Cash Out Of Your Plan Permanently
Some respected CPAs and real estate investors advocate against having a 401. Robert Kiyosaki once wrote, âthe 401 has robbed Americans for over 40 years now,âand proclaims, âI would never invest in a 401.â
Kiyosaki believes more money can be made when people build a real estate portfolio outside a tax-deferred plan. Inside a plan, your tax liability continues to increase with no advantage of depreciation. You are also subject to the changing laws. He outlines his theory in his recent book Who Stole My Pension?
You do have the option of taking your money out of the 401 entirely and investing in real estate with after-tax dollars. Getting rid of your 401 can be an aggressive move because if your investment does not work out, you also now have no retirement. You are also subject to a 10% penalty on top of paying taxes on all the money if you take it out before age 59.5.
You will want to do a cost analysis and speak to professionals before taking action on saying goodbye to your retirement plan. That said, you are growing all your money with pre-tax dollars in retirement plans. At some point, you are going to have to pay up, unless you have a Roth IRA or Roth 401.
Example Of Investing In 401k Vs Real Estate
Consider a couple married filing jointly in California, each earning $100,000. In order to compare rental property investment vs 401 we will run two scenarios.
Scenario 1 Max out 401 contribution and let it grow for 30 years.
Scenario 2 Do not contribute to 401. Invest the additional take-home pay in a rental property for 30 years.
| Scenario 1 |
|---|
| $3156 |
The couple invests the annual cash flow in stocks at the same 8% return as scenario 1.
After 30 years, scenario 2 couple has $386,123.56 in stocks and property worth $181,100 .
In retirement, scenario 2 couple has no mortgage after 30 years but they still have operating expenses on a 30-year-old property. The monthly cash flow after the tenants pay down the mortgage is $600.
Use A Down Payment Assistance Program
Lastly, it’s also possible to receive help in the form of a down payment assistance program. Many states and municipalities offer grants for interest-free second loans to help ease the financial burden on first-time homebuyers. Ask your lender for more information on what programs are available in your area and how to qualify.
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The Rules For 401k Real Estate Investment:
The rules governing the use of 401k funds for real estate investment are not complicated. There are basically three rules that make sure you do not have a conflict of interest when making real estate transactions with your 401k funds. In addition, you have to make sure the real estate transactions you make are not prohibited by the Internal Revenue Service. The three basic rules for 401k real estate investment transactions are:
These rules allow for the purchase of mortgages with your 401k funds, which means you can purchase real estate using your 401k account. In fact, you can use your retirement funds to purchase real estate properties as much as you want. You might want to purchase fixer-uppers to repair and sell at a profit. Or, you can purchase discounted notes or rental properties to provide an income stream. You have many options available to you as long as you follow the 401k real estate investment rules.
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K To Purchase Primary Home Rules
When you take out a loan from your 401k you will have to pay the loan back to yourself, plus interest.
When you are repaying the loan back to your 401k, you may not be able to contribute to your 401k. This depends on the rules of your employer.
Additionally, the repayments do not count as a contribution into your 401k so you will not receive a match from your employer on the repayment amounts or tax benefits from the IRS.
If you leave your job before the loan is repaid, you will have to pay the outstanding amount immediately.
If you want to use a traditional IRA for a home purchase, you will have to take a withdrawal.
Under the rules of the IRS, you are able to withdraw $10,000 tax free for your first home purchase.
It is best to weigh your options and see what works best for you depending on the amount of money you need to fund your home purchase.
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Invest In Syndication Deals
Syndication deals are another form of partnering in deals and are often passive, so you donât need to do any heavy lifting. The opportunity to use qualified self-directed funds makes it very easy to grow a retirement account, keep a solid position in real estate, and reap potentially high returns. Syndications are large deals that are put together with multi-family, mobile home parks, and storage units. Depending upon the offer to participate, you may need to be an accredited investor. The sponsor who is organizing the investment will let you know the minimums and requirements. All of the proceeds and returns need to stay inside the plan.
Taking advantage of your retirement funds through self-directed plans can be a game-changer in growing your portfolio as long as you weigh out all the variables, run the numbers, and ensure your documents allow it.
Statistics show that most Americans these days are not saving enough to retire. While a large part of the problem may be that people canât afford to save, those who can donât always know how to maximize the returns on their savings by investing that money in real estate.
If You Have An Old 401k Heres What You Can Do
So, your options for investing in real estate are rather limited if you have an active 401k, meaning that you still work for the sponsoring employer.
On the other hand, if you have an old 401k, the possibilities are much greater.
While you canât invest in real estate directly through an employer-sponsored 401k, you can choose to roll a former employerâs 401k account into an individual retirement account, or IRA. And while many IRA custodians donât offer the ability to buy real estate, some offer an account type known as a self-directed IRA.
As the name implies, a self-directed IRA allows you to direct how your funds are invested, within the law. To be sure, there are some things you canât invest in. For example, the law prohibits you from investing in collectibles with IRA funds. However, thereâs nothing that specifically prohibits you from using a self-directed IRA to buy real estate.
- Things youcan buy with a self-directed IRA: Real estate, crowdfunded real estate investments, tax lien certificates, precious metals, cryptocurrencies, private equity investments.
- Things youcanât buy with a self-directed IRA: Collectibles, such as coins, artwork, and antiques.
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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.
How To Open A Solo 401 For Real Estate
- Open your Solo 401 online, through our app, or over the phone with one of our dedicated professionals.
- You will then be assigned Solo 401 plan tax specialist will work with you to customize your Solo 401 plan based on your investment, tax, and retirement goals
- The new Solo 401 plan account can be opened at Capital One Bank
- Fund the Solo 401 plan with a rollover of any pretax retirement funds, or by making a tax-deductible or after-tax contribution directly to the new plan account
- All income and gains generated by the Solo 401 plan investment will generally flow back to your Solo 401 plan without tax
- No annual IRS reporting or filing requirements if your plan assets are below $250,000
- We will handle all IRS plan administration
- No transaction fees
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Can I Use My 401 To Buy A House
It is entirely possible to buy a house with the money in a 401 account after all, the money belongs to the account holder. In fact, employees may use the money in their 401 accounts for just about anything they want. However, the IRS designed 401s to help fund peoples retirements. Any attempt to withdraw the funds for anything other than retirement and before the qualifying age will result in a penalty. The opportunity cost for taking money out of the account too soon amounts to an immediate 10% penalty. In addition to the 10% hit, those taking the funds out will also need to pay income tax on the amount borrowed .
K Loan: Pros And Cons
The first way to borrow from your 401k is to take out a loan. As the name suggests, some of this method involves borrowing the money temporarily and then paying it back with interest over time. We’ve listed the pros and cons of choosing to take out a loan so you can get a better idea of how this process works.
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Withdrawing From Your 401k
Before you start investing in a 401k, its important to understand how these accounts work when it comes to withdrawing from them. For one, anything that you withdraw from a 401k before you reach 59.5 years old will result in a tax penalty of 10 percent, which can make for a substantial reduction in your overall savings. You can make a standard 401k withdrawal if you are no longer an employee for the employer that sponsors your 401k plan and are at least 59.5 years old.
If you have invested money into a standard 401k, you will be required to pay income tax whenever you eventually withdraw your money. However, there will be no penalty applied to the withdrawal since youre over the age of 59.5. After you reach the age of 72, you will need to take out the required minimum distributions from your 401k every year. The amount that you withdraw is based on an IRS formula that dictates the amount by the age you are at the time of the withdrawal. While you can always withdraw all of the money from your 401k account in one withdrawal, this can lead to a significant tax bill that you might want to avoid. If youre still working in the same workplace, there are some plans that allow you to delay the required minimum distributions until the year that you retire.
Hardship Withdrawals
Being able to withdraw money from your 401k account without incurring a penalty in the event of one of these emergencies occurring should give you peace of mind about investing in a 401k.
Vesting Of All Documents
Also,the real estate agent/title company will ask for the 7-page solo 401k Trust Agreement. The Trust Agreement lists the name of the trustee.
Now that your self-directed 401k has been successfully invested in real estate, it is important to also understand the ongoing requirements. All ongoing property expenses must be paid from the solo 401k bank or brokerage account. Never pay expenses with personal funds as the solo 401k prohibited transactions disallow it. Make sure the self-directed solo 401k maintains enough liquid cash to cover ongoing property expenses. Just like expenses are paid using solo 401k funds, the rental income and proceeds from the sale of the property must flow directly back to the solo 401k plan.
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What Are The Penalties Fees Or Taxes Involved In Borrowing From Your 401
If you borrow the money, youll be required to repay the loan, typically within 5 years. Youll be paying interest while you do it, which is generally at the interest rate of 2 points over prime rate. But the interest will be used to pay yourself, which makes it a bit less onerous. However, remember these loans are paid with after-tax dollars so youre missing out on the tax benefits that make 401 accounts so attractive in the first place.
And note that if you use a 401 loan and then leave your job, the full amount must be repaid before you file taxes for the year in which you left your job . If you dont, itâs considered a withdrawal, which means it will be taxed at ordinary income tax rates.
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How Much Can You Take Out Without Penalty
With a few exceptions, account holders will be expected to pay an additional 10% early withdrawal tax on early or premature distributions . In addition to the 10% penalty, the money taken out will be taxed as income for the year its withdrawn. Therefore, no money can be taken out before the age of retirement without penalty, unless the reason correlates to the exceptions above.
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Do I Need An Llc To Purchase Real Estate With My Solo 401
Of course, you dont need an LLC for your Self-Directed 401 to buy real estate. The Solo 401 Plan itself can take title of the property. In other words, the plan can own the property.
There is no requirement to establish an LLC with your Solo 401 Plan funds. However, buying real estate under an LLC provides asset protection. Solo 401 owns the LLC, and the LLC will own the property and youre the manager of the LLC. As manager, you have full control over your investments.
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Downside Of Using Your 401 To Buy A House
Tapping your retirement account for money for a house has drawbacks to consider, whether you take outright withdrawals or a loan. The main downside is that you diminish your retirement savings. Not only does your total retirement account balance drop, but even if you replace the funds, you have lost some potential for growth with the funds not being invested.
For example,if you have $20,000 in your account and take out $10,000 for a home, that remaining $10,000 could grow to $54,274 in 25 years with a 7% annualized return. But if you leave $20,000 in your 401 instead of using it for a home purchase, that $20,000 could grow to $108,548 in 25 years with the same 7% return.
With a Roth 401, you can withdraw the money youve contributed at any time tax- and penalty-free. However, if you withdraw earnings on your invested contributions before age 59½, you must pay taxes on them.
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How Can I Invest My 401k In Real Estate
If you want to use your 401k account to invest in real estate, you will need to use a solo 401k plan. A solo 401k requires owners of the account to make contributions with their pre-tax dollars. These contributions can continue to grow within the account tax-free until you withdraw them for retirement…. read more
Using Your Retirement Account To Buy Stocks In Real Estate Investment Trust
If there is no immediate need to buy a property but you see its value in the long run, we suggest investing your retirement fund in a real estate investment trust, or REIT. REITs principle is quite similar to that of a mutual fund but is limited to real estate, mortgages, and other real estate-related assets.
Heres why its a good idea.
First of all, its more of a liquid investment where you can buy and sell shares as if you were trading mutual funds or traditional stocks. Next, REITs offer opportunities to become a passive real estate investor. That means you dont have to worry about the daily operations and will still be able to earn. Lastly, REITs are mandated to pay 90% of the profits to their shareholders, giving you immediate returns.
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