If you have an employer-sponsored 401k retirement plan, which is a retirement savings that employers often contribute towards, you may want to know if you can invest that in real estate. 

Investing in real estate property is attractive for various reasons. Many people choose to invest in property as a way to diversify their assets and investments to spread their risks and maximise their returns on investment. A diversified investment portfolio can mean having a mix of cash, bonds and stock, real estate and other assets like cryptocurrencies and precious metals. 

People weary of stock market fluctuations and associated risks, often feel more comfortable and safe investing in property and the real estate market. This could take the form of land, a residential property, a commercial property, an apartment or condo, a duplex, or even a mobile home.  But there are many reasons that prevent people from purchasing real estate. This may be because they don’t have the personal funds available, or that they don’t realize that they can use retirement accounts in the form of their 401k or self-directed IRA to leverage the money needed to buy property.

And many people who have an employer-sponsored 401k plan don’t realize that there’s a way to save for your retirement while at the same time investing some of your 401k savings in real estate. 

If you are currently employed and you have an employer-sponsored 401k plan, then you probably can’t directly invest in real estate. There are many rules that apply to 401k savings that you will need to follow. However, there are some options available which we explore below in more detail.

Of course, like with any investments, there is an element of risk and therefore you should consult your tax accountant, attorney, and financial advisor for the best options to suit your needs. Careful planning is needed, based on your financial situation and retirement funds, the size of your retirement account, the investment income you plan to generate from the real estate purchased, and a range of other factors.

How to invest 401k in property

There are a few options that allow you to use your 401k funds to invest in real estate. You typically can’t directly invest a 401k in real estate, but the following provide possibilities for using your funds to invest in property.

Take out a loan against your 401k

While you can’t typically use your 401K to directly invest in property, you could take out a loan against it (as long as your plan allows that), which you could then use to buy property. You can usually borrow up to half the value of your 401k account (up to $50,000) and the loan will usually be secured by the property you are buying. You’ll then normally have to repay the loan within 5 years, plus interest. 

If you withdraw money early from your 401k then there are usually penalties to pay, but if you take out a loan then you can avoid those. The interest that you owe on the loan amount is then paid back into your account, not to the bank which is a benefit.

Withdraw your 401k funds to purchase investment property

If you are still employed, another option would be to cash in your 401k funds which you could then use for a cash purchase on a property or for a down payment on a mortgage. However, that will usually incur a 10% early withdrawal fee (If you are younger than 59½) and you will be liable for income tax on the withdrawal. You also won’t be permitted to pay that money back into your 401k account at a later stage, which means you will not benefit from tax-free savings.

Use a hardship withdrawal from your 401k to buy a primary residence

You may be permitted to withdraw $10,000 as a ‘hardship withdrawal’ from your 401k if you’re under 59½ years in age, and if you’re buying your first home or principal residence (not a real estate investment property). The decision on whether to allow this, is up to your individual plan administrator and you would need to show evidence of hardship. 

If you are permitted to do this, you could then avoid the 10% early withdrawal penalty that usually goes with the early withdrawal of funds. However, you will need to pay income tax on that withdrawal. Furthermore, you usually can’t pay the money back into your 401k at a later stage – but you can keep paying into your 401k account. 

Roll funds from your 401k into a self-directed IRA

You could alternatively roll the funds in your 401k into a self-directed IRA and then you would be free to invest in property. You will first need to check that your 401k plan allows you to transfer it to a self-directed IRA. There are also various rules that govern self-directed IRAs which you will need to be aware of.

If you invest in real estate as part of your self-directed IRA, then there are also certain rules that apply to that investment. Some of the restrictions imposed mean that you can’t live in the property and you can’t actively manage it – you’ll have to hire an independent third party to manage it. And any revenue generated through the property has to flow back into the IRA.

Roll funds from your 401k into a Roth IRA

You could also opt to roll over your 401k funds into a Roth IRA, and you could then use those funds to purchase a real estate rental property. However, you will need to pay some income tax when you transfer the money to the Roth IRA, but you won’t owe taxes on the whole amount after you retire.

There are rules about how much money you can withdraw from a Roth IRA, depending on how long you’ve had the account. But you could withdraw up to $10,000 without paying a 10% early withdrawal penalty if you’re making a first time home purchase. 

Buy through a real estate investment trust (REIT)

Instead of directly investing in a property, you could purchase shares in a real estate investment trust (REIT), which is similar to buying stock on the stock market. These shares can then be easily bought and sold, making it easy to liquidate your investment if and when needed. 

The pros and cons of real estate investments

There are many pros and cons to real estate investments. On the one hand, real estate allows investors to diversify their investments and it can also have good growth. On the other hand, there can be unforeseen defects and problems that arise with the property itself that can be costly to fix, and you can also have problems with tenants not paying rent. There’s also the risk that outside factors or natural events (like sea level rise for a coastal property) may cause your property to de-value over time. 

If you purchase real estate through your 401k or self-directed IRA, there are also some specific pros and cons you should be aware of, which we look at below. 

Pros and cons of buying real estate with your 401k

The benefit of buying a real estate property with a loan against your 401k account, is that the loan is tax-free. And any rental income you earn will also be tax-free and will automatically go back into your 401k which you can access when you retire. And there’s no early withdrawal penalty when you take out a 401k loan. Furthermore, there’s no income tax that you have to pay on the amount that you withdraw. 

The drawbacks of buying property through your 401k is that there’s a lot of paperwork involved, you can’t actively manage your property, you can’t typically access any interest as it flows back into your 401k, and there can be large penalties if you don’t repay the loan on time. There are also some other drawbacks – if you lose your job or change jobs, then you may need to pay back the loan sooner and if you don’t then there could be large penalties to pay. And, depending on your particular plan, you might not be able to contribute towards your 401k until you’ve repaid the loan.

The pros to withdrawing your funds from your 401k to buy property is that you can then invest them as you like and there are no restrictions – however the negative side is that this could be risky and your retirement savings could be jeopardised. Furthermore, you lose out on the benefits of compound interest and tax-free savings with your 401k, as well as possibly having your employer contribute towards your retirement plan.

The pros to being granted permission to withdraw funds for a ‘hardship withdrawal’ is that you may really need to buy a property to live in and this may be one of the only sources of funds that you have to enable you to do so. The negative side to this is that you then need to pay income tax on the amount and you can’t later put the money back into your 401k.

Pros and cons of buying real estate with your IRA

The benefit of buying real estate property with your self-directed IRA funds is that any rental income and capital gains tax implications are deferred until you start drawing income from your IRA. And in the meanwhile, your property value may appreciate. 

A drawback is that when you withdraw funds from your IRA to invest in property, you have to pay income tax on the distribution. 

Real estate, rental income and how to purchase real estate

As outlined above, there are many options in terms of buying real estate with your 401k funds and investing in properties that provide rental income. 

But whether or not this is something that you should do, depends on your personal financial situation and your financial goals. It’s important to get advice from professionals to make sure that you make the right decision. 

FAQs about 401k funds and real estate

How do I invest my 401k in real estate?

As mentioned above, you can take out a loan against your 401k and then use those funds to buy real estate. 

If you change jobs or you are retired, then you could roll the funds in your 401k into a self-directed IRA (as long as your 401k plan allows that) and then use those funds to purchase real estate. There are still certain rules that you will have to comply with in this regard.

Or if you prefer to invest your self-directed IRA in property shares, you could do so through a real estate investment trust (REIT).

Can 401k funds be used to invest in real estate?

Most 401k plans prohibit you from directly investing in real estate, so if you are keen to buy property, then you will need to look at either taking a loan against your 401k to invest in property or at rolling your 401k funds into a self-directed IRA (if your plan allows for that). If you satisfy the requirements, you may also be able to apply for a ‘hardship withdrawal’ of funds from your 401k to buy a principal residence.

Is it better to invest in 401k or real estate?

Saving for retirement is important and that’s why many employers offer a 401k plan to their employees. Most 401k plans don’t allow people to invest directly in property, but because property can be a good investment and can also help you to diversify your portfolio, many people wonder whether it’s better to invest in their 401k or in real estate. 

However, it doesn’t need to be a choice between the two – under certain circumstances you can actually do both. As outlined above, you could either take a loan against your 401k that you then invest in real estate, or you could roll your 401k funds into a self-directed IRA that you then use to invest directly in property or more indirectly through a REIT.

But if you are still employed and if your employer also contributes towards your 401k, then if you cash it in early or stop investing in it, then you may lose the opportunity to grow your savings with your employers’ contributions. This is something you should carefully consider before cashing in or taking a loan against your 401k.

Can you buy real estate in a self-directed 401k?

If you are self-employed or you own a small business and you’re the only employee, then you may have a solo 401 k (also known as a self-directed 401k). These generally offer more options and freedom to invest in different assets compared with a traditional 401k. And this includes real estate (as long as the plan’s rules allow for that). However, if you do invest in real estate then there are rules that apply – for example, you can’t live in the house that you buy or rent it to relatives. 

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