How Can I Use My Retirement Account To Invest In Real Estate
Retirement investing in real estate is a broad concept that can involve many types of investment vehicles, varying amounts of risk, and different degrees of involvement required on the part of the investor. Here are a few examples.
1. You can invest your retirement account in real estate stocks, mutual funds or publicly traded REITs
This is the most common way of using a personal retirement account to invest in real estate.
If you own an IRA, you can simply use your account to purchase equity shares of real estate-related businesses. These could be publicly traded real estate development companies or mortgage companies, for example, or mutual funds or publicly traded REITs that are themselves invested in a basket of real estate businesses.
If you have a 401 through an employer, you might also be able to find real estate-related investment opportunities such as these in your plans available offerings. Generally speaking, however, an employer-sponsored 401 can have a more limited range of investment opportunities for you to choose from than your personal IRA might have.
This is the most passive and straightforward way to invest your retirement account in real estate. In essence, you can simply find stocks, bonds or mutual funds to purchase, just as you would with other types of traditional retirement investing. The only difference, in this case, would be that you have chosen real estate as the industry in which to invest.
What Are Alternatives To Buying An Investment Property
A middle-ground approach that many investors consider is using their retirement accounts to passively invest in real estate, for instance, via a real estate investment trust . Buying shares of a REIT is just as straight-forward as buying any other stock, and these shares can be purchased and sold with ease using most retirement accounts.
Another alternative, for those who may not have enough cash on hand to fund a down payment on their own, is to invest in rental property alongside a group of others. Here at Trion Properties, for example, you can invest cash or invest in deals using your self-directed IRAs. In either case, investing alongside others can reduce some of the risk involved, because the projects have been thoroughly vetted and are being managed by a highly-qualified sponsor.
You Can Drop Or Refinance Pmi
If you have a conventional loan, you can drop private mortgage insurance once you build 20% equity in your home. And servicers automatically cancel PMI once you reach 22% home equity.
If you have an FHA loan or USDA loan with permanent mortgage insurance, you could get rid of it by refinancing into a conventional loan later on.
PMI is temporary, but the effects of pulling funds from your 401 could have permanent consequences.
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What You Need To Know About The 401k Real Estate Investment Rules
July 14, 2014 by Justin
One of the best reasons for having a 401k retirement plan is the ability to use it to invest in real estate. Over time, real estate has been an excellent investment because property values have increased exponentially over time. Certainly, there are better times to invest in real estate and others, but right now is an ideal time, which is why you should learn the 401k real estate investment rules as soon as possible. You want to take advantage of the benefits available to you so that your future can be more financially secure.
Your 401k plan is part of the Profit Sharing Plan section of the Internal Revenue Code. This section is what allows you to defer your retirement savings on a pre-tax basis. Employers often make this kind of retirement plan available to their employees to assist them with their retirement savings. While there are limits to how much you can contribute to your plan each year, the best part of a 401k plan is that your employer is able to match your contributions up to a predetermined percentage. You are able to contribute up to 20 percent of your annual salary to a maximum of $9,500 per year. Employers can match your contributions up to 8 percent of your total yearly salary.
Rollover To A Roth Ira
You can avoid the 10 percent early withdrawal penalty and restrictions imposed on a 401 distribution by rolling over as much as $10,000 that you’ve earmarked for building or buying your first home into a Roth IRA. However, because 401 funds are pre-tax contributions and Roth IRA contributions are post-tax, you must pay income tax on the money transferred to the Roth IRA. That means increasing your federal withholding, which will reduce your take-home pay.
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Using Your 401 For A Down Payment As A First
Home prices keep rising which means saving the required down payment for your first-time home purchase can be tough.
But as a first-time home buyer, taking money from your 401 to buy a home is likely not the best option.
First-time home buyers are often at a key age for making retirement contributions. The more cash you put in when youre young, the more time your money has to accrue compound interest.
For example:
- Say you have $30,000 in your 401 at age 30
- After 25 years at 7% interest, that $30K will have grown to $162,800
Now imagine you take out $10,000 to make a down payment on your first home.
- Your 401 now has $20,000 in it at age 30
- After 25 years at 7% interest, it will have grown to $108,500
- So $10,000 withdrawn now means $54,000 less in your 401 at retirement
This isnt to say a 401 loan or withdrawal is always the worst option.
But before you turn to your retirement savings, consider all the other routes available for first-timers to purchase a home.
Using Your 401k For Real Estate Investing
A 401k is an investment savings account thats sponsored by the employer of the individual who holds the account. Workers are able to make contributions to a 401k account via automatic payroll withholding, which means that the money will automatically be taken out of your paycheck and sent to your 401k account. Depending on the account you have, your employer may match a portion or all of your contributions.
Any money thats placed into a standard 401k plan isnt taxed until you withdraw the money, which usually occurs after retirement. If you invest in a Roth 401k plan, your withdrawals could also be tax-free. There are a couple of different types of 401k plans that you should be aware of, which include Roth 401k plans and solo/self-employed plans. A Roth 401k plan is a special type of 401k account thats funded with your after-tax dollars up to a certain amount. Because the account is funded with after-tax dollars, eventual withdrawals dont need to be taxed, which is the opposite of how a traditional 401k works. Both account types have their advantages and disadvantages.
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The Real Estate Investment Process Using Your 401k:
Once you are sure your 401k plan allows you to self-direct your funds, you can begin the process of making a real estate investment. Be aware that you are not going to be given a list of real estate properties available to you. It is up to you, as the owner of the 401k account to find the property or note you want to buy. You should also keep in mind that you are assuming all associated risks of investing in real estate, but you are also going to receive all the benefits of such an investment.
After you locate the property you want to buy, simply make a request to your plans administrator to ask the plans trustee to purchase it with your funds. This process is all done through written communication so there is a concrete record of your purchase. The trustee will ensure all the paperwork is in order and will make the purchase. At that point, the funds you use to purchase the real estate will be deducted from your 401k account.
Again, using your retirement funds to purchase real estate is a great option, particularly right now when the market is improving. You have the opportunity to increase your retirement income and funds through your own self-directed actions. If you have never considered a 401k real estate investment before, perhaps now is the right time.
When Using Your Retirement Savings Might Be Worth It
You should consider all other options before using a 401 account to finance your home purchase. The interest and penalty fees will substantially add to the cost of your home, and borrowing against your retirement savings can have severe financial consequences later in life.
However, if you need to buy a home and have no other option to secure funds for a down payment, borrowing against your 401 can provide the necessary cash. What is a 401 account if not a financial resource to be used to the fullest? If you need access to that money to buy a home, that alone may be reason enough to use your savings now rather than at retirement.
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Set Up Your Plans To Be Self
Several tax-advantaged vehicles include a defined benefits plan, a 401 profit-sharing plan, solo 401, employer-sponsored 401, traditional IRA, and Roth IRA. With any variation, all the documents need to allow you to invest your funds as self-directed for you to invest in real estate. Once self-directed, you can hold alternative investments in your retirement account.
A defined benefit plan is an employee-sponsored retirement plan that is regulated by the Employee Retirement Income Security Act of 1974 and the IRS. They offer higher allowances to defer income based on how much your company earns and are more intricate to set up. Annual government forms are required for all plans if you have retirement assets over $250,000.
If you own a business with no full-time employees other than your spouse, you can set up an individual 401. If you write these plans with a maximum amount of flexibility, you will have many advantages, including check-writing capability. Check writing gives the owner of the plan owner complete signing authority over an account that offers access to their retirement funds. With check writing, the individual monitors their own activity.
Find out how your plan is set up, and remember there are still advantages to advancing your retirement. You can utilize a company match, or if you qualify for a Roth 401 and the company offers both, you can start growing your investments tax-free.
Types Of Solo 401 Contributions
The most popular benefit of the Solo 401 plan is the high annual maximum contributions. In other words, with a Solo 401 plan, one can reach his or her maximum contribution limitation faster than a SEP IRA since a SEP is only a profit-sharing plan. The Solo 401, on the other hand, is a profit-sharing plan, but it also has the employee deferral feature, which will be highlighted below.
There are generally two types of categories of Solo 401 type contributions:
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Determine The Purchasing Method
There are several purchasing methods that can be used when investing in real estate using a Solo 401. They include:
This method involves using cash only from the Solo 401 to purchase a real estate property. This means that the Solo 401 owns the property without any debt financing.
You can use debt financing to fund purchase of real estate property. You can obtain a non-recourse loan from a bank or other lending institution. The IRS prohibits investors from borrowing from relatives such as a spouse, natural and adoptive parents, or any business owned by the Solo 401 owner or family members. Also, the Solo 401 must have sufficient funds to meet the non-recourse loan payments.
Although real estate purchases can be made directly using the Solo 401 account, some investors may opt to create an LLC for the purchase of making the purchase. You can obtain an EIN for the LLC, which will be required to open the LLC bank account. Once the bank account becomes active, you can fund the account using Solo 401 money.
This method allows investors to purchase real estate property using a mix of Solo 401 funds and personal funds. You can partner with another investor or certain family members to purchase the property the ownership of the property will be split based on the agreement. Any expenses and incomes from the property will also be shared based on the agreed percentage between the owners.
Yes You Can Invest In Real Estate With Your Ira Or 401
Patrick Grimes is the founder of Invest on Main Street, a private equity firm managing passive multifamily investments in emerging markets.
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Weekly, handfuls of investors come to me with the same set of issues. Theyre frustrated that their retirement accounts arent performing well, and theyre fearful that they aren’t protected from market volatility and rising inflation. They wish they could diversify into real estate, but all of their funds are trapped in their employer’s 401 or their financial planners IRA until they are 59.5 years old. Additionally, theyre too busy to become landlords and, instead, prefer to spend their free time with family and friends and hobbies.
What is little-known by the middle class but highly exploited by the wealthy is that this is simply not the case. While youre not able to spend the funds in retirement accounts before 59.9, at least not without significant penalties, you can roll those funds into self-directed IRAs or 401 plans and use them to invest in real estate and other alternative assets.
Additionally, while these plans allow the option to become a DIY landlord and spend the golden years dealing with tenants, toilets and trash, they also open up a wide range of completely passive real estate investment options through private equity firms that provide the same advantages as direct ownership without the headache.
Why Everyone Isnt Using Self-Directed Retirement Accounts
Types Of Self-Directed Retirement Investments
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Get A Bank Loan Inside Your Retirement Plan
Getting a bank loan inside a retirement plan is not very common. A Google search comes up with almost no information on the subject, and Iâm not surprised that a CFP on my payroll told me it wasnât possible. But Iâve since learned that depending on the plan documents, it is.
Here is how it works. The lenders qualify your eligibility using a 60-65% LTV and look at how much is in the retirement account to get the loan. Only certain banks offer these loans NASB is one of the most popular ones.
Retirement plans have many prohibited transactions that need to be considered in the loan, including not allowing disqualified persons to benefit, meaning yourself or an immediate family member. A disqualified plan pays hefty fines and loses the benefits.
The loan rates are higher , and flippers are vulnerable to UBIT tax but other than that, it is a viable lending option.
You can even utilize a 1031 exchange. All retirement funds, unless taxes are paid, stay inside retirement plans and the funds remain tax-deferred. A disadvantage is there is no depreciation capture opportunity, but a bonus is that the loan application is also only two short pages.
Real Estate Leverage With The Solo 401
Here is the primary reason to use the Solo 401 for all types of real estate investments: the use of leverage.
We are often reminded about the advantage of owning property, whether its a piece of land or a multi-family real estate property. However, the purchase of real estate requires large capital and as a result, many investors choose to purchase real estate with leverage. In the case of an IRA, when you purchase real estate using leverage this will be considered debt-financed property and will be subject to the Unrelated Business Taxable Income tax. If you use a nonrecourse loan with an IRA to purchase half of the real estate property, the income generated from the financed portion of the real estate property will be taxed at the UBTI tax rates, which can be as high as 37%.
Whereas the Solo 401k is not subject to the same UBTI rules as an IRA, which is the main advantage of using the Solo 401 to buy real estate. Internal Revenue Code Section 514 permits a few qualified organizations to be exempt from the UBTI tax, including qualified retirement plans. Thus, the plan will be removed from the UBTI tax. This is an attractive feature among real estate investors who do not have the finances to purchase the real estate property on their own, or prefer to use less of their retirement funds to make the real estate investment.
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Advantages Of Buying Real Estate With A Roth Solo 401k
Power of Tax-Free Investing: One of the main attractions to the self-directed Roth Solo 401k for real estate is based on the fact that qualified distributions of Roth earnings are tax-free.
However, you must meet certain conditions and the distribution has to be qualified. Roth Solo 401k plan participants will never pay tax on Roth distributions. When you contribute to a Roth Solo 401 plan, income and gains you generate will be tax and penalty-free. This is among the main advantages of a Roth Solo 401.
Unlike with a pre-tax Solo 401 plan, contributions to a Roth Solo 401 are not tax deductible. Take a look at the following examples to better understand the power of tax-free investing.
