By: Dana Udumulla
Key Points
- Though 401(k)s are commonly offered retirement plans, they may not allow you to invest in your ideal asset class.
- Rolling over your 401(k) into a Self-Directed IRA (SDIRA) grants you the ability to take charge of your retirement and invest in alternative assets such as real estate.
- SDIRAs generally render a better substitute to buying a house with a 401(k). Your gains will develop in a tax-advantaged account whilst aiding in diversifying your retirement portfolio.
Notoriously one of the most frequently advised employee-sponsored plans, 401(k)s are undoubtedly prevalent. This leaves a question for account holders with an affinity for real estate: can I buy a house with my 401(k)? In short, the answer is no. The IRS has implemented guidelines preventing you from investing your 401(k) funds directly into any kind of property. There is a road to turn onto in what appears to be a dead end, and that is the lane of Self-Directed IRAs (SDIRAs). It’s important to note that this can only be an investment property, and not a residency for personal use. Put the settings on cruise control – let’s coast further.
The Frames of Self-Directed IRAs
Self-Directed IRAs (SDIRAs) are individual retirement accounts constructed to support a potentially enriching retirement. These accounts allow their owners to participate in alternative investments that align with a passion or possible area of proficiency. Some of the offered investments are real estate, precious metals, promissory notes, private placements, crowdfunding initiatives, and even creative pursuits. These asset classes are typically not available to standard brokerage accounts, which indicates its improbable you’d be able to buy a house directly with a 401(k).
The access to alternative assets allows investors to diversify their retirement portfolio, spreading their savings across a variety of industries generally uncorrelated with Wall Street products. Since your funds will seemingly be allocated in areas outside of stocks, bonds, and mutual funds, the entirety of your retirement savings will not be reliant on the ever-changing tides of the stock market. This is likely to result in an overall reduction of risk. In conjunction, Self-Directed IRAs are tax-advantaged environments, letting your gains grow tax-deferred (Self-Directed Traditional IRA) or tax-free (Self-Directed Roth IRA).
The Alternate to Buying a House with a 401(k)
It’s feasible that you’ve accrued a pretty penny within your 401(k) and want to utilize those funds for the majority of your investments. Though your 401(k) cannot partake in alternative investing, you can still take these accumulated funds and place them in a Self-Directed IRA. An efficient way to achieve this is by rolling over money from your 401(k), into a Self-Directed IRA.
Where to Begin with Your Self-Directed IRA
If you were originally looking to buy a house with a 401(k), there’s no better time than the present to start your self-directed journey. It’s essential that you find a Self-Directed IRA custodian that instills faith and confidence in you regarding their abilities. Custodians are legally required to oversee your SDIRAs per IRS rules and regulations. You’ll want to ensure your custodian is highly knowledgeable on IRS codes and a variety of asset classes.
Additionally, it’s encouraged that you heavily investigate your prospective custodian’s online presence. Comb through reviews and skim through their educational materials. Your custodian should be able to provide a plethora of resources to help you make educated decisions, as you will be the sole manager of your account.
Rolling it Over: Buying a House with 401(k) Fund
The first step in rolling over funds from your existing 401(k) to your new Self-Directed IRA is to check with your current plan administrator to see if you’re eligible to move your funds.
Choosing to perform a direct rollover merely involves your funds being moved from your retirement account – in this instance, your 401(k) – directly to another type of account (Self-Directed IRA). The beauty behind this approach is no taxes will be due, and you can proceed on purchasing your investment property with your SDIRA.
Despite this, the institution that is sending your 401(k) funds will need to report this procedure by filing an IRS Form 1099-R. Furthermore, your Self-Directed IRA custodian must file IRS Form 5498, and you will have to make note of this rollover on your tax return.
Your other choice is an indirect rollover, also referred to as the 60-day rollover. Initially, the funds from your 401(k) will be distributed directly to you. Then, you have 60 days to place the funds in your newly established Self-Directed IRA, or you face relevant tax consequences. This may possibly signal a need for tax withholding, typically resulting in 20% of your distribution amount being sent to the IRS by your plan administrator. This happening is usually dependent on the account owner’s tax bracket and the type of distribution.
The Method of Buying a House with a Self-Directed IRA
Creating a Self-Directed IRA is straightforward, and possibly simpler than your expectations. Madison Trust has developed a three-step process for anticipating investors to walk through:
- Open - Open a Self-Directed IRA with Madison Trust by completing our easy online application.
- Fund – Fund your SDIRA by transferring or rolling over all – or a portion – of your funds from an existing retirement account, such as an IRA or 401(k), or by making an initial contribution.
- Invest – Instruct Madison Trust to send your IRA funds directly to your investment.
Subsequently, you’ll be purchasing your investment property with the funds from your 401(k), through a Self-Directed IRA. This is seldom performed in ways besides rolling over funds. There are two rollover options to choose from.
Purchasing an Investment Property with Your SDIRA
Now that you’ve rolled over your 401(k) funds to your Self-Directed IRA, there are a few different ways in which you could place your investment. One method is instructing your Self-Directed IRA custodian to send your IRA money to fund your real estate investment. You can choose to have your SDIRA custodian send an earnest money deposit (or EMD) and then fund the remaining balance, or you can instruct your custodian to fund the full purchase.
Perhaps you foresee yourself becoming an avid real estate investor, purchasing multiple properties. If this is the case, you may want to upgrade your Self-Directed IRA with the supercharged power of checkbook control. Transforming your SDIRA to an IRA LLC or IRA Trust will garner immediate access to your funds so that you can perform your everyday transactions without the involvement of your custodian. Moreover, this will lead to an avoidance of transaction fees.
If you’re keen on real estate investing but want to behave in more of a passive role, you may find private Real Estate Investment Trusts (REITs) suitable. These are essentially large-scale, income-producing properties that come with an arranged supervisor. These are generally reserved for residential or commercial properties. By investing in private REITs, you can obtain a piece of the action without any direct management on your behalf.
If you want a bit of help with your purchase, you may be enticed by the idea of taking out a loan. This is administratively possible, so long as you acquire a non-recourse loan. In the event of default, your SDIRA will be responsible for providing collateral through the purchased property, as opposed to you personally guaranteeing the loan. Securing another kind of loan will likely result in a prohibited transaction.
When Accompanied by a Self-Directed IRA, You Can Buy a House with a 401(k)
Though a 401(k) cannot purchase any type of real estate directly, you can metaphorically buy a house with a 401(k) by rolling over your funds to a Self-Directed IRA.
If you’re seeking a tool that permits investing in alternative assets, SDIRAs make an optimal choice. Schedule a discovery call with one of our Self-Directed IRA Specialists today. They’re readily available to educate you on your funding options so that you can begin your self-empowerment through self-direction.
