1

I'm saving up to buy a rental property, it will take a few years.

I've been maxing out my 401k contributions at 18k per year plus employer match. I've got plenty in the fund to borrow from it to make a down payment on the property that I wish to purchase.

Downsides I can think of:

  1. If I lose my job, I will owe it back immediately.
  2. I'm only 25, and money taken out of 401k is no longer working for me by generating interest for my retirement nest-egg. (although you can argue a good rental property would generate more income)

Upsides I can think of:

  1. Better than another type of loan. Interest is being paid to myself.
  2. Allows purchasing the property sooner rather than waiting a few years. We are assuming it is a good rental property investment so in those few years I would have gained equity, property appreciation, and cash flow money.

My plan is to do a 1031 exchange and buy more/bigger properties down the road, so the sooner I can get in the game the better.

I've seen some arguments against this idea state that you are getting taxed twice (never can find a good explanation for it, though). The only time you will be taxed is upon withdrawal at retirement, right?

  • 1
    The interest you pay is from taxed money. When you take it out later, it gets taxed again. – Aganju Aug 24 '17 at 23:24
  • @Aganju That makes sense, but in my scenario wouldn't it be a benefit? Interest paid for loan would be extra money deposited into 401k above the IRS maximum (I'm at the maximum now). I'm only 25 so I am sure that in 40 years the interest payments made into 401k would generate more money that the cost of a double tax? Although I suppose a counter argument to that would be to just put that money into a index fund. – James Wierzba Aug 24 '17 at 23:26
  • Also, is it standard for interest to be charged on a 401k loan? – James Wierzba Aug 24 '17 at 23:30
  • 1
    @Aganju After discussing the double-tax issue with my 401k provider (Fidelity) they told me that you do not get double taxed. The tax paid upon withdrawal takes into consideration (deducts) the tax paid on the interest payments from 401k loans. – James Wierzba Aug 25 '17 at 0:32
  • 1
    Do you already own a home? Or do you plan to live in this one for now and then rent it out? – Hart CO Aug 25 '17 at 1:21
4

the most important information that you provided was "I'm 25 years old". You have a few years to save for a rental property. Taking a loan against your 401k only invites a lot of paperwork and a good deal of risk. Not only the "if I lose my job I have to pay it back (in 60 days)", but it effectively locks you into your current job because changing jobs also causes the same repayment consequences. Do you really love your job that much that you would stick with it for the loan you have? (rhetorical)

One could argue that real estate is a good way to diversify away from the stock market (assuming you have your 401k invested in stocks). Another way to get the same diversification is to invest in REITs through your 401k.

Owning rental property isn't something to rush into. You really have to like it.The returns and headaches that accompany it can be a drag and it's harder to get out of then stocks.

1

Make sure you can really do what you plan on doing:

Look at the maximum loan length and the maximum loan amount. From the IRS- retirement plans faqs regarding loans

A qualified plan may, but is not required to provide for loans. If a plan provides for loans, the plan may limit the amount that can be taken as a loan. The maximum amount that the plan can permit as a loan is (1) the greater of $10,000 or 50% of your vested account balance, or (2) $50,000, whichever is less

...

A plan that provides for loans must specify the procedures for applying for a loan and the repayment terms for the loan. Repayment of the loan must occur within 5 years, and payments must be made in substantially equal payments that include principal and interest and that are paid at least quarterly. Loan repayments are not plan contributions.

The referenced documents also discuss the option regarding multiple loans, and the maximum amount of all active and recent loans

Having a 401K loan will still count against the maximum amount of monthly payments you can afford. Also check the interest rate, and yes they required to charge interest.

Some companies will not allow you to make contributions to a 401K while you have an outstanding loan. If that is true with your company then you will miss out on the matching funds.

  • This is good info but does not touch at all on the question at hand, which is whether it is a wise or unwise decision e.g. holding off on a rental property (we are assuming the property is a sound investment for this scenario) until enough $ is saved, versus taking out a 401k loan now and getting started earlier with rental properties. – James Wierzba Aug 24 '17 at 23:53
  • The loan length may differ. My plan allows 15 years for a loan to be used as a down payment on a primary residence. When I took another loan for a medical procedure, that was 5 years. – mkennedy Aug 25 '17 at 22:04
0

Another option you might consider is rolling over some of that 401K balance into a self-directed IRA or Solo 401K, specifically one with "checkbook privileges". That would permit you to invest directly in a property via your IRA/401K money without it being a loan, and preserving the tax benefits. (You may not be able to roll over from your current employer's 401K while still employed.)

That said, regarding your argument that your loan is "paying interest to yourself", while that is technically true, that neglects the opportunity cost -- that money could potentially be earning a much higher (and tax-free) return if it remains in the 401K account than if you take it out and slowly repay it at a modest interest rate.

Real Estate can be a great way to diversify, build wealth, and generate income, but a company match and tax-free growth via an employee sponsored retirement account can be a pretty sweet deal too (I actually recently wrote about comparing returns from having a tenant pay your mortgage on a rental property vs. saving in a retirement account on my blog -- in short, tax-free stock-market level returns are pretty compelling, even when someone else is paying your mortage).

Before taking rather big steps like borrowing from a 401K or buying a rental property, you might also explore other ways to gain some experience with real estate investing, such as the new crop of REITs open to all investors under SEC Reg A+, some with minimums of $500 or less. In my own experience, there are two main camps of real estate investors: (1) those that love the diversification and income, but have zero interest in active management, and (2) those that really enjoy real estate as a lifestyle and avocation, happy to deal with tenant screening and contractors, etc. You'll want to be careful to be sure which camp you're in before signing on to active investment in a specific property.

0

Two simple possibilities:

  1. Stop saving to your 401k long enough to save up to buy the rental property.
  2. Quit, and roll your 401k over into an IRA. then buy the rental property inside the IRA. It's bizarre, but actually legal -- I know somebody whose done it. In his case, he used to live in the house down the street from me, but he now rents it out. Occasionally he's around checking up on things or doing maintenance. His former primary residence is NOT in the real-estate IRA, but he's cleanly bought properties that are.
  • 1
    "Occasionally he's around checking up on things or doing maintenance." That sounds like illegal self-dealing. If his property is in his IRA then he cannot do anything for the property, because that's equivalent to contributing value to his IRA. – user102008 Aug 25 '17 at 21:05
  • 'I know someone who has done it' is a clear case of availability bias. Regarding the allowability to live in and/or repair a property owned in a retirement account, it is 100% not allowed. Even changing a lighbulb is disallowed. – jungledev Mar 12 '18 at 1:46

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.