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Investing 401(k) in Real Estate: Using Real Estate to Boost Your Retirement

When people think of their 401(k)s, many think of buying stocks, bonds, ETFs, mutual funds, and similar assets. Typically, your employer will chip in a little bit alongside whatever you contribute. Then you’ll select (or a financial advisor will choose) a diverse portfolio with the correct amount of risk for your retirement objectives. Many people don’t consider investing their 401(k) in real estate.

However, with real estate being arguably the ultimate long-term wealth builder and with steady rental income being such a compelling prospect in those retirement years, the question is: why not? Why not invest 401(k) money in property?

The good news for prospective real estate investors is that investing retirement funds in real estate is permissible. The bad news is that, as with anything 401(k)/IRS-related, there are technicalities and considerations that you’ll need to make before these investments.

Can Anyone Use Their 401(k) to Invest in Real Estate?

First, a quick disclaimer: this post is not legal or tax advice. Before making significant financial decisions, consulting with these qualified professionals is always a good idea to ensure you get the desired results.

With that out of the way, can you invest your 401(k) balance into real estate? As alluded to in the introduction, the answer to this question is nuanced.

Typically, you cannot invest 401(k) money directly into real estate. For example, you cannot use your employer’s 401(k) plan to buy a house down the street and rent it out. There is only one exception to that rule. You can use a solo 401(k) to invest in real estate, much like a self-directed IRA (more on that later). For qualifications and contribution requirements, along with a comparison between a traditional 401k versus a solo 401k, checkout this article.

You could also use your 401k funds to buy real estate investment trusts (REITs) if you have a self-directed 401(k) (a brokerage account). Those REITs trade on the open stock market. There are other ETFs and mutual funds that also invest in real estate. Again, purchasing those shouldn’t be an issue if you have a self-directed account.

Using two methods, you can also leverage your 401(k) to buy specific real estate- which can be the most profitable way for you to invest in real estate!

Use a 401(k) Loan to Invest 401(k) in Real Estate

Most plans permit you to take a loan against your 401(k). This loan does not incur any early withdrawal penalties and does not count as a distribution. Instead, the plan administrator amortizes it (typically over five years) and sets the interest rate (usually prime + 1%). Through payroll deductions, you’ll pay yourself back the loan. It’s worth noting that any interest you pay to yourself also goes back into your 401(k) account. It does not go to the financial institution.

IRS guidelines permit taking out $50,000 or half your 401(k) balance, whichever is less. Assuming you have more than $100,000 in your 401(k), you could take out a $50,000 loan and invest that money in a real estate syndication, for example. Since most real estate syndications run for about five years, you’d typically be able to make the loan payments with rental income and then have the final sale of the building free and clear.

While no investment is guaranteed, it’s conceivable that at the end of the five years, you’d have $50,000 in non-retirement fund cash plus your 401(k) loan paid off. That 401(k) loan could be the “seed money” necessary to jumpstart your real estate investing career!

Rolling Over Your 401(k) to a Self-Directed IRA

Depending on the terms of your plan, you might be able to roll your funds over to a self-directed IRA (not 401(k)). You can roll previous funds into an IRA without issues if you have changed employers.

Self-directed IRAs permit real estate investments, subject to specific conditions.

The most important condition is to have a passive interest in the property. You cannot actively manage property purchased with IRA funds. For example, buying a single-family home means you’ll need a property manager who handles all the operations.

If you are investing in real estate through other means – like a real estate syndication – those are already passive investments. Those real estate investments are easy to hold in your self-directed IRA.

The second most important rule is that all earnings, including rental income and home sale proceeds, must flow back into the IRA to protect its tax-deferred status. You cannot buy a property, for example, with the IRA funds but use the rental income as ordinary income. Everything done with IRA funds must remain within the context of the IRA.

The Pros of Investing 401(k) Real Estate

No matter your route, there are three significant benefits to investing your 401(k)/IRA money in real estate.

It’s Untapped Potential

For many people, 401(k) money is often the most significant “pot” of funds they have and the easiest to tap into to start a real estate investing portfolio. 401(k) funds can be the springboard you need to grow wealth, whether you’re looking at a 401(k) loan to finance all or part of a project or a longer-term property in an IRA. Both of these options can help you get to a more secure retirement.

Additionally, investing 401(k) in real estate has another upside of the employer match for many people. If your employer matches your contributions, you can potentially build a pot of money to invest far faster than you could without those additional contributions.

A 401(k) Loan Has Unbeatable Terms

If you choose a 401(k) loan to invest in real estate, it is worth noting that the interest rate you’ll pay on the 401(k) loan is probably less than any other borrowing option. And, there’s no “penalty” per se if you don’t pay it back. It gets treated as a distribution and is subject to a 10% IRS levy and ordinary income taxes, but it won’t be a negative mark on your credit score and won’t cause you to have problems obtaining a mortgage or something like that later.

Plus, any interest you pay yourself becomes part of your 401(k) balance, which will grow over time and be available to withdraw in retirement.

Real Estate Is Often a Good Long-term Investment

Lastly, suppose you use a self-directed IRA to invest in real estate. In that case, it’s worth noting that real estate is often a fantastic long-term investment with significant monthly income potential, which aligns very well with an account aimed at providing you with income in your retirement years.

While nothing is guaranteed, it’s not impossible to invest $50k in one syndication, have $100k in your IRA five years later, take that $100k and turn it into $200k, and so forth. When you’re ready to exit the workforce, you might have thousands in passive income – perfect for your retirement years!

Cons of Investing Retirement Funds in Real Estate

The downside of investing your 401(k) money in real estate is simple: you have to plan and meet all the paperwork requirements. If you are thinking of investing this money in real estate, consider consulting with a tax lawyer to ensure your cash remains tax-deferred. If you slip up, you could find yourself with an unexpected tax bill at the end of the year!

Investing 401(k) in Real Estate: It Is Doable

You can use your 401(k) money to fund your real estate investment dreams, either by taking a loan to make an after-tax real estate investment or by converting your available 401(k) money into a self-directed IRA and making tax-deferred investments in real estate. Either of these methods can work.

Indeed, if you’ve wanted to get into real estate and have retirement funds you wish to use towards that goal, consider one of the options above!