Cash-out a 401k for real estate investors
Have you thought about cashing out a 401k to invest in real estate?
Real Estate Investors invest in real assets rather than retirement accounts. Investors with significant qualified retirement accounts discuss cashing out a 401k before 59 ½. This means a 10% penalty in addition to the ordinary income taxes.
Cashing out of 401k plans while still actively employed is difficult and expensive. Let’s discuss a possible option to access a current 401k plan without paying the penalty.
Exceptions for Cashing Out a 401k
The IRS does allow a few exceptions to get at old or inactive 401k or IRAs before 59 ½ without a penalty. These include:
- Medical expenses
- Court-ordered withdrawals such as QDROs (which can be done if you are still married)
- Qualified military withdrawals
- The rule of 55
- The rule of 50 (public service jobs)
- Substantially Equal Periodic Payments aka 72(t) or SEPP
- (IRAs only) higher education and first time home
Sometimes (rule of 50 and 55), you want to leave the money in a 401k or 403b, but most of the time, you want to roll out the money into an IRA, so there is more flexibility.
I don’t need to tell the real estate investor about self-directed IRAs and 401ks or QRPs, but what are the options to get a CURRENT 401k retirement plan funds? There are hardship withdrawals and 401k loans. Details for these withdrawals are in the summary plan description.
How about this—a new way to get at current or active 401k plans so you can invest in real estate? Have you heard of the QDRO?
A QDRO to cash out a 401k?
The concept of using an in-marriage QDRO is not made up. Estate lawyers have trademarked a different term for a happily married QDRO.
Briefly, a QDRO is a state-specific document usually used to separate qualified assets in a divorce. There is no mention of divorce in IRS language, however, and real estate investors are using it to cash out 401k plans penalty-free.
Use a QDRO to Cash Out your CURRENT 401k
If you are currently employed and get a match, you might have a sizable 401k that seems impractical for real estate investing. Your current 401k, however, can be accessed penalty-free with a QDRO. You could get a divorce from your spouse to access the funds. Or, see a family law attorney in your state and determine if a QDRO is possible. Get ready for blank stares or worse, as the idea of using a QDRO when you are happily married is not well established in the legal community.
Suppose you can get a domestic relations order signed by a judge. In that case, your plan administrator should honor the DRO if the distribution is allowed by the plan and meets ERISA guidelines. It is not the plan administrator’s job to vet the alternative payee.
Once you get access to your current employer’s 401k funds for your alternative payee—your spouse, they have two options: rolling it over to a spousal IRA or taking the cash.
Keep the Pre-Tax Status with a Spousal IRA to Invest in Real Estate
If you desire to keep the money pre-tax yet invest in real estate, roll over the 401k funds into a Spousal IRA. Spouses have more special privileges from the IRS than any other type of relationship regarding pre-tax funds.
They can put the spousal IRA into a self-directed IRA or 401k and then invest in any non-prohibited items.
Cash Out Current 401k Assets to Invest in Real Estate
It is true! QDROs are one of the exceptions that you can use to get at your money without a penalty. If you want to invest in after-tax real estate from your current employer’s 401k, use a QDRO and cash out to your spouse’s bank account. Of course, ordinary taxes are due when cashing out, but as the funds were accessed via a QDRO, there is no 10% penalty.
Inactive 401k Plans
With old 401k plans, you have a couple of options.
You can transfer your old 401k into a self-directed IRA or 401k and invest in real estate.
If you want after-tax access without a penalty for cashing out early, you can also consider a QDRO for an old 401k.
IRAs are not qualified plans; thus, QDROs do not work on IRAs. Only plans covered by ERISA (which include pension plans and perhaps some 403b plans as well) can be accessed and severed by QDROs.
Can I Withdraw Money From My 401k to Invest in Real Estate?
Yes, you can withdraw money from your old 401k to Invest in Real Estate. There will be a 10% penalty if you are under 59 1/2. Exclusions are above. Some folks think the penalty is no big deal as they are confident they will quickly earn that 10% back using real estate instead of stocks and bonds.
Getting money out of your current employer’s 401k to invest in real estate is trickier. Of course, you could take a loan from your 401k, but this does need to be paid back, and it might be better just to use that after-tax money to invest in real estate rather than paying back a loan. Otherwise, check out the plan summary document to see if there are in-service distributions that allow you to withdraw before separation from service.
401k Withdrawl to Invest in Real Estate
401k withdrawals to invest in real estate are a good idea for those who understand real estate. While there are limits to who can withdraw money from their active 401k (see above), and you always have to consider the 10% penalty, many folks who understand real estate will be better off investing after-tax money in real estate rather than tax-deferred.
Remember, depreciation benefits are a significant reason why you invest in real estate. If you are invested in a tax-deferred account (such as a self-directed 401k or a QRP), you miss out on the depreciation and can be stuck with UBIT if you are otherwise using leverage.
If you will invest in real estate, use after-tax accounts and consider a 401k withdrawal to invest in real estate.
Conclusion: Cashing Out a 401k to Invest in Real Estate
General recommendations are to let pre-tax money continue to compound tax-deferred. Real estate investors not infrequently want more flexibility in their investing, however.
QDROs are new legal maneuvers that some real estate investors have tried to cash out current or old 401k plans penalty-free before 59 ½. Taxes are due if you cash out to your bank account, or a Spousal IRA can continue the pre-tax status of the money for investing in real estate.
Want to cash out your current 401k to invest in real estate? Well, if you live in the right state and want to lawyer up, maybe you can with a QDRO.
Otherwise, look for other opportunities to liberate your pre-tax 401k to invest after-tax in real estate.