With the rising popularity of real estate investing, more people are exploring the option of using 401k funds to purchase investment properties. This allows them to leverage the tax benefits of 401k while diversifying their retirement savings. However, there are also risks involved that need careful evaluation. In this article, we will look at the key considerations around cashing out 401k for real estate investments, especially via Fidelity 401k plans, and discuss the pros and cons based on perspectives shared on Reddit.
The benefits of using 401k funds for real estate
The primary advantage of using 401k funds for real estate is the ability to leverage pre-tax retirement savings. Since contributions to 401k are made before taxes, the compounded growth over decades can result in a sizable sum. This capital can be used as a down payment on a rental property or flip houses for profit. Many real estate investors highlight this benefit on Reddit when discussing Fidelity 401k withdrawals.
Another major pro is diversification. Real estate as an asset class behaves differently from stocks and bonds. Adding real estate to a retirement portfolio can reduce overall risk through diversification. It also provides more control compared to REITs or real estate funds.
If structured as a cash-out refinance, the interest payments on loans taken out against a 401k balance can be deducted against rental income. This tax deduction can improve cash flow from rental properties.
Lastly, those looking to retire early can start supplementing their income by buying rental properties with 401k funds well before 59.5 years. The rental income can cover living expenses while allowing their 401k balance to further grow.
The risks of 401k withdrawals for real estate
The most discussed risk on Reddit is the loss of tax-deferred growth on the 401k funds. When you withdraw money from a traditional 401k, income tax has to be paid on the distribution. For someone still far from retirement, this can result in not just loss of principal but also loss of decades of compounded returns.
There are also penalties to contend with. Those below 59.5 years will have to pay a 10% penalty on top of income taxes for early withdrawals. The taxes and penalties can eat into a significant chunk of capital, severely impacting investing capability.
Another complication is the 60-day rollover rule. The IRS requires that 401k funds be reinvested within 60 days of withdrawal to avoid taxes and penalties. This timeline could be problematic for real estate deals that take longer to close.
If the real estate investment ends up requiring significant maintenance and repairs or doesn’t generate expected rental income, it can become a financial burden. Without enough cash reserves, the investor may be forced to sell at a loss.
Tips for using Fidelity 401k for real estate
For those still interested in tapping their Fidelity 401k for real estate, there are a few tips shared on Reddit threads:
– Only withdraw the minimum amount needed for a downpayment to reduce tax and penalty exposure. Don’t empty the entire 401k.
– Have a large emergency fund to deal with unexpected expenses related to property maintenance or vacancies.
– Research opportunity zones that allow penalty-free withdrawals for real estate projects to reduce tax burden.
– Consider taking out a 401k loan instead of a withdrawal if your plan allows it. This avoids taxes and penalties.
– Evaluate all other financing options before deciding on a 401k withdrawal to see if it is absolutely necessary.
– Consult a financial advisor to review the full impact on retirement savings and model different scenarios.
While using Fidelity 401k funds for real estate investments is an option, there are sizeable risks involved as well that need careful evaluation. The loss of retirement savings and reduced compounding can outweigh any potential benefits for long-term investors. Proper planning around minimizing withdrawals, emergency reserves, and alternative financing is key.