Retirement Savings to Purchase an Investment Property
Purchasing an investment property can entail significant cash needs. An Alternative Documentation or Hard Money loan can cover a significant portion of the financing, but it might help to have a larger down payment, money to fix up the property after purchase, or just a cash cushion while investing in property.
While not often a utilized strategy, using retirement funds can be a potential alternative. It sounds risky, but when employed at the right time, going outside the box can be advantageous. If you are considering utilizing a 401(k), 503(b), or IRA to use in property investment, here’s what you need to know.
Advantages of Utilizing Retirement Funds
Many investors have more money invested in retirement funds than in a standard brokerage account. However, these kinds of accounts are generally considered to be inaccessible until age 59 and a half – but a clever investor knows that retirement accounts can be quite useful. These advantages should be carefully weighed when evaluating financing options for an investment property.
Quick and More Access to Cash
If you need even more cash to fix up a property, in excess of your approved loan amount, tapping your retirement funds for a quick withdrawal is an option worth considering. You can use this money to make further improvements on the property or have the cash available for unexpected costs. Additionally, in the future if you take out a loan on your 401(k), you can use a cash out refinance to pay back the loan. Note that most 401(k) accounts do not permit withdrawal while an employee is still with the company providing account access, so keep this in mind when planning a strategy.
Retirement Residence Opportunities
Purchasing a property for rental purposes is generally done to provide a passive – or active, depending on management style – income stream. However, this doesn’t have to be true forever. A suitable property purchased earlier in life can actually serve as a home in retirement, providing a resource that serves you in multiple ways, both now and in the future. This doesn’t necessarily have to be a point on which to fixate when investing using retirement funds, but it’s something worth considering – securing a residency for retirement early can be an advantage that many people do not consider.
In planning for this option, keep in mind the characteristics in the property you’re buying. For example, a single-family property can provide an easy transition, but a duplex, multi-unit dwelling, or apartment building may require your continued involvement as a landlord if you want to call your property (eventually) home.
Transfer of Investment to a Tangible Asset
While most people keep their retirement savings in accounts that hold stocks or bonds, there are other ways to prepare for the future. As investors know well, real estate is an investment that can pay dividends now and in the future. For example, when upgrading the property as a rental, you can make upgrades not only based on what your ROI will be, but what you would enjoy while in retirement. Additionally, having real estate as part of your retirement portfolio is a great way to ensure a better retirement.
Disadvantages of Utilizing Retirement Funds
While there are advantages to using retirement funds for investing in real estate, there are some disadvantages to consider. There are always downsides in investing, and drawing money from retirement is no different. Keep these disadvantages in mind before pulling from your 401(k).
Loss of Growth Over Time
Your funds are meant for retirement and as a consequence, you can lose out on growth in the stock market.
The point of investing early in retirement is to take advantage of growth over time. With an assumed 7% annualized growth rate over 30 years, just $1,000 becomes $6,600, creating capital potential if you begin saving early. Withdrawing from this amount both compromises the balance you will have available at retirement as well as any potential growth on the principal. Say, for example you withdraw $50,000 to put a down payment on a property at age 45, 20 years before retirement. If left to grow at a rate of around 7% annualized, that $50,000 would be worth approximately $286,000 by the time you are 65. However, it is important to keep in mind that using retirement funds to invest in real estate isn’t a complete forfeiture as spending still results in an investment that is expected to increase in value over time. Real estate not only gives you a tangible asset that also can appreciate over time, it can give you a place to live once you have retired.
Withdrawing from most traditional retirement accounts as needed is fine – but only after age 59 and a half. Otherwise, the IRS imposes hefty penalties, including a 10% penalty upon withdrawal and inclusion in gross income for tax purposes.
However, there are exceptions. The principal invested in a Roth IRA is available after 5 years, and there are penalty-free hardship cases permitted by the IRS for other forms of retirement accounts, including, the purchase of a principal residence. Further, a self-directed IRA is also an option. These accounts permit a wide range of investments to be held within them, including real property. Setting up a self-directed IRA and preparing for a property purchase likely will take some maneuvering, but the benefits can be well worth it.
Potential Paybacks in the Case of Job Loss
For those who do not want to withdraw money from a retirement account, a 401(k) loan can be a comfortable alternative. These loans are available up to either $50,000 for a vested balance of $100,000 or more or 50% of the vested balance, whichever is less. This allows for significant flexibility, providing cash for a down payment without withdrawal penalties or a guaranteed loss of investment growth.
Despite this, a 401(k) loan isn’t risk-free, particularly for those who work in volatile industries. Leaving a job when a 401(k) loan is outstanding can result in a request for immediate repayment. It is important to keep this immediate pay back in mind when taking out a 401(k) loan.
As with all things in real estate investing, there’s no perfect way to guarantee a successful investment. In some cases, purchasing a property with retirement savings, can be a great benefit to your strategy. Not only will you own a property you can live in for retirement, your property can also increase in value. However, if you’re sure you have a sound strategy and are minimizing your risk of loss, it may be a great idea to tap into your 401(k) in addition to taking out a loan to fund your investment purchase.
Please consult a tax professional to determine whether using retirement funds is beneficial to your specific situation.
In a future article, we will tell you about how investors can convert their IRA into a Self-Directed IRA for real estate and note investing.
Scott Clift is a licensed real estate broker with Westpark Loans. He has been in the real estate industry since 1994. His team of seasoned professionals specialize in providing real estate loans for investors and other self-employed individuals. When you are ready to invest in real estate, call Westpark Loans to secure your financing at (844) 574-LOAN or by visiting westparkloans.com.