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Things I Would Never Do: Raid My 401k to Buy Property

Should you raid your 401k for a home purchase?

Welcome to my monthly installment of things I would never do. I started this series last month to shed light on some maybe unwise practices that may not always be the best idea from a financial perspective. Again, it’s not meant to be judgmental in nature but more informative and possibly humorous. Last month I discussed the car loan industry and the insanity of a 97 month car loan. I received some good feedback on it, so here’s to hoping for more of the same. :-)

 

Related: Looking for other investment options? Then check out my Etrade review for a potential new brokerage to use.

 

The issue that I am looking at this month comes from a Yahoo Finance article I read a few weeks ago that covered the topic of amateur investors increasingly raiding their 401k(s) and retirement accounts to purchase property. The story highlighted a 48 year-old woman, with heart disease, who took a $50,000 loan against her 401k in order to purchase an investment property. The lady was quoted as saying that since she has heart disease she’s looking to further diversify and views purchases like this as life insurance. I’ll readily admit that while many should have life insurance, it’s not a necessity for all, and last I checked real estate was not life insurance. The ultimate driver behind this, as quoted by one analyst, was that people are lacking trust in the stock market and thus viewing the hard asset of real estate as the appropriate destination for these funds.

Should We View our 401k as a Coffer?             

I’ll readily admit that investing in the stock market is not for everyone and there is real fear out there amongst investors who lost a big chunk of their portfolios during the Great Recession. That fear is real, but does that really mean that we should avoid it altogether? No, it doesn’t. The point though, is that while it may be convenient to take loans against your 401k and there may be times where it may be beneficial to you, your 401k should not be viewed as a coffer from which to take money out and throw it at other things.

The inherent problem behind taking a loan from your 401k is with changing jobs or encountering unemployment; you run into the risk of early withdrawal fees if you’re younger than 59 ½ as well as income tax on any unpaid portion of the loan. When you’re talking about tens of thousands of dollars in a 401k loan then you’re potentially talking about a decent chunk of money, not to mention the risk of loss of value in real estate.

Diversification is Good to a Point

I’m not meaning to bemoan owning real estate as we know people who invest in real estate. I think that owning real estate is a great way to further diversify your investing. If we had the time and resources in the Frugal Rules home then we would likely look at it. The housing market has been showing signs of being on an upswing and I think it can be a great tool to use as you seek to build wealth.

That said, the article cited that 401k raiding is increasing and that some people are looking to purchase multiple properties. I think it’s great to pursue something like this, as long as it’s in your best interest. As opposed to raiding retirement accounts why can’t there be an option to raise the cash outside the 401k and use that as a down payment on a house? I guess my point is that, as with any type of investing,  there needs to be balance.

The Problem of Following the Herd

The real issue I have with this growing practice is the problem of following the herd mentality. Herd mentality thinking can take place in various scenarios and we see it all the time in the stock market and we’re seeing it here. The article stated that there has been so much demand for real estate that property prices are starting to rise. Not only are individuals snapping up properties, but Wall Street has taken notice; hedge fund managers to private equity investors to foreign investors are all snapping up property because prices are going up.

Added to that, many of these properties are also located in the same locales that were going crazy prior to the downturn – Las Vegas, Phoenix and several cities in Florida. All of this has resulted in many retail investors seeing as little as 2% return, if they’re lucky, by chasing after this real estate. What all this means for those that are raiding their 401k(s) to try investing in real estate is that they are, generally, playing with fire for little potential return and are taking a major risk with their retirement planning. For those that do not have a solid cash cushion or willingness to deal with the unique problems surrounding owning real estate, they could end up in a situation where they’re unable to repay their 401k loans. Additionally, they also have to deal with the real possibility that they could earn a much better return by simply staying in the market.

Please don’t get me wrong, I believe that investing in real estate can be a great thing but it needs to be done within reason just like investing in the stock market. The issue is that investors need to do what’s right for their specific situation and not chase gains, wherever those may be, because they see others doing it. I know that not all people who take loans from their 401k(s) will end up miserably, but it is not a risk I would take on without doing my research first.

What are your thoughts? Would you borrow against your retirement accounts to fund a real estate purchase?

 

Photo courtesy of: Sherwood CC

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I'm the founder of Frugal Rules, a Dad, husband and veteran of the financial services industry. I'm passionate about helping people learn from my mistakes so that they can enjoy the freedom that comes from living frugally

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58 Comments

  • Mrs. 1500 says:

    I laughed out loud when I saw the title to this article. We are in the process of buying a house, having finally sold ours. We are purchasing a much smaller and far less expensive home, in an area where the housing market is red-hot. We have a substantial 401(k), having maxed out contributions for multiple years when we were younger.

    We took out the maximum 401(k) loan we could, in case we needed to make a cash offer on a house. It is now turning our offer into a nightmare, trying to prove where this influx of cash came from. With the cost of borrowing money so cheap, it doesn’t seem worth it to raid the retirement coffers. Ours was a special circumstance, and we hope to pay it back very quickly. We are starting to diversify our portfolio, and a rental house is a good first step. But I wouldn’t recommend anyone do it unless it is absolutely necessary.
    Mrs. 1500 recently posted…Happily losing $13,000My Profile

    • John says:

      Lol, sorry Mrs. 1500! :) I can understand why you would’ve done it, especially with the plan to repay it so quickly. The problem is that many do not take that time to plan and take on way too much risk.

      I agree that money is generally cheap to borrow these days and would hate to see someone use their 401k as a piggy bank only to get burned big time in the end.

      • Mr. 1500 says:

        One thing I’ll add is that my 401(k) offers the worst investment options imaginable. I’d be better off investing in tulip bulbs probably. I actually tried to convince my company to let me quit so that I could roll my 401(k) out of their account. Then, they would immediately rehire me. They didn’t like this idea so much, so my account continues to stink.

        With that said, we are in a situation where we could pay the money back immediately if I lost my job.
        Mr. 1500 recently posted…Happily losing $13,000My Profile

        • John says:

          Ugh…I HATE those kinds of plans. I had one of those at a former employer and I just wanted to shake the group benefits people because it sucked so bad. That said, I am confident you guys handled it the right way and the fact that you could pay it off if you lost your job points to that.

  • I feel bad for this woman. Too many people get suckered into investment property by the TV shows and articles they read. They think that it is really easy to do. But it’s not. Especially finding the place. Once you take into account all of your expenses, you will find many properties just aren’t fit to be a rental. I hope that when she was figuring her expenses, she took into account a property management company. It’s great to have the goal o being a landlord, but it isn’t for everyone. Having a property manager costs money and even they won’t do everything for you. Add in a few months of it sitting vacant and you suddenly have a loss instead of a profit.
    Jon @ MoneySmartGuides recently posted…Reader Writes: Short Term SavingsMy Profile

    • John says:

      I do as well Jon, especially considering her health concerns. It might seem great and all, but it has the potential to turn south very quickly.

  • This is actually fairly common practice in Canada, but that’s because there’s a Home Buyers Incentive program that allows us to take an interest and income tax free loan again our RRSP accounts, to a maximum of $25,000, repaid over 15 years.

    Even though that program is available, I would still not borrow against my RRSP in order to buy a house. That money is there for retirement, not as my personal piggy bank to use as I please.

    That said, if I was actually looking to buy, and knew that taking that $25k from my retirement account could get me into a great home/investment property, it would be mighty tempting.
    Jordann @ My Alternate Life recently posted…Life Updates & Call for Guest PostsMy Profile

    • John says:

      That’s interesting to know Jordann. I can understand how that would make it tempting to borrow from it. Though, I would have to have a solid plan in place before I would feel comfortable looking at it seriously. I agree that retirement accounts should not be viewed as a piggy bank… I want that money for retirement. :)

  • I would, but it would I would have to be 99.99% sure that it was going to appreciate in value or that it was positively geared. I also wouldn’t do it if I was only a 5-10 years away from retirement age. At my current age I don’t see too much risk as I still have plenty of time before I hit my 60′s.
    Glen @ Monster Piggy Bank recently posted…How Much do you Spend on Birthday Gifts?My Profile

    • John says:

      That’s just the thing Glen, who knows with real estate? This is especially the case as it’s going on in much of the same places that became so inflated before the downturn. With as many as they claim are doing it I am very leery of it.

  • I suppose if it’s for investment and diversification purposes, borrowing against your 401k would not make sense. The investments in your 401k are likely more diversified than a physical property, especially because we are prone to bubbles from the Fed’s easy money policies.
    DC @ Young Adult Money recently posted…How Embracing A New Culture Saved Me MoneyMy Profile

    • John says:

      I don’t think it really would DC, unless you have a solid plan in place to pay it back and do so in quick fashion. Without that plan it could be a VERY costly lesson.

  • I think the difference between Mr. 1500′s 401k loan and so many others is that Mr. and Mrs. 1500 have proven themselves to be highly financially responsible and we know that they will kick that loan to the curb as soon as humanly possible. Others usually don’t have such commitment to good financial management, and therefore this is a huge risk. I can see the logic in it, but not sure that we would do it.
    Laurie @thefrugalfarmer recently posted…How Waiting Before You Make that Purchase Can Save MoneyMy Profile

    • John says:

      I completely agree Laurie! For 99.9% of the crowd out there it would not make sense, given the risk involved. If you have that plan like the 1500′s do then I generally have no problem with it.

  • I wouldn’t do it either! I only think that a 401K should be borrowed against or raided at the very last resort…..like if you’re about to lose everything.
    Holly@ClubThrifty recently posted…I Just Wrote a Check for $3,500…My Profile

    • John says:

      I tend to agree Holly. I think for the large majority out there that it should be the very last resort. That said, there are those who can make it work…but it takes A LOT of due diligence.

  • Saving for a down payment on the house outside of the 401k is definitely ideal, but when the average savings rate is around 3-4% it’ll take forever to build up a 20% down payment. And that’s assuming that the temptation to use your savings for something else that catches your eye doesn’t come along. So I understand the temptation to use 401k funds because that is where the bulk of employees savings are at.

    Using it to buy an investment property doesn’t make sense to me. I could understand using it to purchase a primary home but the risk is still there, at least in the US since unemployment or job change triggers a full repayment. I’d probably say that 99.9% of people that go the 401k loan route don’t have the cash on hand to be able to payback the loan in a short time frame, or they would have used it in the first place.

    This goes back to most people’s lack of patience and need for instant gratification. Considering how dismal the retirement savings are I hate to see this.
    JC @ Passive-Income-Pursuit recently posted…Net Worth Update – May 2013My Profile

    • John says:

      Great points JC! I agree that the time to build up the down payment can take too long for many and that instant gratification can easily trip you up.

      I agree that 99.9% of those doing it likely do not have the cash on hand to repay it or have not thought through the ramifications of the risks involved. I know it can be done, but so many do not take the time to employ thorough due diligence to make sure they can actually handle it.

  • I don’t think I’d ever do this either. I like having money set aside for retirement, and I just can’t imagine giving that up for any period of time. We didn’t take the incentive, as Jordann mentioned, to do this.
    SuburbanFinance recently posted…Earn Your Degree Without the DebtMy Profile

    • John says:

      I do like having that money set aside for retirement as well and can only imagine doing it if I had the cash on hand and plan to repay it very quickly.

  • Matt Becker says:

    It’s so typical for everyone to jump on the bandwagon of an investment class that has already seen a rise in price? Why is something more attractive when it’s more expensive? I understand the fear part of it, but if people compared it to how they do their normal shopping they would think it as crazy. Like you say, I think owning real estate can be a good way to diversify in the right circumstances. But it’s not inherently safer than the stock market. Does everyone forget the housing bubble? It just happened! And managing rental properties takes real work that not everyone is going to be up for. It’s certainly not a magic bullet.
    Matt Becker recently posted…Is a Coffee Habit Comparable to a Debt Habit?My Profile

    • John says:

      I know Matt, I was thinking that as I read the article…does everyone forget what happened 5 years ago? That’s what honestly makes me the most concerned about this is that it’s happening in the very places that got hit hardest…because they were the most inflated.

  • I think as a general rule, you shouldn’t raid your retirement accounts to purchase a house. I am considering this route because my job is relatively stable (government) and I have a pension. Also, here in NYC, to get a decent downpayment I’m going to need a large amount of money.
    Andrew@Living RichCheaply recently posted…The Liebster AwardMy Profile

    • John says:

      I can see how that would make it a viable option to look at Andrew as long as you have that plan in place to take care of it as quick as possible.

  • I’m 100% with you there. It’s simply too risky, compared to a relatively stable alternative.
    Mike@WeOnlyDoThisOnce recently posted…7 Paths to Successful BloggingMy Profile

  • This would likely be only for the truly savvy, but one could invest in real estate through an IRA (created from rolling over a 401k or by direct contribution) by setting up a Self-Directed IRA. You can think of a self-directed IRA as sort of your own little umbrella company of which you’re CEO. You can invest in virtually anything, not just real estate, through a self-directed IRA. BUT, there are lots of rules, and like I said, you really, really need to know what you’re doing. Certainly not for the average joe and jane.
    Kurt @ Money Counselor recently posted…Our 3 Best Money Choices—#2My Profile

    • John says:

      That is a great point Kurt! And I agree is only really for the truly savvy that know what they’re doing and have a good plan in place.

  • Jake @ Common Cents Wealth says:

    I definitely would not borrow against my 401k to buy an investment property for the exact reasons you mentioned above. If you were to move jobs, you would be required to pay that back within 6 months or else pay a 10% penalty plus tax on that loan. It’s pretty dangerous. I would, however, save up money outside of my 401k to buy a property.
    Jake @ Common Cents Wealth recently posted…When is the Best Time to Get a Dog?My Profile

    • John says:

      I generally would not either Jake, though I do know it can be done. The problem is that too many want to do it and have no plan in place. This results from no due diligence and they end up paying for it in the long run.

  • I imagine there are scenarios where this might work, but real estate is always tricky and I would personally never do it. To me, my retirement account is off limits at all costs until retirement age unless it was a life or death situation. I do know people who get sick of the stock markets and have pulled everything out to put into rentals. In my opinion, this is no better. Real estate could crash as well. I believe you should have retirement accounts and real estate if you truly want to be diversified.
    Kim@Eyesonthedollar recently posted…Broke in Retirement: Why It’s Important to Know Where Your Money Is.My Profile

    • John says:

      That is a great point Kim, the housing market can be just as crazy as the stock market and you could end up losing as much if not more. I think it can work, though I do not know if I have the stomach for it and would require a solid plan and cash on hand to repay.

  • AverageJoe says:

    I would not do that, BUT I just had a long talk with Sandy at Yes, I Am Cheap, and she has done it and (I think) done it successfully. Here’s where she got it right: she started with an overall plan and examined all strategies available. Then she put together a clearly defined set of parameters on her investment. she did all the things you complain that people don’t do above….and you’re exactly right. People raid their 401k without giving any thought to the consequences. It’s horrifying to see.

    Great advice, John!
    AverageJoe recently posted…How To Become a Great Saver (It’s Not As Hard As You Think)My Profile

    • John says:

      It’s funny, because I believe I saw the discussion about this on Twitter AFTER I wrote this post. ;) Sandy handled it exactly the way you should and 99.9% of the people out there would just jump without doing that due diligence.

      I don’t know that I would do it, but if I did I would follow much of what Sandy did.

  • Thanks for bringing up a huge point when it comes to investing in general – the herd mentality. We want the best deal possible (which I can understand) so when someone says they made a killing of [insert whatever it was] suddenly everyone is on the bandwagon regardless of whether it makes sense for them. Or they even understand what they are really doing – like this woman. Real estate is not life insurance. It is also not without risk. I have no problem with people investing in real estate because it absolutely can be a profitable investment, but most people forget flipping houses doesn’t always work and managing a rental property also takes time and money too. People get caught up in the “make money” part of the story and overlook the rest.
    Shannon @ The Heavy Purse recently posted…How to Talk to Your Kids about Family DebtMy Profile

    • John says:

      I could not agree more Shannon. People hear “make money” and they often seem to lose all sense of wisdom. It can be done, obviously, though it has to be right for you and wise risk as opposed to crazy risk.

  • anna says:

    I think in her situation specifically, it’s more risky. If she develops more heart problems (which sounds so awful and hope she doesn’t!), then she might have to go on an early retirement and have to pay the penalty fees.
    anna recently posted…“Mary and Max”My Profile

    • John says:

      I agree Anna, I think that lady does bear more risk and it makes me concerned about what may happen if things do not work out well for her.

  • Sandy says:

    I actually just participated in a roundtable about this very phenomenon.

    Okay, I’m on the flip side of the coin here. I have purchased two homes successfully this way and repaid the loans very quickly. Like Joe mentioned, I researched this for a very long time before jumping into the pond.

    I always looked at my loans in an ULTRA short-term basis. One loan was repaid in less than a year and the other in 2 months. I used the 401(K) money to purchase the homes outright and then backed my way into either a personal loan or a mortgage. I own one home outright with no mortgages or liens and the other I have a mortgage of $26K on. My money went right back into my retirement accounts and I am left owning 2 investment property that more than cover their keep but will break even completely after only 4 years of ownership.

    Since I’m in my 30′s I have decades of income to look forward to from these homes PLUS any appreciated value if I choose to sell. so far, one home is up $20K an the other $15K after less than 2 years.

    Would I recommend this for everyone? Absolutely not. You have to know your risks and really crunch your numbers. Would I do this as a 55 year old wanting to retire soon? Probably not. Would I use money from my 401K to purchase a home that I would live in? Maybe not, but I can see why people do.

    In the end, I know that my retirement account is for just that, but if a lucrative deal comes along that will net me an even greater return than the stock market, I can’t say that I wouldn’t consider raiding my account again.
    Sandy recently posted…June 1 Debt Check InMy Profile

    • John says:

      Thanks so much for your input Sandy, I really appreciate it! I do have to admit that after I wrote my post I saw some conversations on Twitter about this and was curious how it would play out. :)

      All that said, I think you bring up some very solid points and are ones that should be taken into consideration. You obviously had a well detailed plan in place after running the numbers and so many miss that salient point.

      The problem is that so many do not do what you did…it’s like they hear “I can make money” and do the complete opposite of what you did and end up taking crazy and needless risk as opposed to you taking a measured and smart risk.

      I don’t know that I could do it myself, but if I did I would look to take the same route you did as something of this nature calls for measured action to make sure it makes sense. Kudos to you for working it out and using leverage to bring some great diversification to your overall portfolio!

  • That is something that I would never do. We have seen how the housing market can change quickly. You never want to gamble with your retirement money
    Sean @ One Smart Dollar recently posted…5 Way to Reduce Summer Energy CostsMy Profile

  • I won’t do it. I don’t think about my 401k as even being there. Out of sight and out of mind. If I know there is money in there, there could be too much temptation and you might want to use a loan. I don’t think it is wise and with the way real estate is, you could lose a lot of money.
    Grayson @ Debt Roundup recently posted…Great Last Minute Father’s Day Gift IdeasMy Profile

    • John says:

      That’s a great way to look at it Grayson and many could face that temptation. There definitely is the possibility of losing out significantly by doing it, especially if you do not have a solid plan in place.

  • Debt Blag says:

    I’d prefer not, but I know that there are worse things than a loan against a 401(K). Sure, it’s an interest-bearing loan, but you pay the interest to yourself.
    Debt Blag recently posted…Making my own almond milk (for fun and profit)My Profile

  • Pauline says:

    I can’t touch my retirement accounts because they are government schemes and you can’t access until you are 65, but I was offered a private pension with employer match once and did not fund it so I could buy more real estate. I feel more confident about real estate than stocks but it sounds like you lose money if you take it out of a 401k so I would probably not fund it in the first place.
    Pauline recently posted…Financial independence: do you have a plan?My Profile

    • John says:

      Yea, the risk of borrowing out of the 401k is that you can owe taxes on it if you leave for your job for any reason and can be counted as income. This is also not to mention the fact that the hotbed for a lot of this activity is places that got burned with the housing bubble five years ago.

  • We have different systems here – Individual Savings Accounts and Self Invested Personal Pensions. These are similar to 401(k)’s I believe. With an ISA you can withdraw money and there isn’t any real penalty except there is a maximum that you can invest per year and you don’t get matching investment from an employer at all. With SIPPs you can’t withdraw until you are 55 then you can only take out 25% without attracting tax. You can take out the rest if you have £20k alternative pension available.

    There were tax efficient endowment mortgages but these have been oversold by banks who are now having to pay people back. In the end you are better keeping these things separate – you need a retirement pot so don’t put it at risk.
    John@MoneyPrinciple recently posted…5 Exciting Things You Could Do When You Pay Off All Your LoansMy Profile

    • John says:

      Very interesting to see the differences between the two countries. I would tend to agree that the two should stay separate, unless you’re savvy enough to know what you’re doing and have a solid plan in place.

  • I don’t have a 401k (non-profits have 403b-I’m not even sure if you can borrow against that?) but if I did I wouldn’t. The money I’m putting into retirement is for…well retirement. We’ve very interested in real estate and want to buy a rental property in the next year or so. We’re saving for a down payment now. If we didn’t have enough in cash for the down payment we wouldn’t buy.
    KK @ Student Debt Survivor recently posted…What Are High-Deductible Health Plans? Who Do They Hurt?My Profile

    • John says:

      That’s a good question, I am not certain if you can or not with a 403b. I had one a number of years ago but rolled it over to my new employer. I would be inclined to do the same thing, but would be open if I did the due diligence and had a solid plan.

  • We did the Canadian equivalent of taking money from a 401k to put a down payment on our first house. We took our $20,000 from husbands RRSP’s (Registered Retirement Savings Plan) to enable us to buy our current house. I’m not sure whether that was the best course of action but we are paying it back and I’m hoping the equity in the house if the property market recovers will make up for some of that in the long run. Thanks for the article – wise words!
    Lindsey @ Cents & Sensibility recently posted…Online Dating: The Rise of the McRelationship?My Profile

    • John says:

      Thanks for sharing your experience Lindsey! It sounds like you have a plan to repay it which is ultimately where many fail in this area.

  • I agree with many of the commentators here that money is so cheap right now that it would be crazy to borrow from your 401k. I think you should keep that money in there untouched as long as possible to grow big and strong :)
    thepotatohead recently posted…Relationship Status : It’s Complicated–And Costly (Wedding Edition)My Profile

    • John says:

      I agree, money is cheap (generally) these days. I would be inclined to do the same thing, but I know it has been done…don’t know that I have the stomach for it though.

  • Great post John. We are going to share it next week on our Dinks Finance round up. Have a great weekend.

  • Brent says:

    Borrow against my 401k, no.

    Use business structuring to invest in a company that I control to purchase real estate investments, yes (assuming the legal side of the business structure was sound as I have not yet discussed this with a lawyer or accountant).

    Real estate can be a great vehicle to generate long term wealth and passive income. I own a number of rental properties myself but it’s true what Jon @ MoneySmartGuides said about how HGTV makes things look easier on TV than it actually is!
    Brent recently posted…7 Common Characteristics of Debt-Free PeopleMy Profile

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