Borrowing From My 401(k) to Buy Land
It's tempting to borrow from your 401(k) for that lakeside property. But beware.
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Some 401(k) plans allow members to borrow from them, as long as the participant is still employed with the company. This can be useful, because it gives participants a way tap their cash balances in what is often their most significant asset without generating an immediate income tax liability or generating the 10 percent penalty on early withdrawals.
Plan Specifics
Some 401(k) plans allow for these loans. Others do not. Some companies do not want to get involved in administering these loans, which can drive up costs for other participants. However, some employers do set up plans specifically intending to allow loans. Where it is allowed, a 401(k) loan can make for a convenient way to raise money for such things as a down payment on a new home, an investment property, funds for a startup business, dealing with an emergency or anything else the plan participant wants. There is no underwriting to deal with or lengthy application.
Borrowing to Buy Land
Undeveloped land can be an attractive investment in some circumstances, but there are some things to consider: Unless you are able to rent the land out somehow, farm it or exploit the land for minerals, undeveloped land does not typically generate an income. It does, however, generate property tax liability. You must be able to make the payments, if any, on the mortgage for the land, pay your own 401(k) back with interest within five years, and pay the property tax bills at the same time.
401(k) vs. Land -- Investment Considerations
When you borrow from your 401(k), you are essentially taking assets out of a vehicle that is easily diversified and plowing them into an asset that is not diversified at all and highly illiquid. Also, any income your 401(k) earns is tax-deferred; you get no tax deferral on rental income on land you hold outside of a retirement account. Also, your 401(k) enjoys practically unlimited asset protection against the claims of creditors. A creditor could seize your land, however, and you will still have to pay off your 401(k) loan or face taxes and penalties.
401(k) Loan Considerations
Typically, you have five years to pay back a 401(k )loan. Your plan typically charges you interest as well. However, when you pay yourself back, you must pay back the loan with after-tax dollars -- even though you borrowed pre-tax dollars. If you fail to pay off the loan, you will be charged income tax and possible early withdrawal penalties on the interest -- depending on your age. If you lose your job for any reason -- voluntarily or involuntarily -- you will have to pay off the loan very quickly. This could cause you a nasty tax hit just as you have lost your income if you cannot pay off the loan in the required time frame. Also, if repaying your 401(k) plan causes you to cut back on new contributions, you may also not be able to pick up on a company match. Another possible option: Roll your 401(k) balance over to a self-directed IRA and own the land within your IRA. However, there are a lot of special rules concerning self-directed IRAs. Consult an experienced adviser before attempting this transaction.
References
Writer Bio
Leslie McClintock has been writing professionally since 2001. She has been published in "Wealth and Retirement Planner," "Senior Market Advisor," "The Annuity Selling Guide," and many other outlets. A licensed life and health insurance agent, McClintock holds a B.A. from the University of Southern California.