How to Use a 401(k) for Real Estate Investing

By Peter A. Elwell, CFA | January 29, 2024

City Buildings

Have you ever considered diversifying into real estate but aren’t exactly sure how? Several avenues enable investors to break into the real estate market while using the assets or accounts they already have. A prime example is a 401(k). Many people have this type of employer-sponsored or self-directed retirement savings account but may not know its full growth potential.

Depending on your plan type, you may be able to transfer or convert your employer-dependent 401(k) account assets into a self-directed 401(k) that is eligible for real estate investing. Some employer-sponsored 401(k) plans may offer a self-directed option, but the investment options are usually limited.

Consider this strategy if you’re looking for a way to hedge against inflation and market volatility without becoming a hands-on landlord. This guide covers the rules and requirements for using a 401(k) to invest in real estate so you can decide if this strategy can help you meet your financial goals.

What Is a 401(k)?

A 401(k), named after Section 401 of the tax code, is a retirement account an individual receives from their employer. If you sign up for a 401(k), you agree to have a portion of your paycheck deposited directly into the account for retirement. A 401(k) allows individuals to contribute to the savings account and choose from various investments with those contributions, such as exchange-traded funds (ETFs) or mutual funds. There are annual contribution limits for 401(k)s. For 2023, the limit is $22,500 for people under 50 or $30,000 for those over 50.

A 401(k) provides account holders with special tax benefits, such as a tax break on contributions and capital gains. Some employers deposit money into your account based on how much you contribute, known as 401(k) matching. The specific benefits and options vary based on the type of 401(k) plan you have and the contributions you make, which we discuss in detail later.

Types of 401(k) Plans

Several types of 401(k) plans are available for both employed and self-employed individuals. Before rolling over your funds into real estate or using other alternative investment strategies, remember that your individual account may vary depending on your employer and specific plan. Here are the most common types of 401(k)s:

  • Traditional 401(k): Contributions to this plan are deducted from gross income or before income taxes are calculated. This account allows you to reduce your taxable income and take a tax deduction for that tax year. You only pay taxes when you start taking withdrawals at age 59 ½, and these withdrawals are taxed as regular income.
  • Roth 401(k): Unlike a traditional 401(k), a Roth 401(k) requires individuals to make contributions with after-tax income. Although there is no immediate tax break, you will not have to pay additional taxes on distributions as long as you take them during retirement.
  • Safe Harbor (401k): This type of plan operates similarly to a traditional plan, except employer 401(k) matching is required. This means employers must contribute to an individual’s account regardless of their title, compensation, or length of service.
  • SIMPLE 401(k): The Savings Incentive Match Plan for Employees, or SIMPLE 401(k), is generally used by small businesses or start-ups with a small number of employees. Employers are required to make fully vested contributions with this type of plan. Employees and employers make contributions with pre-tax dollars.
  • Solo 401(k): Only self-employed individuals or business owners without full-time employees can use this type of 401(k), which enables the investor to maximize retirement contributions and business deductions by making contributions as an employer and an employee.
  • Self-directed 401(k): This type of plan enables individuals to invest in a broader set of assets beyond pre-approved mutual funds, stocks, and bonds with pre-tax retirement contributions. Investors can invest in real estate, tax liens, commodities, and other alternatives. A self-directed 401(k) is subject to the same contribution and withdrawal rules as a traditional 401(k).

Ways You Can Use Your 401(k) to Invest in Real Estate

A self-directed 401(k) allows the most flexibility for various real estate investments.

To invest in real estate through your 401(k), you must have a specific plan type. A self-directed 401(k) allows the most flexibility for various real estate investments, such as real estate syndications and rental properties. Though investing in real estate with a traditional 401(k) or solo 401(k) is possible, your options may be more limited.

If you don’t already have a self-directed 401(k), you’ll have to rollover your assets from your current 401(k) into this type of plan. This process usually takes several weeks to complete and requires a custodian who will allow you to invest in real estate property. Every custodian will have a unique process for signing.

A self-directed 401(k) provides several investment opportunities, including private loans and limited liability companies. However, investing in real estate may offer higher returns and a more predictable cash flow that better meets your financial and life goals. For instance, you might invest in a commercial property that rents out to businesses or a residential property such as a rental home.

With these investments, you may receive stable returns while gaining appreciation in your properties over time. Once your self-directed 401(k) is all set, you’re ready to create a real estate investment portfolio that suits your retirement goals. Investing in real estate with a 401(k) can give you more control over your investments and allow you to explore various opportunities. 

Benefits and Risks of Using a 401(k) for Investment Properties 

Before rolling a 401(k) into real estate investments, you need to understand the possible advantages and drawbacks of this strategy.

One main benefit of using a 401(k) for real estate is that you can access tax-free and penalty-free loans on withdrawals. Compared to traditional loans, 401(k) loans generally have lower interest rates, making them a more appealing option for financing. Additionally, you might have more control over your repayment schedule and loan terms, allowing you to tailor your investment strategy to your needs.

When you purchase an investment property with a 401(k), you will not be taxed on the funds you receive as a loan if you pay back the loan according to the terms. Additionally, income generated from the rental property is deposited directly into your retirement account to access in the future. This can be an ideal strategy for individuals who want to generate passive income. Finally, diversifying into real estate enables you to accelerate your portfolio growth and increase your buying power as an investor through the equity you can build in the investment property.

As with any investment, however, there are several potential downsides. Firstly, investing in real estate using a 401(k) requires significant planning and paperwork if you plan to take out a loan. You’ll need to keep detailed records of all documentation. Secondly, if you make a mistake on your paperwork or fail to meet the 401(k) real estate investment rules, you may disqualify your tax-deferred benefits. You will want to consult with your own tax professional before investing in real estate using your 401(k) to make sure you understand all the implications.

Finally, if you fail to repay the loan taken out against your 401(k) within the required window, your loan may be subject to a withdrawal penalty and taxed as ordinary income. As with any investment, be sure to consult with your tax professional to determine your eligibility.

Unlock Investment Opportunities With 1031 Crowdfunding

Choosing an appropriate investment strategy that aligns with your financial situation and goals can be challenging. Consider using your 401(k) to diversify your portfolio and access real estate opportunities and passive income if you’re eligible. At 1031 Crowdfunding, we can help you identify alternative investment solutions that fit your goals.

Our extensive marketplace of vetted real estate properties and 401(k) eligible investment offerings makes finding the right investment for your portfolio easier. Register for an investor account today to learn more about how we help our clients.

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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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