investment would not be worth the taxes. Let us know!

      • Nate Reed

        After my post, I realized I did not describe my situation accurately. While I could have invested in these syndication deals using a self-directed IRA, I did not like the disadvantages, which I pointed out in my other post. For me, the choice was whether to keep the funds in a retirement account or liquidate, pay the taxes and invest. The middle choice — using a self-directed IRA — was possible but comes with the following deal-breakers (for me):

        1) Can’t take income without penalties from the investment until 59 1/2. My goal is to have my passive income from my RE cover my expenses so that I can retire early.
        2) Have to deal with UDFI/UBIT taxation issues, whereas by investing after tax funds, it is possible avoid taxes on distributions completely by taking depreciation. If we sell, taxes would come due on the depreciation recapture. In an ideal world, the proceeds would go into a 1031 exchange and I would be able to defer taxes indefinitely. In reality, I probably will incur taxes 5-7 years from now when the properties are sold, although if we can get the partners to agree, we might be able to 1031 exchange using the partnership. For me, it’s worth it to be able to access the funds and do more deals that generate cash flow outside an IRA.

        These syndications were done by experienced investors and it has been very educational to be an investor and learn from them while they solve all the problems associated with the multi-family business. Eventually, I would like to take the refinance / sale proceeds from these and purchase my own deals, where I will have total control and can do 1031 exchanges when it comes time to sell and trade up, deferring taxes indefinitely. In 5-10 years, I could see being able to live off the income, whereas I will have to wait 20 more years to be able to start taking distributions from a retirement account.

      • Nate Reed

        @CRAIG CURELOP: “If the first deal only yields you 6%, then maybe the investment would not be worth the taxes. ”

        6% is the cash-on-cash return net of fees. The NOI is up and the value is on track to double, hopefully within 3-5 years. I am fairly confident that should pay the taxes/fees on the 401k/IRA distributions and leave some profits.

  4. John Murray

    I’m a very experienced and highly successful RI of SFH rentals. I’m a huge risk taker but would never transfer or roll a retirement account into an investment that is not highly liquid. The first rule of the investors whether worker bee or entrepreneur is diversification. At a young age to take all your eggs and place them in one basket is not a sound investment plan. I’m going to 60 soon and a multimillionaire, dollar cost averaging and taking huge risks with money that was already taxed. Investments that are not highly liquid can be a disaster to those that are not savvy, educated and worldly enough to know what is prudent.

    • Craig Curelop

      Thanks for sharing your wisdom, John! There seems to be a couple of different perspectives here. The most common is definitely diversification.

      To play devil’s advocate, I have also heard the approach of doing your research, become an expert in one specific asset class, and put all your eggs in that basket. That way you can get the highest return with little risk because you know so much about it.

  5. Terri Dyer

    My husband will be “retiring” in a couple months from his 9-5. We have been discussing what to do with his 401K. These are some interesting ideas and thoughts to check out before we decide.

    Can you take a loan out from your 401K once you have quit (since it was mentioned if you loose your job you may have to pay it back immediately)? Or must you cash it out or roll it over into something else? What would you do?

    P.S. He had saved 12% of his pay in “traditional” retirement for 15 years and had $0 monthly cash flow and almost $200,000 saved.

    He came to the “dark” side 🙂 with me and in under 6 years we now have gross rental income of over $6,000/month with most of all our houses paid off. And we have half a million in equity in real estate.

    Needless to say he no longer believes in traditional retirement and get’s fed up with being told when and how he can have HIS money and being penalized for taking it before some magical age. But we also don’t want to be over penalized for cashing it out, but if we can make double it in real estate, why not?

    • Cindy Larsen

      Terri,

      My understanding (not a financial advisor or CPA) is that you can’t borrow from a 401k unless it is the 401k from your current employer. However, you can become a business owner of an S corporation (The businees can be anything, and does not have to be full time: I tutor math) and your S corporation can have a solo 401k. You can rollover 401k funds from one 401k to another 401k with no taxes or penalties as long as the money goes from401k to 401k without you touching it. You have three roles with respect to your S corporation: owner, CEO, and employee. As an employee, with a 401k, you can contribute to your 401k, and you can borrow money from your 401k (I think it is the lesser or 50%of the money in the 401k or $50,000). Once you pay off the loan, you can borrow it again, and again.

      You might also want to gradually convert the 401k to a Roth IRA, because when you turn 70, they will make you take Required Minimum Distributions, so they can tax the 401k money. Roth IRAs can never be taxed. I take my 401k money out (amount = difference between my taxable income and the top of whatever tax bracket I am in) and pay tax on that amount each year, in order to get the money into the Roth IRA. Moving the money from 401k to Roth IRA is called a conversion. In retirement, I will have tax free income from real estate investments in my Roth IRA.

      • Craig Curelop

        Hey Terri,

        Thanks for mentioning this! And I’m glad you knocked some sense into your husband :). I couldn’t agree with you more. I’ve got a pretty sizable 401k for someone my age (thanks to a company match), but thankfully I have made very few contributions without the company match. It’s also great to hear how successful real estate has been for you.

        If you quit or get fired, you will likely not be able to take a loan out against your 401k if it’s with an old employer. You can either transfer it to your new employer or do a self-directed account, which you then can take a loan out against.

    • Curt Smith

      You can roll an employers 401k to a Self Directed IRA and buy rentals, do hard money loans etc. Which is what we did and grew that nest egg to 4x in 6 yrs and now throwing off $6k / mo in cash flow, from one SD-IRA account funded from an employer 401k roll over.

      • The 401(k) – The Holy Grail

        Candidly I am amazed at how many people who have responded to Craig’s post consider the Company 401(k), as opposed to the Individual 401(k), some form of Holy Grail.

        The phenomenon reminds me of the movie, “The Wizard Of Oz” where the citizens of an entire kingdom, the Emerald City, cringe at the dictates spewed by the image of the almighty Oz projected on a screen. That is until “Toto,” Dorothy’s faithful companion pulls back the drapes to reveal nothing more that a little man manipulating levers.

        My POV is Wall Street is the little man (perhaps better said “Big man”) behind the screen who for decades has convinced 30 million people that the 401(k) is the “Oz” of all retirement plans. And just like the citizens of Emerald City, few of these 30 million 401(k) owners consider questioning the almighty Wall Street Oz or their Employers why they believe in, and so passionately, promote the 401(k).

        If you asked a typical Company 401(k) owner, if there is such a person, how long the 401(k) has been around you would probably hear a wide range of answers. Many would undoubtedly say a “Long, long time”. Perhaps so long of a time few remember when the Company 401(k) owner came into being and what or who created it

        The answer will probably surprise you and would likely stump most contestants on Alex Trebek’s Jeopardy Show.

        The Birth Of The 401(k)

        In the 1970s a group of high earning individuals at Kodak Inc. convinced Congress to allow a part of their salary to NOT be taxed if they invested in the stock market. The idea was to basically allow them to use highly taxed income to buy more stocks by shielding the income from taxes. The taxes would be paid at a later date when the Executive had retired and in theory in a much lower income tax bracket.

        For reference in 1980 Jimmy Carter was President and the highest tax bracket was 70%. Reagan brought the highest tax rate down to 50% which was still much higher than the current 39.6%.

        Using tax sheltered income dollars was a great idea and you can’t blame high earning executives for wanting it. The end result was Section 401(k) being inserted in the tax regulations. Originally the 401(k) was designed exclusively for the benefit of highly paid Executives, not the working class.

        The Company 401(k) available to millions of working Americans today is a section in the Internal Revenue Code whose origin was more by accident than design.

        The introduction of the 401(k) to the working class is credited to Ted Benna, an Attorney and Benefits Consultant, who in 1980 applied his interpretation of the law to create a 401(k) plan for his employer. It allowed full-time employees to fund accounts with pre-tax dollars and if willing, the Employer could proportionally match up to 100% of the employee contributions.
        Benna persuaded the Internal Revenue Service to change a few proposed rules under the law that resulted in the wide spread adoption of 401(k) plans by employers beginning in the 1980s.

        In the beginning employees could contribute 25% of their salary, up to $30,000 per year, to their employer’s 401(k) plan. The maximum allowable today for a 401(k) contribution is $18,000.

        Why would Employers want to embrace the 401(k)? This is a great question and the answer is illuminating, especialliy when we know from experience Employers often have rigid comfort zones and resist change to the entrenched “Status quo”. Economics 101 tells us when corporate Shareholder dollars are demanded they aren’t given up easily.

        The Company 401(k) available today to most of the US work force enables the Employer Sponsor to avoid offering a much more retsrictive and expensive “Company Pension Plan” with “Defined Benefits” that must be funded by the Employer

        Fast forwarding from 1980 to the present, how did the 401(k) for the working masses turn out?

        A few years back Mr. Benna had this observation when he told Workforce Magazine:

        “I knew it (the 401(k)) was going to be big, but I was certainly not anticipating that it would be the primary way people would be accumulating money for retirement 30 plus years later”.

        How does Mr. Benna feel about his brainchild n a 2011 Smart Money magazine interview? Mr. Benna stated:

        “My creation is a monster”.

        Unfortunately, few Amercans will ever hear these words that might prompt them to question why Mr. Benna would make such a statement.

        And Wall Street isn’t about to inform the public that the very creator of the 401(k) has serious reservations about its effectiveness. To do so would “Kill the Goose that lays trillions of dollars of golden eggs”.

        Wall Street has invested tens if not hundreds of millions of dollars re-inforcing the idea that the 401(k) is the flagship of all retirement plans. And for good reason, with Management and Transactional Fees ranging from 1% – 3% and more, when assessed against trillions of dollars the resultant Fees and Commissions are both lucrative and staggering.
        Wall Street is the undisputed Titan in the financial world and has yet to be seriously challenged for its lucrative fees routinely extracted from 45,000,00 IRAs and 30,000,000 Company 401(k)s.

        However, the “Rich” have used an alternative strategy that eliminates the “Risk” or downside of Wall Street and generates “Tax Free” money during their liftime and at their death.

        Unfortunately, it isn’t an IRA or 401(k)

        And unfortunately, it isn’t real estate.

  6. Rachel Steenland

    For a while I’ve been considering tapping our 401k but for now I’ve decided to leave it investing in the stock market as I currently prefer to have a diversified portfolio… i.e. not all my eggs in one basket … time for I’ll tell if I change my mind LOL

    • Craig Curelop

      Hey Rachel,

      People definitely have different risk profiles. Some people wish to diversify (less risky) while others like to put their eggs in one basket (more risky). However, I don’t think the answer is black/white. Take it or leave it. I think intelligently using your 401k to achieve financial freedom quicker makes a lot of sense.

  7. jay esk

    Sorry,but if i may be straight tot he point, I think this advice is reckless and incorrect.

    I know we are mostly here to discuss real estate but you don’t have to be pro real estate to be anti stock market. That is a common mental (cognitive) mistake that many investors get into. Different asset classes perform differently in different markets over time. And there’s a spectrum of active vs. passive. Real estate people almost always pitch the dream of “passive cash flow” but the reality is that really only exists in the stock market. Is your rental property really passive and requiring no effort? No, definitely not. So it should be an “either-or” about real estate vs. the stock market. If you have a 401k option you should take it first. Most people that want to get rich quick in real estate might not be properly evaluating risk, so it’s good to have a solid 401k foundation as part of your overall investment portfolio, assuming you are managing that portfolio correctly.

    Your assumptions are incorrect because they don’t reflect: 1. Tax savings over time as you make more money and are taxed at higher rates. 2. Higher contributions amounts to maximize the tax advantages (e.g. max contributions of $18k or higher vs. the $3k in your example), 3. Company matching money (FREE!) and 4. Possible savings on federal income tax brackets – 401k contributions can lower your overall tax rate and then you also get a marginal savings too.

    Over time, assuming you are doing well in your career, you will be making more money and presumably going up to higher tax rates so the tax deduction increases over time. And as you start working for better companies you will get a higher match and other tax benefits. Many companies will match 3% of your contributions or higher. So you end up with a massive tax advantage that compounds over time, passively!

    Example – lets say you are making $100,000 and your companies does a 3% 401k match (very common in corporate America to get a match of up to 6% of salary). You can do your max 401k contributions of $18,000. And then with a 3% match of your salary the company is contribution $3,000 to your 401k. So now at the end of the year you have $21,000 in your 401k, to invest per the options in your plan.

    As a result of your contribution, you are dropping your federal tax rate from 28% (91k-190k) to 25% ($37.6 to $91k) so you are also saving on taxes too.

    (Analysis – you have saved at least $5,000 in taxes and you got $3,000 from your employer, so you are already up basically $8k, separate from how your investments perform).

    Also…Currently in 2017, the max 401k amount is around $18.5k for most IRA’s but this can vary depending on a lot of factors (e.g. if you are self employed and make a lot of money you can put up to ~$55k away annually depending on how your business and 401k are structured). And there are ROTH IRA options that further these tax advantages too.

    There are so many easy tax savings here….please keep them in mind and use them to grow your wealth, separate from real estate.

    • Craig Curelop

      Jay,

      Thank you for your comment! You have some very valid points here and I would like to address each one individually.

      First off, this article was meant for the person who is in their mid 20’s and in pursuit of financial freedom. They are looking to perform their first house hack and have a 401k that they are unsure of what to do with. This article was meant to help them show what they can do to either increase their net worth or two expedite their way towards financial freedom.

      I agree with you that real estate has some sort of “activeness” to it. Even if you have a property manager, you need to check in on the manager. However, one would see far better cash on cash returns over the course of 20-40 years if invested in real estate over the stock market. When investing in real estate you can leverage up to 5x what you put down. If you are taking the loan out against your 401k and house hacking, you can purchase a $400k property with under $20k down. You can’t do that in the stock market. Over the course of the 40 years, you will not only see appreciation of the property, but you will be paying down your loan all while receiving monthly cash flow (i.e. dividends). This simply is not possible in the stock market.

      The assumptions do reflect tax savings over time. See the line that says “Accumulated tax savings.” The reason why I kept it at $3,000 per year is because the average American makes ~$50k per year and puts ~6% towards their 401k. Most Americans do NOT make enough money to max out their 401k. This does not take into account any company matching. Of course you take the free money if it is presented to you!

      Saying the assumptions and calculations are reckless and incorrect is in fact….reckless and incorrect. Everyone has different strategies and not many people can afford to put $18k into their 401k each year. Also, the average American makes ~$50,000 per year. Will that go up over time? Sure! But so will inflation and other cost of living expenses. That is why I did not include that in the calculation, another variable that makes things confusing.

      Again, this is a broad calculation so assuming a tax bracket drop could be different from one person to the other.

      Additionally, the points you bring up are great points for those looking to solely increase their net worth. But for the young folks in pursuit of financial freedom, it likely makes more sense to take out a loan against the 401k.

      Thank you again for this well thought out comment! You definitely brought up valid points we should all think about!

      • Brandon Hall

        Why was a 30% tax rate used on an assumed $50k of income? That person would be in the 15% or 25% tax bracket depending on filing status.

        I liked the article. I’ve written about this in the past around roughly the same idea. I’m doing so, I learned two things: (1) always scale your variables with expected increase in income – otherwise people will point out that the analysis is not realistic; (2) don’t debate people (as hard as that is for me to say as I’m an ENTP) as they will latch on to minute details and try to derail you. Thank them for their insight and save your energy 🙂

        • jay esk

          Ah lets just kept the point simple – the tax advantages of the 401k INCREASE as you make more money (bigger tax breaks, you can contribute more which increases your tax break…and depending on your situation may also lower your overall tax break)…and of course compounding over time.

          I think there is too much all-or-nothing “i’m All in on real estate” and think it’s important to articulate these things to people in their 20’s….so want to make sure people hear these points as I don’t think they are often represented here from what i’ve Seen so far.

        • Craig Curelop

          Thanks, Brandon. Lesson learned :).

          I was just going off the “average” American as opposed to the individual with a scaling income. And the tax rate depends on what state you live in. I was being taxed upwards of 40% while making ~$65k per year. However, this was while I was living in CA.

  8. jay esk

    Hey Craig – didn’t mean to insult you, this is my 1st post here. i didn’t really mean “reckless” i just meant incorrect on the calculations/assumptions. I think you are making the real estate case overly positive and not accurately representing 401k tax advantages.

    I made my money with the stock market and 401k things as i mentioned. I’m here because i’m Looking to invest in real estate. So i just wanted to provide a broader perspective.if there is one piece of advice i could give anyone in their 20’s it is this- “push yourself as hard as possible to max out your 401k contributions and automate them each year.”

    (Personally I would NEVER take a loan against 401k. That just means you are over leveraged. I’ve had friends in their 40s that have caused massive problems for themselves doing this. Eventually the stock market crashes and now you are underwater and don’t have the assets to back your loan, have jeopardized retirement, etc. maybe others will disagree with me, but i would never do this…too risky). And this goes against the notion of diversification too. I’m advocating that you do 401k 1st and then real estate. Versus all real estate. If you’re doing a 401k plan at work you are also doing monthly contributions so you are dollar cost averaging your contributions against ups and downs in the market and that helps provide additional safety measures too as it ensures you are getting shares at different prices (and then you will hope that market declines at points so you get to buy more shares!)

    Do the real estate/housing hacks with borrowed or leveraged money or one time bonus or separate savings pool. Or other one time event, etc.

    I understand your point about house hacking and leverage. And that makes sense. Yes i wish i would have done that in my 20s!

    But make sure you do the 401k every year and max out the tax advantages. They snowball and will accumulate massively over time.

    Historically, the stock market has outperformed housing by a wide margin. There are exceptions of course, but if you look for the data you’ll see extensive analysis that the average home price appreciation is on the magnitude of only 1% a year long term. Don’t trust my word on this, this comes from Robert Schiller. https://www.cbsnews.com/news/history-says-home-real-estate-is-a-bad-investment/ – (quick overview article).

    I think you misunderstood my “tax savings over time” comment. Assuming you are doing well at work, you should be making more money each year. So that should enable you to increase your 401k contributions even if you can only start with $3000. Any bonuses or salary increases you add to your 401k (or at least 50% of them). That’s an easy, essentially automatic way to keep increasing your contributions. As you make more money, you will eventually move up tax brackets and then you are saving more money with your 401k deductions per the math in my post above. The more you make, the more income tax you are saving….so this becomes a big deal because you are saving on income tax and maximizing your 401k contributions which are growing tax free for 20, 30, 40+ years and you’re able to take advantage of compounding interest/returns w/essentially zero effort.

    And then there are ROTH tax advantages…which are tax free. There’s a lot more to discuss there.

    • Craig Curelop

      Jay,

      Sorry, I might have been a little bit trigger happy as well. I was not offended by what you said, so no need to worry there. These discussions are great. The article would hardly be useful without these comments and different perspectives.

      To me, taking a loan out against your 401k is ONLY risky if you are not cautious with the numbers you are running. If you include the ~4% interest you are paying yourself back on the 401k in your numbers and your property can cash flow nicely. Then it does not matter whether the market goes up or down. Service your debt through the downturn and you should be fine.

      Admittedly, my calculation could have definitely been more robust and in depth by taking into account accelerated earnings, tax advantages, etc. However, my intention was to keep it as simple as possible so the less financial savvy pursuer of financial freedom could use and understand their 401k.

      Again, love the discussion and don’t feel as though you’ve offended me. It takes a lot to get under my skin. 🙂

      • jay esk

        Seriously still can’t disagree more. One of the reasons people underperform on investments is due to emotional reasoning. Often this includes the mindset there is some better deal out there. Also includes emotional decision making. There’s HUGE value in easy automatic decisions (A la David Bach automtic millionaire book). The 401k is a perfect example…should be done automatically. If you can save 10k a year that is 100k in 10 years and assuming historical numbers that will double every 10 years. 100,200,400, 800. 10k is a lot when you are making 30k or 50k but it still can be done. And over time your contributions increase so these numbers could easily be double.

        Also, i can’t tell why you are pushing this so much. Is this something you personally have done and have numbers to report on? I see a lot of idealistic perfect scenario thinking here. E.g. if economy is really bad, rents sometimes decrease.

        If you take a loan against an asset you can lose both things (e.g. market declines so stock goes down and now you have borrowed more than your asset…and housing declines in rent reductions/appreciation projections, etc.) – that’s incredibly risky, c’mon!

        I think this is painting a completely unrealistic picture for people in their 20’s and appeals to the “get rich quick” mindset which 99.9% of the time leads to very poor decision making

  9. Bob Ebaugh

    A case study. Starting in Jan 2014, we rolled 581,000 into a Solo 401K. We then fully invested (less operating reserves) into residential rentals. The portfolio has 8 properties and 10 rental units. The last property purchased mostly from retained rental income. No mortgages because as discussed, they are both difficult to get, and generally at high interest rates.

    We did this to generate income that would allow us an early retirement. Assuming we don’t have any December disasters, this portfolio will generate 75,000 in income, about 60,000 in cashflow, the difference being capital expenses. Projected ending valuation for 2017 is 1,110,000. Thats a 90% cumulative gain since Jan 2014, compared to the S&P 500 of 53% with dividends reinvested over the same timeframe.

    This is a lot more work than buying a S&P 500 ETF. But it’s far better than we ever managed in prior years with our 401K funds. Most important, it generates a predictable income stream we can use for retirement without having to worry too much about principal. Our initial objective was only a 7% return and appreciation if it happened, was a bonus. So far, largely due to both a great real estate market and rental market, we’ve done better than we ever imagined in the beginning. Our timing was exceptionally fortunate.

    Can this be repeated today? Probably not the next 3 years, the timing isn’t right. But with the stock market, timing is just as important. We only made about 5% over a 15 or so year period of time buying the Janus fund and American Century Ultra with a fixed investment every month. Our timing was really bad.

    I’m not sure my 2013 self would take the plunge today, but my 2018 self would do it again. Probably have to lower the initial target to a 5% return. The reason isn’t solid, but I really like having some control of my destiny, rather than leaving it all to Wall Street.

  10. Susan Maneck

    I did precisely what you suggested with my solo401K. I invested in properties for cash, plus I loaned myself money to buy my principle residence. I’m not hacking it, however. I’m 61 and too old for that. However, the drawback is that while this can be done with a solo401K it cannot be done with a self-directed IRA. And you have to have at least some self-employment income to qualify for a solo401K. I’m a professor but I do a little consulting on the side. That qualified me. Once I opened my solo401K I rolled my IRAs into it. For the record, I still have a great deal of retirement funds invested in mutual funds. And if you have a 401K or other retirement plan and work you certainly want to contribute up to the max. Another word of warning; taking a loan from a standard 401K is risky for reasons other than what you mention. If you lose your job you usually have to pay back the loan immediately or it counts as a distribution. With a solo401K you don’t have that problem because you’ll never fire yourself.

    • Bob Ebaugh

      I don’t think there is any reason to get too worried about the amount of self employed income needed to justify the business initially having a Solo 401K. There isn’t any stated minimum. What I’ve never really gotten a good answer for is how long that Business needs to operate. Fast forward far enough, and you probably don’t really want the business anymore. Can the 401K continue alone? For now, I’m assuming ending the business means liquidating the properties and transferring to an IRA. But I hope that changes.

      The other gotcha is this only works for someone without employees. Not just in the business that has the Solo K, but any other business partnership or LLC where you are a principal. Otherwise DOL rules require a full blown 401K offering equal benefits, and the flexibility we have in a Solo K likely not advisable.

  11. Cory Binsfield

    Interesting post Craig. I want to clarify a few things for the readers since it was not discussed.

    It’s stems around the taxation of retirement plans along with the intent of the young investor to attain financial freedom before age 59 1/2. This is the age you can pull money out without a penalty.

    You mentioned capital gains in your example. Money in a retirement plan is not subject to capital gains. It is taxed at ordinary income tax rates once you withdraw the money. This is one of many reasons why I do not recommend investing in real estate inside a retirement plan.

    Who wants to pay up to 39.6% to the Fed and another 10-12% to the state when you withdraw funds?

    As mentioned before, buying real estate in a retirement plan strips away all the key benefits of real estate. Here is a summary of what you lose.

    1. Can’t offset your W-2 with your passive losses from real estate. Due to real estate, my effective income tax rate is 1-3%.
    2. You lose the lower capital gains tax rate
    3. You lose the ability to leverage a stable asset in a tax effective manner.
    4. You lose the ability to 1031 exchange and defer taxes till you die
    5. You the ability to step at your basis in your asset for your heirs.
    6. Can’t reap the rewards of cash flow today because you can’t touch the money till age 59 1/2.
    7. You have to be extremely careful about self-dealing and prohibited transactions. I prefer the freedom of doing anything I want with the property.
    8. You can’t write off your loss if you end up in a terrible deal.

    Too add insult to injury, the investment becomes taxed at the highest possible tax rate once you are forced to pull money out at age 70 1/2 under the RMD rules.

    Ask any retiree what it’s like to pull $100,000 out of their 401k. It pushes their income tax bracket higher and forces them to pay taxes on their social security benefits.

    I agree that you are better off taking the loan. However, it is risky. You have to pay it back if you lose or transfer your job. If you don’t pay it back, you pay a 10% penalty and the loan proceeds will hit your tax return that same year-potentially pushing you into a higher tax bracket.

    In my opinion, the best strategy is to contribute just enough to get the free money match from your employer. Any excess funds should be used to purchase real estate. The real estate tax deductions will easily offset the lost tax benefits from contributing to a 401k.

    Plus, it helps you qualify for loans. Banks love seeing a 401k balance on your balance sheet.

    Finally, If you find a smoking deal, cash out of the 401k, pay the 10% penalty.

    Especially if your goal is to retire before age 40.

    • Craig Curelop

      Thanks for this comment, Cory!

      Ultimately, I agree with you. Take the Company match and save the rest. However, if you are in a spot where the Company does not match it, but still has the 401k, I feel as though it makes sense to either invest it through a self-directed IRA or take a loan out against it to help on a house hack (make sure the numbers work of course!).

      It doesn’t necessarily have to be purchasing real estate property. You can do invest in notes, tax liens, and other high yielding investments as well.

  12. Chris Watson

    Safety Nets are important. Cashing out a 401K might be okay for a 27 y/o, but not recommended for a 39 y/o. Why? Time! Do not let your emotions to be retired by age X make you actually work a decade longer. In looking at real estate deals there are several 1st and 2nd time investors loosing it all including their primary home because they got in over there head. One ethos I see repeated on BP by members is get to financial retirement at all costs FAST!!!

    You don’t need to be the hare or the turtle, but instead a reliable mule. One that keeps plugging away. While building capital do your research. When you think you have learned enough then start from scratch and learn again and begin networking. Develop a 5 yr plan and a 10 yr plan. Consider the 401K your safety net if realestate turns south for 5 yrs in retirement.

    Need extra income to start the your Real Estate Dream? Sell on Ebay/Amazon/Etsy or deliver Pizzas. I made $40K in 3 months flipping items on ebay/amazon this past fall. Then took the returns bought two properties from an REO auction for 10 cents on the dollar. While I am way over 6 figures in my retirement fund I took my time and worked like a mule and preserved my safety net. Meanwhile my 401K has exceed 20% return this year.

    • Craig Curelop

      Chris,

      I like your analogy of the turtle, hare, and mule. The culture here on BiggerPockets definitely does promote getting to financial freedom as fast as possible. Admittedly, I am probably one of the biggest proponents of that.

      However, I do make sure that I have a comfortable amount of reserves when I go into a deal to make sure I don’t fall on my face.

      I don’t think cashing out your 401k ever really makes the most sense unless you have the deal of the century and are guaranteed a phenomenal return.

  13. jay esk

    A 401k is’nt a monolithic “Wall Street” entity…you can control your asset allocation in a smart way – again that’s a point that i think is missed here. Like real estate people want to be anti-wall street. But there’s no “enemy” out there other than bad habits, right? 🙂

    Tom – yes a Roth has limitations but there is the “backdoor” Roth which basically allows anyone to make a $5500/year contribution regardless of income (google it for details). Not many people still seem to know about this. And there are other more advanced tax strategies which i’ve Only recently learned about. The mad fientist has written about this and TBH i’m Still trying to process his genius level post – https://www.madfientist.com/after-tax-contributions/

    In essence he suggests you can convert your ira/401k to a Roth and not pay any taxes if you stop working and convert it when your income tax is zero. He outlines a ways to convert your 401k to a Roth at that point. Normally you would pay taxes but in his method you don’t and then it’s all tax free.

    Or you can pay the taxes upfront and pay them now and then its tax free forever. Personally i did that and took a big tax hit and paid high taxes a few years ago when the IRS allowed you to take the hit over 2 years.

    The other advantage, in terms of family is that you can roll over the Roth to family and it can accrue interest free longer, which applies more snowball interest. I’m not an account/financial advisor so disclaimer there. But basically if you are 40 for example and have Roth, you can roll it over to your kids and then they don’t have to take distributions until they are 65. So then assuming 2 things: 1. Law of 72 as doubling and 2. 7% s&p 500 minimum annual return, you can assume it will double every 10 years (conservatively). So $100k becomes 200k at year 10, 400k at year 20, 800k at year 30, $1.6M at year 40, etc.

    This is why it’s a huge thing to get started early!

    My understanding is that in an inheritance situation, the family can either take it as a lump sum or let it continue to stay in the Roth. The advantages of the latter is the snowball effect above….it can continue to appreciate tax free for many decades.

    Tip – if you’re in control of your own 401k you can’t beat vanguard – they operate as a non profit and you should be able to get a free account once you get a few thousand in there and they also have mostly the lowest fees in the industry which furthers your returns and performance.

    Also, i love watching Grant Cardone videos on YouTube, hes’ quite entertaining and a total hype machine. He is very anti 401k’s and he is dead wrong! (But of course because he is “all in” on real estate).

    MASSIVE passive snowball.

  14. Cory Adams

    Great post!

    You should max your employer’s match in a 401K. Then when you leave start a self directed 401K.

    I took out a 401K loan and my renters paid the balance back of almost 1,000 USD a month over and above the primary loan.

    If I find a good enough deal, I might dip into the funds and take the penalty as others have above. I have done this on a few flips.

      • Cory Binsfield

        I had one of my clients take a 401k loan to purchase a 8 unit. It worked out awesome. It cash flows like crazy. He knew the risks and had a back up plan if he had to pay back the loan early. Just saying…know what you are getting into. As long as you go in with eyes wide open, nothing wrong with the 401k loan.

    • Craig Curelop

      Garfield,

      I would recommend you talk to a lender, but I don’t think so. If you have a self directed IRA that is liquid (i.e. in cash, stock/bonds, etc.) then it qualifies as liquidity when applying for a loan. Since you would be using part of this to invest in a property, which is much less liquid, the lenders will not accept this.

  15. Marshall Hooper

    I didn’t see any mention of a 401k with a match from the employer. Assuming you’re speaking to beginners because they are likely the ones still working for someone else, it honestly makes little sense to cash out and stop contributing to a 401k if every time you put $1 in, you automatically double it. And we’re not even taking into consideration the failure rate for a lot of people who are getting into real estate for the first time.

    I’d recommend anyone wanting to cash out a retirement account for REI to make sure you have a portfolio established and know what you’re doing before doing so. Because if you do have an employer match, it will likely take 5-6 years before you break-even.

    • Craig Curelop

      Marshall,

      If you get a match, take the match! It’s silly to decline free money. However, once you get beyond the match what do you do? Or what happens when you switch to an employer who does not offer the match? Rather than have the 401k sit there or contribute your own money to it, it makes a lot of sense to either do a self-directed IRA where you can invest and see the same large returns (tax free) or take a loan out against it to make your way towards financial freedom.

  16. Craig,

    Are replies to your post being “Censored”? That is, if you don’t like the content it won’t be posted?

    I wrote a REPLY and have yet to see it posted???

    I am not referring to profanity of defamatory remarks but perhaps ideologies quite contrary to the traditional wisdom of Real Estate and Wall Street.

      • Craig Curelop

        Tom/Jay,

        I do not monitor the comments. The only time a comment gets deleted is if one of our moderators deem it inappropriate or if someone hits “report comment” and is then deemed inappropriate.

        Profanity or any offensive remarks are likely to get deleted. Showing different perspectives would definitely not be a reason it gets deleted. We love seeing things from different angles here.

        • jay esk

          Well, i wrote a detailed post that is gone. There were no bad words i promise. Definitely feels like someone is censoring. We need to have objective discussions or this whole website is useless.

        • Craig Curelop

          Hmm…. Let me check with who runs the blog. There may have just been a glitch at the time you hit “post comment.”

          It is a shame that we cannot see what you wrote.

      • Craig Curelop

        Hey guys,

        So I checked with Allison (the person who runs the blog) and she said that nothing was taken down. She suspects what happened is that the site may have slowed down a bit at the time. When it did, you may have accidentally hit the “post comment” button twice. When you do this, the site registers that you are posting too rapidly and that it’s spam so it doesn’t post at all.

        Nothing was taken down. The only stuff that gets taken down is profanity or truly offensive behavior that is off topic.

  17. Danny Randazzo

    Craig,

    Great post and good insights into 401k investing options. I find the 401k loan to be a good use of the funds without a lot of headaches. A lot of employers have rules regulating uses of 401k if you are an active employee with them. Thank you for your insights.

  18. Phl Olinger

    I have enjoyed reading the article and comments. When talking to people about how to achieve your financial dreams, I tend to let people know that they should invest in what they know. If you like reading about the stock market and learning about it, use this as the investment vehicle. If you work in construction, are an agent, lender or in anything real estate related then property may be the best way to invest your time and money. With that being said this discussion has missed one massive issue … EMPLOYER MATCHING. If you don’t include that figure in this argument, you are missing the biggest benefit of the 401k.

    Today if you have a decent job, most employers match 3% of your pay. Please look at the example below

    Hypothetical Example:
    Yearly Salary: $100,000
    Your 401k contribution rate = 10% or $10,000
    Employer contributions = 3% or $3,000
    Return on your personal money = 30% to start with
    Average historical stock market returns = 8%
    So the 3000 earned 240 and the 10,000 earns 800 in 1 year
    After 1 year with the historical returns total = 14040
    Actual cash return on your personal investment is (4040/10,000) *100 = 40.4%

    This is the very definition of using “Other peoples money” to grow your wealth. You can’t deduct, add subtract multiply or divide your way to where the real estate and its returns come out ahead. Also when you do the above taxes, this person’s income on their returns is $90,000.It lowers your taxable income at the end of the year, doesn’t have a loan attached to it, no tenants to call you in the middle of the night, no property to manage and no repairs to be made. Simply put the math is on the side of adding to your 401k with an employer match. So the two drawbacks are you can’t touch it until you are 65 and you get taxed at normal tax rates when you hit age 65. The only way it makes sense to me to pull from the 401k is when you have built this account up to 1 to 2 million and it is throwing off 80k or 160k in growth, then pull that growth off and buy a property.

    • jay esk

      Yes i discussed this above a couple days ago. 🙂
      There is more to your numbers that you left out though…which make the case even more!

      You have the 25-28% savings on your contribution which means you are saving $2500-2800 on your taxes as a result of the contribution.

      Also, this would drop your income from 100k (28% tax bracket) to 25% tax bracket…so you are getting a marginal tax break too. (Not sure the exact math on this but it’s at least $1500)

      So cash on cash return is even higher than your computation above. Hopefully someone can work through the specific numbers and post them.

      • Craig Curelop

        Phil,

        Thanks for your comment! In the case of a company match, I agree. Take it. It’s free money! But if you are switching jobs (both former and new offer 401k benefits), then you have a choice to make. You can either roll over the 401k to your new employer OR you can roll it over to a self-directed IRA or solo 401k account. So effectively, you could do both. Take the match from your new company while investing your 401k yourself.

      • Phl Olinger

        I had most of the math in my post and deleted it out because I thought… this looks too nerdy.

        If you decide to not invest and take the money home that 10,000 gets taxed at 25-28%

        So you go home with 7500, so your return on your income is -25% just to start because you wanted the money now. (goodbye $2500)

        But you also lost that 3% match so again (goodbye $3,000) or -30%

        And you lost the possible historical returns of 8% (goodbye $1040 in gain from the above) or -10.4%

        So what does ROI on the cash you decided to take look like for the above example?
        If you took the $7500 = Losing $5500 in guaranteed money (-73.3% with taxes and Employer match, -33.3% just in taxes)
        **In other words, you have to take that $7500 and find a deal where your Cash on Cash return is 33% just to harvest tax losses and 73% to make up for
        Just look at this table and see how bad it really can be when you stop your 401k
        Year No 401k Yes 401k 401k + match 401k + Match + 5% Growth
        1 $7500 $10,000 $13,000 $13,605
        2 $15,000 $20,000 $26,000 $27,973
        3 $22,500 $30,000 $39,000 $43,018
        4 $30,000 $40,000 $52,000 $58,815
        5 $37,500 $50,000 $65,000 $75,401

        Just a quick glance tells someone that in year 5, if you don’t use the 401k, you have to double your cash on cash return just to catch up to these conservative estimates. If this chart keeps going, what you end up seeing is an exacerbation of the problem. The 401k pump is primed and year 1 its about a 60% cash on cash mistake by 5 it’s more than a 100% problem, and the problem also grows exponentially.

        10 $75,000 $100,000 $130,000 $171,635
        15 $112,500 $150,000 $195,000 $294,456
        20 $150,000 $200,000 $260,000 $451,211

        Argument #1: My employer doesn’t offer a match! Just by keeping the money in tax savings you can see that in year 5 $12,500 is yours and not the governments. Also if you do a 5% growth model your total account is worth $58,108. It becomes a $20,000 mistake, again it is you keeping your money and not letting the government touch it. If you were to do real estate deals with you need a rate of return of 15%. Cash on cash to match the 401k growth.

        Argument #2: Wall Street is full of crooks! Hold on a second, the DJIA is the 30 largest companies in the US, do you know anyone working with google, apple, etc.. are they crooks? The S and P 500 is the 500 largest companies in the US? I won’t go on. Finally, when I hear people talk about this, their argument boils down to this, these crooks will cause a crash and lose all of my money!! When that happens, do this one simple thought experiment with the following statements. If the 30 largest companies in the US go down swiftly or over a year or 3-5 years, how would housing and “rentals” or investment properties not be affected? I truly believe this, If wall street proves to be the crooks that you say then guns, bullets, and food will become the barter system of the future! Gold and bonds too would completely lose their value. It ends up with anarchy. I actually challenge anyone to respond to how our system survives and your rentals hold their value through the DJIA companies going down over 5 years. (they can’t change out either, that is just making my point, that has happened). the worst possible time for investments to get in was in 1999, and if you reinvested dividends you today are still making 5.46% You would be doing better if you had foreign investments though.

        Lesson #1 All investment comes with risk, even if you are a working professional, care enough to read and learn about the stock market and real estate to invest with. When you get comfortable to make your pick, choose based on your understanding of the downsides and the upsides.
        Lesson #2 Not taking the 401k and the match is really, really, really dumb. This is the epitome of using OPM to build your wealth. But if you leave the stocks, bonds and fund selection up to your company or a friend or even a “professional” be ready to be let down. Personally, I have been the best one at managing finances and it is because I care about my money. Not many other people care as much as I do about the money that I have earned and they don’t have the interest like I do. Develop your own strategy, not theirs!!

  19. Jered Souder

    I wish Bigger pockets would stop pushing this bad idea. It is really not a debate for working professionals that invest in RE on the side. In this environment, if you are a working professional (have a 401(k), there is no reason you should need to cash out your 401(k) to invest in real estate. There should also be no reason that you would need to stop funding your 401(k) and apply those funds to investing on a monthly basis. If you make good real estate investments, you should have more cash flow and thus be able to contribute more to your 401(k). If you are a full time real estate investor (1 out of 100)…that’s different but that advice would be very personalized for the type of investing you are doing and how successful you are and what your cash needs are. This is also a very low percentage of people reading bigger pockets blogs.

    • Craig Curelop

      Jered,

      It’s just a more unconventional way of thinking and it’s just an option. I am likely in a unique situation, but because my previous company offered a 401k match, I took advantage of that fully (contributing $18k per year), while saving very little. When switching jobs, I ended up with most of my net worth tied up in my 401k. For someone in their 20’s, it’s a bit frustrating to have all of this money, but having no access to it for ~35 years.

      There may not be too many people in this situation, but I figured it would be good to illustrate to people how you can use these retirement funds to achieve early financial freedom.

      • Ruth Russell

        I didn’t discover until later that you can roll over your traditional money into a self-directed account and don’t have to wait until you retire or are older as long as your employer will allow. I rolled over a third of my 403(b)3 deferred comp into a self-directed to buy and flip houses. I’m a full time school business official nearly ready to retire and take care of the fiscal side of a flipping business and contract the rest. You can partner with the self-directed IRA to help grow faster. I have a house right now – 50% my IRA, 25% my husband’s IRA, and 25% my individual investment. Paying the contractors required 3 checks, but it is doable and makes it possible to do deals.

  20. Dilip John

    Be really careful on any decisions on using retirement funds. BUT, there is more than one way to do this.
    There are a lot of rules to follow to keep so you can avoid the IRS. Besides Self-Directed and Solo401k, there are Rollover Business Startups (ROBS). But there are big differences between them for the IRS

    https://fitsmallbusiness.com/rollover-business-startups-robs/ ROBS defined
    https://fitsmallbusiness.com/best-rollover-business-startup-robs-providers/ Guidant, Benetrends, and FranFund are the biggest and with best reputations and experience

  21. Craig, your Company 401(k) opposed to an Individual 401(k) is not a fortress that cannot be breached and in the case of the young person concerned about tying up his/her money for 35-years, he/she had the perfect out when he/she left the prior job, e.g. he/she could have converted the prior Employer sponsored 401(k) into an Individual 401(k) if qualified, not everyone is qualified. Or, he/she could have converted the prior Employer sponsored 401(k) into a Self-Directed IRA with Checkbook Control. His/her dilemma illustrates the problem of the lack of reliable , accurate information from Wall Street, a prior Employer’s Human Resource Department and yes, himself/herself because after all it is his/her money.

  22. Here’s a good example at how effective a ROBS (Roll Over Business Startup) can be.

    I knew of a case in the state of Washington where a High School Music Teacher retired after 30-years of teaching … music. He knew everyone in his community and everyone knew him. He converted his Retirement Plan, I don’t remember if it was a 453b or 457 Plan but he retained a Professional (an ex-lawyer with DOL that regulated 401(k)s to structure a ROBS and use the money to buy a local … yep, Music Store. He worked as an Employee and drew a salary. It was the perfect pairing.

  23. Craig,

    The Department Of Labor (DOL) oversees 401(k)s. The IRS oversees IRAs under ERISA.

    My contact is an ex-attorney for the DOL who is an expert on any type of IRA including the Self-Directed IRA with Checkbook Control, and he is well versed in ROBS.

    The problem with any type of IRA is the restriction on small amounts of contributions. At least an Individual 401(k) has a much higher contribution limit, e.g. over $50,000 and a husband and wife can belong to the same Individual 401(k) Plan.

    My attorney contact will speak to people I recommend if they are interested in setting up an Individual 401(k) or ROBS, and his consultation is typically gratis (free). However, I carefully give out his contact information because I don’t want people calling him and burning up his time with basic questions they could have learned on Google.

    I own vineyards in Argentina and I sell boutique 5-acre Malbec vineyards. I suggested to prospective vineyard Buyers to use an Individual 401(k) or Self-Directed IRA with Checkbook Control to invest in a vineyard. They talked to my attorney contact and now own vineyards with their retirement places.

    Note, however, there is one major distinction between the Individual 401(k) or Self-Directed IRA with Checkbook Control ownership, the Self-Directed IRA with Checkbook Control cannot deal in or own any form of alcohol, i.e. it cannot make wine from the grapes or buy wine.

    • Ruth Russell

      I am interested in check book control of my IRA. I am trying to set up an LLC that my ROTH IRA along with my husband, my brother, and my sister-in-law could own to flip houses. I would also like to start an online business through my ROTH IRAs in the LLC. I have not been able to find a custodian that will help with that. It’s going to be my highest priority in 2018 since I am ready to retire from my JOB and start a new business in my ROTH IRA. Any help would be appreciated.

      • Thomas Phelan

        Craig,

        What is “Protocol” if one is asked for a recommendation or referral, for example the contact info for a Lawyer who specializes in creating a Self-Directed IRA, a Checkbook Control Self-Directed IRA, an Individual 401(k) and a ROBS?

  24. Ruth Russell

    You know, I hope people will take a serious look at their retirement plans. When I was in my 30’s I was in a low tax bracket, but I was advised to put money in my 403(c)3 which is education institution’s equivalent to a 401K. The advise was to tax defer so you could take it out when you were in a lower tax bracket due to making less moeny.
    However, several years ago, i realized that as I am reaching retirement, it only makes sense to tax defer you plan to retire poor. My tax bracket will only go down by 3% when I retire. For several years now, I have been putting money in a ROTH IRA through my employer since I can cap at $24,000 per year. I have both a self-directed traditional IRA and a ROTH. I have flipped a couple of house in my traditional IRA. I plan to move my ROTH IRA to my self-directed and start flipping houses with that money. All proceeds earned inside a ROTH is tax-free – never taxed. I wish I had made that decision years ago. It is also important to remember there are many ways to invest in real estate – buy and hold is one with appreciation most likely and where the property is matters – I’m near Seattle where property is appreciating very quickly, but it can also go down. I also do fixer uppers in my IRA which has a higher rate of return that traditional buy and holds. You can partner with your self-directed IRA also. You need a good custodian to help you. Tax deferred only works if you will be in a lower tax bracket when you retire – consider a ROTH.

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