Yep, you heard me right! “Screw my 401k, I’m buying rental properties with it” and I am glad I did. I’m sure you might be thinking “that was stupid! You will have to pay penalties and taxes!” and you are right. So what? Granted there are many other ways to invest in real estate inside of your 401k but it didn’t sit right with me.
How I Feel About the 401k
The goal of a 401k is to help you save (or invest) for retirement. Let’s face it when you’re ready to retire, you shouldn’t have to worry about money. You spend a lifetime working and you are done! Go live on a white sandy beach with blue water and sip drinks with tiny umbrellas in them. Sounds AWESOME but for many people, it is not that at all.
Many people have to worry if they have saved enough money to retire? Do I have to downsize my living because it’s too expensive? Can I afford health care? The 401k is supposed to help you with all of that and you still have to pay taxes on the money you receive as if you were working. Additionally, the pool of money you have is subject to the ups and downs of the market. Doesn’t sound too different from work stress to me.
All in all, this is a great vehicle to save for retirement. Employee matches are awesome! Some would even say it’s free money. Total BS! When I added up how many hours I’ve worked past 40 per week with various companies, hell they owe me money. I’m not complaining, just making a point.
There are aspects I appreciate in my 401k like you can take money out to use as a down payment for your first property without a penalty. You can take loans against it and leverage it in a lot of creative ways. Super cool! The one I hate the most past the taxes is the one where I have to wait until I’m 59+ to get money out and be taxed on it. Let us not forget that the rules change from time to time and I’m positive that age limit will go up in due time.
I Want My Money Now
My thought is if I were able to invest that money into real estate, I can potentially gain monthly cash flow for the rest of my life. The properties will build equity and appreciate over time. In that time I will be paying down the principle unless I paid cash for it. As market rents grow, so will my cash flow, and I will receive several great tax benefits!
The cool part is this will last as long as I keep paying tenants, keep the property in good shape, and as long as I own it. That could be literally for the rest of my life! As a bonus, I can pass them on to my kids so they can continue the flow and own the asset. Damn, that makes sense!
Let’s Talk Numbers
For simplicity sake, I’m going to break down some simple math and use an example of a property that I purchased with the money. This was a real transaction and the numbers are accurate.
401k
- Balance: $25,000
- The penalty for early withdrawal (10%): $2,500
- Income Tax Bracket (28% – $25,000): $7,000
- Total cost for withdrawal (penalty + taxes): $9,500
Rental Property (Duplex)
- Purchase Price: $67,000
- Downpayment (25%): $16,750
- Mortgage Rate: 4.75%
- Term: 30 Years
- Tax & Insurance: $116.10
- Closing Cost: $6247.26
- Due at Closing: $22,129.02
- Total Monthly Payment: $378.23
- Actual Rents ($650×2): $1300
- Property Management ($1300 – 10%): $130
- Monthly Cashflow (Rents – Mortgage – PM): $791
Let’s talk this through. I put $25k into the purchase and cash flow $791 per month. Sounds like a good deal to me. What about the $2,500 penalty for the $25k? According to the numbers, I will make that back in 3 1/2 months in rent. What about the $25k that will get added to your income tax. Since I’m calculating this in the 28% tax bracket, I would owe $7000 on that $25k. I will make that back in 9 months worth of rent. Once I am clear of all that, it’s all mine and life goes on.
The reason I am sharing this is that I know plenty of people who want to get started but don’t necessarily have something they can ponder over. There is quite a bit I didn’t put in this post in regards to buying real estate. A lot can go wrong (and has) and a lot can go right. Be careful with budgeting and research everything.
A good property management company is key to helping you maintain and be hands off. If you’re in GA, one I recommend is BTDC Properties. They have been amazing in helping me purchase and maintain my properties. If your curiosity about real estate rentals is turned on, check out Buying Real Estate for Passive Income. It contains more numbers like above and context around investing in rentals.
For more information about stocks and investing, take a look at How I Invest In Stock Using the MACD. It’s a good resource if you do decide to stay in your 401k and want to trade money around that you can use to re-invest. There are plenty of ways to make it work for you over time.
Hope this helps!
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