Discover how to use your retirement funds to build a passive stream of income through multifamily investing. Whether you are a beginner or a seasoned investor, this video will help you understand the pros and cons of using retirement funds for real estate investing and the best way to mitigate taxes and penalties.
Disclaimer: Do not withdraw any money from your retirement funds unless you have a solid plan and the help of an experienced advisor. For no-obligation information, text “PETER” to 833-942-4516, and our team can provide suggestions as to how you may use your retirement funds to invest in multifamily real estate.
Pros and Cons of Using Retirement Funds
There are two major drawbacks to using your retirement funds. First, when you withdraw from your retirement account before the age of 59 and a half you incur a 10% penalty. The second drawback is that all withdrawals are subject to standard income tax rates. These two deterrents typically discourage people from cashing out their savings prematurely and traditional finance wisdom reinforces this mindset. The idea of withdrawing hard-earned retirement money to invest in real estate is outside the box of most conventional investors.
This is one of the reason why some people find themselves struggling financially while others thrive. It often comes down to the assets they own. In his book, The Key Person of Influence, Daniel Priestley teaches that income follows assets, and we couldn’t agree more. Smart investors, with the right guidance, turn their retirement savings into income-producing assets and use tax strategies to mitigate the associated penalties and income taxes.
Benefits of Using Retirement Funds to Invest in Multifamily
- Cash Flow: Investing your retirement funds in income-producing assets like multifamily properties ensures steady cash flow; a consistent income from rent that that isn’t possible with retirement accounts.
- Depreciation: Commercial real estate investments offer significant tax write-offs through depreciation, including cost segregation which allows you rapidly depreciate your property.
- Appreciation: Multifamily real estate not only appreciates through mortgage pay-down but also through forced appreciation. By raising your rents over time, you can increase the net operating income, thereby increasing the value of the property.
- Insurance: Multifamily properties can be insured against total loss. For instance, if your property is destroyed by fire, it’s covered by insurance and you can rebuild. On the other hand, when stocks plummet due to factors like company scandals, there’s no insurance to recoup your losses.
- Tax-Free Liquidity Event: Through strategies like cash-out refinances, you can access the equity in your property tax-free until you decide to sell.
- Real Estate Professional Status: Achieving real estate professional status (per IRS) allows you to write off nearly all expenses related to your business and investments. To learn more about how to achieve real estate profession status and the many benefits it provides investors, check out these videos:
Why Reach Real Estate Professional Status
How to Reduce Taxes with Commercial Real Estate
How to Turn Your Savings into Income-Producing Assets
Sometimes, a single deal is all it takes to start experiencing the many benefits of owning real estate. So, let’s dive into two practical examples of investing retirement funds in multifamily properties. The first example will illustrate how to invest using a conventional loan, and the second will explain how to leverage your retirement funds using creative financing. While the average retirement account holds $94,000, the median is actually above $300,000. For our purposes, we’ll use a middle-ground figure of $200,000 from a retirement account.
Example 1: Conventional Bank Financing
Step 1: Liquidate a $200,000 Retirement Account
- You’ll pay a 10% penalty unless you’re older than 59 and a half. So, cashing out $200,000 will cost you $20,000 in penalties.
- Also, any amount withdrawn from the retirement account is subject to regular income tax. For our example, if you are in the 15% tax bracket, withdrawing $200,000 will cost you an additional $30,000.
- After penalties and taxes, you’ll be left with $150,000.
Step 2: Acquire an Income Producing Asset
Your next step is to buy a five-unit apartment building in the Midwest for $500,000, which will cost you $125,000 (25%) down payment and $10,000 in closing costs. This equates to $135,000 of your $150,000. The property would cashflow approximately $800 a month ($9,600/year), which is a 7.1% cash-on-cash return (ROI).
Step 3: Mitigate Taxes and Penalties
An essential technique to mitigate penalties and taxes is with a Cost Segregation Study. Cost Segregation is a strategy of accelerating your depreciation and can provide significant tax savings that offset the federal taxes. We recently performed a Cost Segregation Study with a similar 5-unit property in Illinois and our students got a $60,000 tax deduction in year one. In our example, those deductions can offset the $50,000 in penalties and taxes, making the withdrawal virtually cost-neutral in the first year. But there’s more! You can write off the annual cash flow of $9,600 with the remaining $10,000.
Was It Worth Cashing Out Your Retirement Savings?
With Cost Segregation we were able to neutralize the penalties and taxes, plus year one income taxes, and gain 7.1% return on investment. So, I think it was definitely worth it. But can it get better? Is there a way to leverage your retirement funds to buy more units? Absolutely! Using creative financing strategies we can structure an even better deal!
Example 2: Creative Financing (Master Lease Agreement)
The funding for this example comes from the same retirement account; however, the difference is in the financing method. We are using creative strategies rather than a traditional bank loan.
Step 1: Liquidate a $200,000 Retirement Account
Again, you incur $50,000 in penalties and taxes, leaving you with $150,000.
Step 2: Acquire an Income Producing Asset
With your funds, you will purchase a 12-unit property for $1,000,000 using a Master Lease Agreement. This only requires a 10% down payment ($100,000) and closing costs of $10,000.
The Master Lease Agreement is the most powerful technique for creative financing. In commercial real estate, the term “Master Lease” refers to a creative financing arrangement where the seller becomes the bank for you, allowing you to structure the deal with a lower down payment and control the interest rate. No banks are involved; there is no requirement for an appraisal nor a loan application, or credit check. For a more in-depth training on the Master Lease Agreement and other creative financing strategies, go here: Creative Financing Commercial Real Estate
A lower down payment allows you to purchase of a larger property, which would generate a monthly cash flow of $1,920. The remaining $40,000 could be used to renovate units, allowing you to increase rents by $100 per unit over the next two to three years. By raising your rents over time, you are increasing the net operating income, which in turn increases property’s value. Here’s how the math works out:
12 units x $100 rent increase = $1,200/month
$1,200 x 12 months = $14,400 annually
To determine the new property value, divide $14,400 by a 6% capitalization rate, resulting in a forced appreciation of $240,000. Therefore, by raising rents by just $100 per unit, the property’s value could be increased by $240,000.
Was It Worth Cashing Out Your Retirement Savings?
Absolutely. With strategic planning and the right guidance, you can not only neutralize the penalties and taxes but also build a sustainable passive income stream and benefit from various tax advantages. The moral of this story is clear: Buy income-producing assets! It’s the key to building and maintaining wealth!
Questions or Comments? Text PETER to 833-942-4516.
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