Should You Hold REITs in a Roth IRA?

By Thomas P. Roussel | December 18, 2023

Discussing holding REITs in and IRA

When you invest, diversifying your portfolio can help you offset wide swings in certain sectors and enable you to hedge against market risk. If your current portfolio heavily consists of stocks and bonds, you can achieve this diversity through real estate investments in a Roth IRA. While you may not instantly think of holding real estate in a retirement account, it can be an ideal opportunity for certain tax advantages and more stability. 

One way to invest in real estate is with a real estate investment trust (REIT) within your Roth IRA account. By buying shares in a company that owns one or various property types, you can receive dividends and other benefits without having to buy or manage the property yourself. 

If you’re unfamiliar with REITs and Roth IRAs, this beginner’s guide can help you understand how it works and the potential benefits and drawbacks of REITs in IRA accounts.

How to Use Your Roth IRA to Invest in REITs

A Roth IRA is a popular choice for individual retirement savings that allows contributions to grow tax-free. In a Roth IRA, qualified withdrawals are also tax-free, making them ideal for many individuals. Investors can also withdraw their contributions to a Roth IRA at any time without incurring any penalties, though there is a penalty for withdrawing earnings before age 59 ½. Though there is no minimum requirement for contributions, there is a $6,500 annual limit to Roth IRA contributions — or $7,500 if the investor is 50 or older. However, this amount is subject to income limits. People whose income is over a certain limit cannot contribute to Roth IRAs or can only contribute reduced amounts. The limits vary based on the taxpayer’s filing status.

After opening this account, investors can choose to invest the money in various interests, such as stocks, bonds, mutual funds, exchange-traded funds (ETFs), or REITs. A REIT is a company or institution that buys and manages income-producing properties and assets, such as:

  • Senior housing and other healthcare facilities
  • Apartment buildings 
  • Medical facilities 
  • Retail centers 
  • Warehouses
  • Hotels

Investors can buy shares of a REIT and become shareholders. However, the shareholders aren’t responsible for taking on the individual risks and tasks associated with the day-to-day management of the properties as landlords. Every year, shareholders receive a minimum of 90% of the REIT’s taxable income as dividends. 

If an investor is looking for a relatively simple way to invest in real estate through their Roth IRA, a REIT may be the ideal solution. Both share distinct tax benefits that can become even more fruitful when combined. Investing in REITs through a Roth IRA is a fairly straightforward process — you buy REIT shares as you would with any other investment sold on a securities exchange.

As with all investments, you’ll want to consider this strategy carefully. When it comes to investing in REITs, using a Roth IRA can be more tax efficient than a traditional IRA because investors pay taxes on the money they contribute and not what they take out later, assuming they follow the Roth IRA withdrawal requirements.

This setup means you can avoid taxation down the line because you’ve already paid upfront. Your current tax bracket and projected retirement tax bracket can impact these advantages — you’ll get the most benefit if you expect to be in a higher tax bracket in retirement than you are now. Generally, the favorable tax treatment you receive through your shares in a REIT should be amplified by using a Roth IRA. Ultimately, it depends on whether you prefer to pay your taxes now or later.

Typically, REIT dividends are taxed individually as ordinary income, but you can avoid the tax burden if your investment grows within a Roth IRA.

Benefits of Investing in REITs Through Your Roth IRA

If you decide to pursue REIT investments in your Roth IRA account, you may experience several advantages. First, you benefit from tax-advantaged growth — the dividends you receive will not be taxed since they are in a Roth IRA, which you fund with money you already paid taxes on. You can withdraw funds from your Roth IRA without paying taxes. However, if you withdraw funds before age 59 ½, you may be subject to a 10% early withdrawal penalty.

Typically, REIT dividends are taxed individually as ordinary income, but you can avoid the tax burden if your investment grows within a Roth IRA. Investment earnings are tax-free in a Roth IRA – including REIT dividends — so you may end up keeping significantly more of your earnings than you would with a REIT alone.

The dividends are also a benefit in and of themselves, as they can serve as a source of recurring income. Because REIT dividends are generally more liquid than physical real estate, you can access your capital more quickly and easily while in retirement. Depending on the circumstance, REIT dividends may even outperform stock market dividends.

A major benefit of investing in a REIT is that it can help you reduce overall investment risk. Since a REIT allows access to the real estate market without having to invest in a property directly, you can diversify your portfolio and balance out your investments instead of just keeping them in one asset class.

Considerations and Potential Risks for REIT Investments in a Roth IRA 

As with any investment, weighing the risks and benefits is always wise. When investing in REITs, one of the first things you’ll want to consider is how much you want to invest in the REIT you choose. It’s usually recommended to avoid allocating too much of your investment portfolio to one investment if you want to maintain a diverse and agile portfolio and mitigate risk. If you shift all your funds to REITs because of the many benefits they can offer, you may lose sight of the diversification you originally aimed for.

Because your Roth IRA is your retirement savings fund, weighing your options carefully based on your needs and goals is critical. Every investment comes with a degree of risk, so getting the full picture can help you narrow down your choices and find one that’s suitable to your risk tolerance and needs. IRAs have their own considerations as well, such as early withdrawal penalties.

With a Roth IRA, in particular, you may be subject to a 10% penalty and income tax if you decide to take out earnings from the account before age 59 ½  and if the account is under five years old.

Recall that REITs are directly affected by the health of the real estate market, which means you could lose value if interest rates rise, resulting in less investment capital. This same risk could be exacerbated if you have a concentrated portfolio or choose a REIT that does not hold a diverse portfolio itself. For instance, if the REIT you choose solely invests in retail centers, it may be affected if a recession prevents people from shopping for more than necessities. 

Another consideration is to do your research and due diligence when it comes to deciding which REIT to invest in. There is always a risk that the company you choose may not perform well. With a real estate investment platform, such as 1031 Crowdfunding, you can view an online marketplace of vetted real estate offerings and understand more about the process to invest confidently. 

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Learn More About Investing in REITs With 1031 Crowdfunding 

Investing in REITs within your Roth IRA can help you achieve the real estate portfolio diversification you desire without increasing your day-to-day responsibilities. Owning shares in a REIT can also help your investments remain more stable in an otherwise fluctuating equity market while reaping the benefits of a tax-advantaged account like a Roth IRA. 

At 1031 Crowdfunding, we focus on helping our members meet their investment goals by providing access to various resources and opportunities for real estate investments. Our experienced and knowledgeable team is ready to help you make better-informed and more strategic decisions about investing using your retirement funds. To learn more about how we can help you build a diversified retirement portfolio, register for a member account with us today.

This material does not constitute an offer to sell or a solicitation of an offer to buy any security. An offer can only be made by a prospectus that contains more complete information on risks, management fees and other expenses. This literature must be accompanied by, and read in conjunction with, a prospectus or private placement memorandum to fully understand the implications and risks of the offering of securities to which it relates. As with all investing, investing in private placements is speculative in nature and involves a degree of risk, including loss of your principal. Past performance is not necessarily indicative of future results and forward-looking statements and projections are not guaranteed to achieve the results described and your actual returns may vary significantly. Investments in private placements are illiquid in nature and there may be no secondary market or ability to sell the investment should the need for liquidity arise. This material should not be construed as tax advice and you should consult with your tax advisor as individual tax situations will vary. Securities offered through Capulent, LLC Member FINRA, SIPC.

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