How to Use Your 401(k) to Invest in Real Estate

Most 401(k) plans invest in mutual funds, stocks, bonds, and other financial instruments, but you can also use these funds to invest in real estate. Real estate investing can diversify your retirement savings and potentially boost returns. To invest in real estate with a 401(k), you need to follow specific rules and choose the right type of 401(k) plan. 

A financial advisor who specializes in real estate investments can work with you to identify investments and manage them.

401(k) plans are employer-sponsored retirement accounts that allow employees to contribute a portion of their salary on a pre-tax or, in the case of a Roth plan, post-tax basis. 

Most employer-sponsored 401(k) plans are limited to traditional investment options like stocks, bonds and mutual funds, and they generally do not allow for direct investment in real estate.

If you want to invest directly in individual REITs or more specialized real estate assets, you would need a self-directed 401(k) plan, which would offer you greater flexibility in choosing specific investments beyond the typical options that are provided by most 401(k) plans.

Another option for real estate investing with a 401(k) is with a self-directed 401(k) plan, which may be available through a solo 401(k) or individual 401(k). These plans are designed for self-employed individuals or small business owners with no full-time employees other than themselves and their spouses. However, even if you only generate a portion of your income from self-employment, you can set up a solo 401(k).

To set up a self-directed solo 401(k), you’ll need to establish the plan with a provider that offers self-directed options, as not all financial institutions will support real estate investments within a 401(k). Once the account is established, you can make contributions almost exactly as you would any other 401(k) plan. One positive difference is that total contribution limits for a solo 401(k) are typically higher than those for traditional 401(k)s (as you contribute as both the employee and the employer)..

With a self-directed solo 401(k), you can use the funds to invest in various types of real estate, including rental properties, commercial real estate, land and even tax liens. However, it’s important to understand the rules and regulations governing these investments. 

For example, the IRS prohibits certain transactions within a solo 401(k), such as purchasing a property for personal use or transacting with disqualified persons, including yourself and certain family members.

When using a solo 401(k) to invest in real estate, you must also ensure that all income and expenses related to the property flow through the 401(k) account. This means that you cannot take any of the income for personal use. All income must be returned to the 401(k). You can still withdraw the money later to fund your retirement later on.

Similarly, any related expenses must be paid from funds that are in the solo 401(k) to avoid penalties and maintain the tax-advantaged status of the account. This includes expenses for insurance, property taxes, repairs, maintenance, management and so on. If the IRS determines that a prohibited transaction has taken place, the account immediately loses its tax-advantaged status with all of the money in it becoming subject to taxes and penalties.

Investing in real estate through your self-directed 401(k) offers several benefits that can enhance your retirement portfolio:

• Diversification: Adding real estate to your self-directed 401(k) portfolio can provide diversification, reducing your reliance on traditional stocks and bonds. Real estate often behaves differently from other asset classes, offering a hedge against market volatility.
• Tax advantages: Like other 401(k) investments, real estate investments made through a self-directed solo 401(k) benefit from tax-deferred growth. This means that income and gains generated by your real estate investments grow tax-free until you begin making withdrawals in retirement. Withdrawals then will be taxed as ordinary income, but you’ll owe no capital gains tax if properties appreciate.
• Potential for high returns: Real estate can offer significant returns through property appreciation, rental income, and other revenue streams. By using your self-directed 401(k) to invest in real estate, you can potentially achieve higher returns than those available through more traditional investments.
• Control over investments: A self-directed solo 401(k) allows you greater control over your investment choices, including the ability to select and manage your real estate investments directly. This level of control can be appealing for experienced investors who want to take a hands-on approach to their retirement savings.

Investing in real estate through a 401(k) could help diversify your retirement portfolio and potentially offer higher returns. Some 401(k)s will allow you to invest in real estate through REITs, if they are included in your mutual fund or ETF investment options. But, if you have a self-directed solo 401(k), you might be able to invest in more real estate options.

• If you want to use your retirement plan to invest in real estate, a financial advisor could help you determine the benefits and risks for your finances. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now. 
• No matter how you invest the funds in your 401(k), you can use SmartAsset’s 401(k) calculator to project how your account balance will look in the future.
• If you want to know how much your retirement savings could grow over time, SmartAsset’s free retirement calculator could help you get an estimate. 

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