The rule most people learn about retirement plans, most often in the form of a 401(k), is to put as much money as you can into it and have a financial advisor place the savings in mutual funds or stocks until you are 59.5 years old. A CNBC study showed that 63% of Americans are confused about how the 401(k) works.
The majority of people don’t realize how to use retirement funds to invest in real estate. Part of the reason many financial advisors don’t recommend it is that they are not familiar with real estate investing. A licensed advisor makes money by selling you stocks and insurance, but they don’t earn any money when you take your funds and put them into real estate. That said, some fiduciaries will oversee your portfolio for a fee and make those recommendations.
I’ve been investing in real estate for years inside of a retirement plan. A certified financial planner (CFP) I hired over 20 years ago introduced me to the concept. He advised me to purchase properties inside my plan. Over the years, I continue to learn more about the underutilization of retirement plans and how confusing they can be to understand. I’ve learned that the CFP I was using at the time gave me half of the information I need to benefit fully.
With that said, I am not a licensed fiduciary or CPA. I recommend that you go over the details of these recommendations with them. The laws are complex, and sometimes even credentialed professionals have varied interpretations of the rules. You want to make sure your CPA and financial advisor understand and support real estate investors. The best access to knowledge and potential benefits is in your ability to ask the right questions and to research your discoveries.
First, read the rules
As an investor, you know the importance of reading through all documents thoroughly. Usually, there is a plan provider that will handle the execution of the documents for a reasonable fee and the business owner simply needs to sign those documents to “adopt” the plan.
Each retirement plan varies, and the provisions will determine your options. If you are the business owner writing your company’s plans, you are in the best situation to create documents with the most flexibility for investing advantages.
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Set up your plans to be self-directed
Several tax-advantaged vehicles include a defined benefits plan, a 401(k) profit-sharing plan, solo 401(k), employer-sponsored 401(k), 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 (ERISA) 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(k). 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.
W2 employees may also be able to self-direct their funds. If your employee plan prohibits it, you still might be eligible for a solo 401(k) with a side business or a self-directed IRA LLC if you have funds from past employment. With previous employee funds, you can roll them over into a self-directed IRA and make real estate investments through your IRA. There are no penalties or taxes involved in the transaction as long as you are only moving retirement money to another retirement account.
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(k) and the company offers both, you can start growing your investments tax-free.
Borrow from your plan
If the plan documents allow, and many of them do, you can borrow up to $50,000 of vested funds or 50% of your balance. So, if you have $80,000, you can borrow $40,000. If your spouse is a vested participant in the plan as an employee, they can also borrow up to $50,000.
The borrower needs to repay within five years, but installments of the fully amortized payments are due at least quarterly. The interest rate can vary, but you essentially pay back the loan to yourself (your retirement plan) at an average interest rate of 1.5% plus prime. You can also take out subsequent loans before you pay back the original loan depending on the balance and again if the plan allows it.
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 I’m not surprised that a CFP on my payroll told me it wasn’t possible. But I’ve 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 (this is the standard rate, but it could fluctuate moderately) 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 (around 5-6%), 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.
Cash out of your plan permanently
Some respected CPAs and real estate investors advocate against having a 401(k). Robert Kiyosaki once wrote, “the 401(k) has robbed Americans for over 40 years now,” and proclaims, “I would never invest in a 401(k).”
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(k) entirely and investing in real estate with after-tax dollars. Getting rid of your 401(k) 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(k).
Pay for properties in cash inside the plan
Paying for a property in cash inside your self-directed plan is a reasonably straightforward process. If you have confidence in real estate and its ability to earn you stable returns and appreciation over time, it is a great option. I utilized this strategy several times to make sizable profits over the years. If you don’t have a large number of funds in your plan, you will want to find partners or get a loan as described above.
Invest in syndication deals
Syndication deals are another form of partnering in deals and are often passive, so you don’t 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 can’t afford to save, those who can don’t always know how to maximize the returns on their savings by investing that money in real estate.