If you have a 401k, you may be wondering how you can put it to best use. You can take this bit of money out of your paycheck before taxes are deducted. Many people put it in a savings account or a retirement plan. Another option is to use it for real estate investments. If you’d like to explore this route, the first thing you should do is check with your retirement plan administrator. There are IRA custodians who do not allow real estate investments. They can provide you with alternative options if this is the case. If you are cleared to invest, here is a simple guide on how to go about it.
It is a difficult and time consuming process and isn’t always the best choice for everyone. “We’re seeing many people cash out 401(k)s or IRAs because they want to take advantage of the market,” said Sean Galaris of financial services firm LM Funding, based in Tampa. “This new scenario involves people losing significant personal funds since they are financing real estate through retirement accounts, savings and life insurance.”2
Here are three basic rules to investing your 401k in real estate:
- You are only permitted to purchase assets that are not prohibited, such as real estate. This means you are allowed to buy mortgages.
- You are not permitted to deal with yourself or anyone to whom you are related.
- All transactions must be at arm’s length.
How does it work?
Find the property or note, which are self-directed and not chosen from a list. You will be responsible for any risks and receive all the benefits of the plan you choose. If you don’t design your plan properly, the employer or plan trustee is not liable for any losses.
Through an array of written documents, “ you request that the administrator of the plan ask the trustee of the plan to purchase the asset you have selected for your benefit in your plan.”1
It’s common for people to purchase properties and flip them, meaning fixing them up from a distressed state and selling them again for a profit. You can also purchase discounted notes or income streams. All options come with rules that you should be aware of before jumping.
What about taxes?
You are usually permitted to borrow half of the value of your 401k account, not exceeding $50,000. By doing this you incur tax benefits. Those benefits are lost if you use funds outside of your 401k to buy real estate.
Here is a simple breakdown of how to use your 401k to invest in real estate. If you follow these guidelines, you will enjoy multiple tax benefits and almost no ramifications:
- Make sure you are allowed to invest in real estate by talking to your retirement plan administrator. Open a self-directed IRA if your IRA custodian doesn’t allow for real estate investments.
- Research loan regulations that may apply. “In order to keep taxation low, you must limit your income stream and capital gains to the best of your ability, but that would most likely run counter to the objective of your investment.”3
- Rollover your 401k into an IRA tax-free and invest with the proceeds. This allows you to bypass the rule that states you cannot use your 401k to buy real estate.
- Hire a real estate management company to help you. You must do this in order for your IRA to receive tax benefits
- Monitor any cash flow carefully.
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