How to Invest in Real Estate with a 401(k)

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Want to double down on the tax benefits of real estate investing with your 401(k)?

I get it. Fortunately, you have several options for investing in real estate with a 401(k) or 403(b) account.

Not all of them are created equal, however. And the more flexibility you want, the further off the beaten path you’ll have to venture.

 

Options for 401(k) Real Estate Investing

Sit down with your accountant or financial advisor to discuss these options to invest in real estate with a 401(k) and decide which one fits your goals best.

We’ll start with the easiest options and work our way to the more flexible but involved options.

 

1. Public REITs

Many 401(k) administrators already offer publicly-traded REITs as built-in options for investing. If you want to include publicly-traded REITs (real estate investment trusts) in your broader portfolio anyway, your 401(k) account is a convenient place for them.

Just bear in mind that public REITs don’t actually offer much diversification from stocks. There’s an uncomfortably close correlation between REITs and stocks, which defeats the purpose of diversifying your portfolio to include real estate. The correlation between U.S. REITs and the broader U.S. stock market is 0.59, which is comparable to the correlation between the total U.S. stock market and other sectors such as telecommunications stocks, energy stocks, and consumer staples.

If you want true diversification with uncorrelated assets, you’ll have to look further afield.

 

2. Borrow Money from Your 401(k)

Often the cheapest person to borrow from is yourself. Or at least, your future self, by borrowing from your 401(k) balance.

You’ll still pay interest, but at a lower interest rate than loans from banks. And that interest actually goes toward your 401(k) balance, not a lender.

You can use borrowed funds to cover the down payment on a rental property, closing costs, renovation costs, or anything else for that matter. Loans from your 401(k) are flexible, cheap, and don’t require lengthy credit applications. If you default, it doesn’t report on your credit history.

But you do pull cash out of your 401(k) account that would otherwise be invested and earning a return for you. It’s up to you to ensure you earn a higher return on your borrowed funds than you’d have earned if you’d just left the money in your 401(k) invested in stock index funds.

If you leave your job, you typically need to repay the loan balance quickly. And in the case of default, the IRS considers the balance an early withdrawal and hits you with both taxes and a 10% early distribution penalty.

 

3. In-Service Rollover to an SDIRA

With a self-directed IRA (SDIRA), you can invest in nearly anything you want, including real estate.

But can you transfer funds from your 401(k) to your IRA while you still work at a job? In most cases, you can; the Profit Sharing Council of America (PSCA) estimates that up to 77% of employers allow in-service rollovers to IRAs.

Of course, “can” is not the same as “should.” Self-directed IRAs require a custodian to oversee your IRA funds and keep you in compliance. And custodians charge for their services, typically hundreds of dollars each year.

That said, self-directed IRAs let you invest in anything from real estate crowdfunding platforms to direct property ownership to real estate syndications. Many of the members in our real estate investment club invest via their SDIRA.

If you invest with a self-directed Roth IRA, your investments compound tax-free. And at compound returns of 15–30%, like we aim for in our real estate investment club, that can mean doubling your money every few years, tax-free.

As a final thought, in-service rollovers can let you contribute huge amounts to your IRA. So long as you meet the income requirements, you can max out both your IRA contributions and your 401(k) contributions each year.



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