Should I Use My 401 (k) to Buy a Rental Property?

You’re looking at a second home as an investment property, but the only way you could finance it would be to tap into your 401 (k) to do it.

Is that a good idea?

There Are Penalties for Early Withdrawal from a 401(k)

Your 401(k) is there as an investment, not a savings account. So if you take money out of it before you’re 59 ½, there will be penalties. You’re putting your money in your 401 (k) pre-tax with the understanding that you’ll pay the income taxes on it when you withdraw it. If you withdraw a little at a time during retirement, the taxes typically aren’t that bad. But if you withdraw it all at once, you’re going to get hit with a pretty high tax up front. And you’ll also most likely have to pay a 10 percent early withdrawal penalty on the money. You can borrow from your 401(k), but you'll be missing out on the income it would have earned, and if you leave your job, you may have to pay it back quickly, usually within 60 days.

But There Are Exceptions

If you’re able to, you can roll your 401 (k) over to a self-directed retirement account. Once the money is in that account, you can use the retirement account to invest in real estate. You should be careful when you do this though, there are a lot of stipulations, like you’re not allowed to stay at the house, and investing in real estate isn’t easy money. It takes hard work. Like any investment, there's an element of chance.

Planning Ahead Can Help

Many retirement plans have an exception for borrowing money for a first-time home buyer. If you plan far enough ahead, you can use that exception to buy your first home and eventually buy a second home and turn the first into an investment property.

Explore Other Options Before You Use Your 401(k)

Have you looked at all your options? If you currently own a home, you might be able to get a home equity line of credit (HELOC) to buy your investment property. Or, you might be able to use your life insurance policy to finance it. Be creative and talk to a financial professional to find your best option.

Rental properties can be a good source of income, but you should always know what you're getting into. And tapping into your retirement is serious business, so make sure you can afford whatever risks you're taking!