By: Daniel Gleich
Key Points
- Those hoping to partake in real estate investing may consider cashing out their 401(k) to buy a rental property. Doing so may trigger certain taxes.
- Since you cannot purchase a rental property directly with your 401(k), rolling over your 401(k) funds into a Self-Directed IRA (SDIRA) can garner access to these funds without losing your hard-earned savings to withdrawal fees.
- A Self-Directed Roth IRA may serve as the ultimate realty investing tool. It will allow all rental income to develop in a tax-free entity.
Real estate investing glistens with appeal – with its potential for steady returns, those enticed tend to succumb to the bait. Between the massive rise in Airbnb and vacation rentals, many who’ve spent years growing their 401(k)s have concluded they’d like to use their savings to buy a rental property. The IRS inhibits 401(k) holders from purchasing real estate directly with their retirement plans. This has equated to some contemplating if they should cash out their 401(k) to accomplish this rental property goal. If you’ve found yourself pondering if this is the most efficient manner you can conquer such an ordeal, consider reading on.
Buying a Rental Property with a 401(k): Is it Possible?
No, it’s not possible to invest in real estate directly with a 401(k). If you cash out a 401(k) to buy a rental property, you’re likely going to trigger taxes. Furthermore, if you’ve not yet reached the age of 59 ½, you would acquire a 10% penalty on top of the tax. The fine print also reveals that what you withdraw from your 401(k) will count as part of your income when the time arrives to file your annual taxes. This might place you in a higher tax bracket altogether, which can possibly cause complications.
The purpose of establishing your 401(k) is to provide the future you with a cushion and sense of security during your retirement. While the rewards of real estate investing are intriguing, it does come with possible risks. It’s considered best practice that prior to embarking on any real estate investment, you perform thorough due diligence and consult with a financial advisor. Whether withdrawing your 401(k) funds qualifies as the best option can only be answered by you and those aware of your monetary specificities.
Where Does That Leave 401(k) Holders Ready to Buy a Rental Property?
If you feel as though you’re in an agreeable position and are ready to dive into potential property prosperity, there is another alternative. By demonstration, choosing to roll over funds from your 401(k) into a Self-Directed IRA (SDIRA) can be a remarkable route. Through this process, you’re avoiding penalties and taxes. Additionally, you’ll be able to buy a rental property directly through another retirement savings vehicle, thereby helping your nest egg blossom further.
You can opt to perform either a direct rollover or an indirect rollover to place your funds into your SDIRA. A direct rollover is simply the act of your 401(k)-provider moving over all – or a portion – of your funds into your Self-Directed IRA. Your newly formed account will be administered by your Self-Directed IRA custodian.
An indirect rollover (or 60-day rollover) occurs when the allotted funds from your 401(k) plan are originally distributed to you directly. It is then your responsibility to ensure that these funds are placed in your Self-Directed IRA within 60 days. If this is not achieved in this time frame, the outcome will result in fees owed. An indirect rollover is generally only permitted to occur once a year.
The first step in rolling over 401(k) funds to an SDIRA is to contact your current plan administrator. They will determine if you’re able to rollover your funds. If the 401(k) is with a past employer, you will likely be able to roll over your funds. If the 401(k) is with a current employer, you may not be eligible to roll over funds, depending on the plan’s rules.
Recognize the Roth Rewards
When creating a Self-Directed IRA, you’ll be building a retirement account centered around tax advantages. As the creator, you’ll decide if you’d like your gains to develop tax-deferred or tax-free by the type of Self-Directed IRA you establish. Generally, when rolling over 401(k) funds to buy a rental property, Self-Directed Traditional IRAs are usually better if you believe your tax rates will be lower during your retirement, letting you reap the full potential of tax-deferment. As we typically strive to be of a higher tax bracket in our later years, the Self-Directed Roth IRA makes a prime selection for most.
Self-Directed Roth IRAs require that all taxes are paid upfront upon creation. Since 401(k) funds are usually pre-tax contributions, you may be required to pay taxes on the money you rollover. The benefit of this is that any income you accrue from renting out your investment property will bloom entirely tax-exempt. Subsequently, your Self-Directed Roth IRA can qualify for distributions after it’s been in existence for five years from the date you first contributed and if you’ve reached the age of 59 ½. If any future predicament arises where cash is needed, this will make it easier to resolve.
Conclusion: Buying a Rental Property with a Self-Directed IRA
For real estate investing, Self-Directed IRAs reign as supreme retirement accounts. Unlike a 401(k), a SDIRA can directly invest in property as well as a collection of alternative assets such as precious metals (Gold IRA) or small businesses. Since alternative investments are generally uncorrelated to Wall Street products, a Self-Directed IRA will behave as a mobilizer for your retirement portfolio, aiding in diversification. This can help mitigate risk and possibly safeguard against inflation.
As real estate is tangible, opting to buy a rental property typically stands the test of time. Rarely does a property or raw land lose all it's worth. Rather, this investment tends to generate stable and persistent returns which can make planning and budgeting for the future smoother.
At the Helm of Your Retirement
When it comes to retirement, you might want to take the reins and build your future as you deem fit. Self-Directed IRAs grant control to their account holders. You have the potential to exceed your wildest expectations by investing in what you know and believe in. Schedule a free discovery call with our Self-Directed IRA Specialists today. Start self-educating so you can self-direct your retirement.
