15 Feb Can I Use Funds From my Retirement Account to Buy an Investment Property?
Yes! (Under certain conditions. I’ll explain.)
With IRAs and 401ks, you could charged a 10% penalty for withdrawing money before age 59 and a half. Plus you might have to pay taxes on the amount of the early withdrawal if it comes out of a traditional IRA or 401k. With a 401k, there are more restrictions.
If you have a Roth IRA, you can withdraw your contributions without penalty if you have had your Roth account for at least five years. For example, let’s say you contributed $30,000 to your Roth IRA over a five year period. That initial investment has grown, making your account worth $55,000. You can pull out up to $30,000 (your initial contribution) tax and penalty-free since the tax was already paid on that money. When my wife Amira and I bought our first home together (a fixer upper), we withdrew our Roth IRA contributions to help pay for the renovation.
Another way to pull money out to buy real estate is by using the first-time homebuyer early withdrawal exemption. The IRS allows a withdrawal up to $10,000 from an IRA to buy a home for the first time. To qualify as a first-time homebuyer, you cannot have owned a principal residence during the prior two years. This $10,000 exemption is per person, so a married a couple could each pull out $10,000 for a total of $20,000.
There is a caveat to the $10,000 exemption. You won’t have to pay a 10% penalty on the early withdrawal if you’re using the money for the purchase of your own home. However, you will have to pay taxes on the amount withdrawn from a traditional IRA. For instance, if you pull out $10,000 and are in the 22% tax bracket, you could owe up to $2,200 in taxes next April 15th.
Back to Roth IRAs for a moment. Let’s say you pulled out your initial contribution to buy real estate, yet you needed up to $10,000 more for a down payment on the purchase of your own home. You can actually withdraw up to $10,000 of the gains (not the initial contribution) tax and penalty-free for that home purchase. So let’s say you contributed $30,000 over five years, and your account has grown to $55,000. You could withdraw the $30,000 contribution AND an additional $10,000.
Now let’s talk about 401k accounts. Not only could you do an early withdrawal (incurring the 10% penalty in some cases), you could borrow against your 401k penalty-free.
You can borrow up to 50% of your vested 401k balance, up to a maximum of $50,000. You must pay interest (essentially to yourself), which could be 1% to 2%. The 401k loan does not affect your Debt-to-Income (DTI) ratio, does not require a loan application, and does not affect your credit score. However, you and your employer cannot contribute more to the 401k until the loan is paid off. Loan payments can be automatically made from your paycheck. If you leave your job, you have to pay back the loan in full right away.
You have the option to withdraw $10,000 from your 401k for the purchase of your first home. There is also an option for a hardship withdrawal, which is also up to $10,000. If approved by your employer, there would not be a 10% penalty yet tax would need to be paid at the next filing.
Two points I need to make:
- The topic of this article is how to withdraw money to buy investment real estate, yet the $10,000 early withdrawal is for the purchase of your own home. If you’re playing the long game, you could use the $10,000 to buy your own home. Live in it for at least a year, and then you’re free to rent the house or sell it (hopefully for a profit). I recommend that you don’t sell the asset, but keep it by leasing the house when you do move out.
- So we examined if you can use retirement account funds to buy investment real estate. The next question is should you use those funds for real estate? When you pull money out of your tax-advantaged retirement account, you are stunting the growth of your portfolio. The whole idea of a tax-advantaged retirement account is to let it grow exponentially over a long period. Sure, if you own and rent real estate over a long period, you could see exponential growth from the rental income, appreciation, depreciation on your tax return, and ability to borrow against the asset (to buy more real estate, of course). Nevertheless, it’s good to diversify among your asset classes and leave money in your retirement account. Check out this article on diversification in real estate.
Every situation is different. Consult your tax and investment advisors to determine what is best for you.
Tai DeSa is a graduate of The Wharton School of the University of Pennsylvania. He became a full-time real estate investor in 2004 after serving in the U.S. Navy. Tai has made colossal mistakes in investing (and learned some things along the way). He has helped hundreds of homeowners avoid foreclosure through successful short sales. Check out Tai’s books on Amazon.com. Tai may be available for coaching and speaking engagements on a variety of real estate topics. Send an email to tai@investandtransform.com.
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